Feb 07

A few weeks ago, I talked about the end of estate planning. It might have been a bit of an over-reaction to the news that the estate exemption was made a permanent, inflation-adjusted figure of $5.25M for 2013. Perhaps I was jumping to conclusions as there are a number of reasons one may want a trust. More important, you may have done some advanced planning years ago when the $1M exemption wasn’t enough to keep your estate (death) tax free.

You may have discovered, however, that income retained within that trust is taxed at some pretty crazy rates;


This, as compared to a single filer that would not hit 28% until a taxable $85,650 or married couple filing jointly at $142,700. Fortunately, in 2013, there is still a long term capital gain rate, albeit a higher one,  20%, plus 3.8% if the trust is in the top bracket. Nearly 24% when the trust beneficiary may very well be in the 15% bracket.

How to navigate this? First, you need to consider whether the trust should retain all of its earnings or if the beneficiary is responsible enough to get this small distribution. In 2013, a child subject to the ‘kiddie tax’ can receive up to $1000 in unearned income and pay no tax. Additionally, the next $1000 is taxed at the child’s rate, likely 10%. If the trust assets are loaded with CDs earning interest, this may be tough, as interest is all taxed at the ordinary rate. Invested in the right mix of low dividend stocks would keep the need to distribute any income to a minimum.

Even with the generous estate tax rules currently in place, a trust can help your heirs avoid probate, and in case you have a child whom you fear would blow his inheritance on a weekend in Vegas, the trust can be used to provide an annual stream of income instead of a lump sum windfall.

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Jan 11

Not quite, but close to it for many taxpayers.

As part of the American Taxpayer Relief Act (ATRA) of 2012, a benefit you may appreciate has been slipped in, a ‘permanent’ fix to the estate tax issue. First, here ‘permanent’ simply means a provision that has no sunset date, no automatic falling off the tax forms. That said, let’s look at the estate tax, before and after, and why you should be concerned about this even if you are not a ‘one percenter.’

In 1998, the year our daughter was born, we bought life insurance. Since we both worked, and had similar incomes, we each bought a million dollar policy. This may sound like a lot of money, but we had a house with a mortgage, and college tuition 18 years hence, both of which would whittle this windfall down pretty fast. But. As I learned in 1999, estate tax would kick in for an estate over $650,000. So even if we had no other assets, our insurance of $2M would see $700K taxed as high as 50% if my wife and I should perish together. It gets worse from there. If I passed first, I could leave an unlimited inheritance to my wife, but then if she would die soon after, $1.35 (everything over $650K) is subject to estate tax. Off to see an estate attorney. Time to set up trusts. With a bit of financial smoke and mirrors, the insurance is purchased from small gifts given to my daughter through the trust. In other words, the insurance itself is not part of our estate. Back then, I’d have casual conversations on death and dying (I know, real ‘life of the party’ discussions) and I realized most people had no idea that if you own the insurance policy, it’s part of your estate when you die. So even a couple with a $500K policy each could be heading for an estate tax issue. Maybe not when the first person passes, but when the surviving spouse also passes and still owned all the assets from when they were both alive.

Enough history. ATRA (Bonus points – what does this acronym stand for?) provides some excellent estate tax details:

  • A $5 million per person exemption (indexed so 2013 should be $5.25M)
  • A top rate of 40% (kicking in on amounts over $1M taxable)
  • ‘Permanent’ portability. i.e. the surviving spouse adds on the exemption to her own estate, so a couple truly has a $10.5M exemption
  • The annual gift exclusion is $14K per person for the year, but the full estate tax exclusion may be tapped for lifetime giving as well.

If you are blessed with wealth over $10.5M, the $14K annual gift may not seem like much, but keep in mind it’s per giver/recipient combination. So, you and your spouse can give $56K per year to your child and spouse. You can also gift each of the grandchildren $28K. With a large enough family, the total can easily exceed $250K if you are looking to be that generous.

On a final note, you can see how, in 1998, with no clear understanding that the estate tax would take such a generous turn, it seemed the right thing to do a bit of extra planning. Today, we’d save the expense of a trust, and only have a will in place.

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Apr 20

Sometimes an example of a financial mistake is an easier way to deliver an important bit of advice than the usual soapbox lecture. Given the recent changes back to old style of estate taxes and the step up in basis the beneficiary enjoys, it seems timely to share this story with my readers.
The house is a four family, a small apartment house, purchased in the early 1940s when $4000 went a bit further than it does today. Owned by the grandmother, the four apartments are each occupied by family members. Well before the grandmother passed away, she quit-claims the property half to her son, the other half to her two daughters. This was the first mistake, in effect, the house was gifted, no paperwork filed, and no stepped up basis on her passing. To make matters worse, the son had since passed on, but not before transferring his half share to his daughter. His surviving spouse and daughter continue to occupy half the house, i.e. Two of the four apartments. The real issue has yet to surface. When the mom (surviving spouse) passes and the daughter wishes to sell her half along with the other relatives, there was never a step up in basis, and while she may be able to take the $250,000 exclusion on her 1/4 value she lived in, the quarter occupied by her mom is nearly all a capital gain. The current building value is about $800,000, so this woman is looking at a potential near $30,000 tax bill. Three chances to avoid it, all missed due to lack of knowledge and lack of good counsel.

As I was getting ready to publish this, I heard back from a fellow newsgroup reader;

It’s not as bad as it seems.  If the woman still lives there (or could) when she dies, §2036 says, “The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death—
“(1) the possession or enjoyment of, or the right to the income from, the property, or
“(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.”
Then under §1014 says that a recipient gets a stepped up basis “if by reason thereof the property is required to be included in determining the value of the decedent’s gross estate under chapter
11 of subtitle B….”

It was not the smartest thing to do, but it doesn’t have to be a problem, either.

So, in the end, it’s a matter for the tax guy for the beneficiary of the house. Hopefully he has his facts straight.

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Jul 30

Sometimes, a reader’s comment will be so insightful that it’s a shame to let it get buried in a comment section many may not see.  This is such a comment, by my longtime reader Elle. She also shares her knowledge at the Usenet group misc.taxes.moderated where I am one of the mods.

This ‘guest post’ by Elle is in response to my recent The State of the Estate Tax.

“The years immediately following the repeal of the
inheritance tax [in 1902] were witness to an unprecedented
number of mergers in the manufacturing sector of
the economy, fueled by the development of a new
form of corporate ownership, the holding company.
This resulted in the concentration of wealth in a
relatively small number of powerful companies and
in the hands of the businessmen who headed them.
Along with such wealth came great political power,
fueling fears over the rise of an American plutocracy
and sparking the growth of the progressive movement.
Progressives, including President Theodore
Roosevelt, advocated both an inheritance tax and a
graduated income tax as tools to address inequalities
in wealth.”

— From the IRS article The Estate Tax: Ninety Years and Counting.

Tax laws do not come about in a vacuum. Voters put people in Congress who make these laws. Presumably those in Congress consider arguments like the one above, along with what their constituents say. Many Christians (among others concerned about poverty) reject Dave Ramsey’s argument. Many would call his stance on this issue the immoral one.

All is far from perfect in our economy and the way government is addressing economic problems. I see a lot of resentment from the lower classes that is justified. I also see the lower income classes denying, at a stunning rate, they have any self-responsibility. These are the people at the bottom without whom economies cannot function. Capitalists do not quite get that you have to watch out for the little guy/gal or businesses will implode.

People are mad. I think things will get worse before they get better. When they do get better, it will be because people seek reason behind actions instead of resorting to “Gimme this; gimme that!” Eventually, people will come back to the realization that they get more of what they want–better stock dividends, better economic growth, more for you and for me–when we work together. It can be done in a capitalist society. It has been done in the past.

(Thanks, again, Elle. A great take on this issue)

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Jul 27

Even though I am not a baseball fan, I know who George Steinbrenner was, as he was someone a bit larger than life. As you might have guessed from the title, this post is not an homage to Mr. Steinbrenner, but a discussion of the current estate tax rules.

There was a time (seems like yesterday) when the estate tax exclusion was one million dollars, but that was back in 2002 and 2003, and the number was even lower in years prior. But along with the rising exemption came one strange anomaly in the code, a year with an unlimited exemption, no tax on the estate of anyone fortunate enough to die this year. This doesn’t mean his heirs get away with no taxes ever due. Along with the estate tax, the rule allowing a stepped up basis went away as well.

I know, this is a bit technical, so let me take a step back. To keep the numbers simple, if one died in 2002, and left, say $4,000,000 to his non-spouse heirs, the first $1M is tax free, and then the remaining $3M is subject to an increasing scale up to a 50% rate. So the heir would collect about $2.7M and their basis would be the value at the time of the decedent’s passing (or 6 months later whichever is higher). Under these rules, the decedent’s cost makes no difference. The $4M could have been stock purchased for  $10,000 (Don’t we all wish?) or cash from having sold something else and just paid the taxes.

With the 2010 rules, however, the estate gets only a $1.3M step up. So in our example, it makes a big difference whether that $4M is cash or if it’s stock that cost the decedent $10,000. Old rules allowed an unlimited spousal inheritance, new rules give Mrs. Steinbrenner an additional $3M step up. If the number I read are accurate, the Yankees were bought for $10M and the estate is worth $1.1B.

If the family sells their stake, capital gain taxes are due at the prevailing rates, this year, 15%, but expected to rise in 2011. Eventually, Uncle Sam will see some of his money.

So far, I’ve made no judgment, just offered some facts. I don’t know if there’s any structure that will be agreeable to all. There are those who feel the money has already been taxed along the way and the estate tax is a form of “double taxation.” Other feel that there’s too much money concentrated among too few people and somehow the estate tax will help to “level the field.” Objectively speaking, if that’s possible, I think the current rules help avoid the former concern as only gains not already taxed will be taxed eventually and only when the assets are sold. The risk that the “family farm” will have to be sold to pay taxes  when gramps dies is gone.

Personally, I can live with whatever structure there is, my only objection is these erratic changes over the years. You see, each set of rules requires its own planning. A fixed exemption of say, $1M, would point toward setting up insurance trusts to cover the tax on the overage. Note, this isn’t tax avoidance, it simply means if I know my estate will have a tax bill of $500K, I can choose to pay for some life insurance to pay that bill, and leave the full amount to my heirs. It’s the changing rules that cause more confusion and anxiety than anything. I’d bet not one in ten people you meet today can tell you what the rules are for those leaving a large inheritance this year. No, not one.

Even now, there’s talk of our congressfolk ‘fixing’ this year’s rules, and making it retroactive to January. We’ll see. We’ll also see what they do regarding the 2011 return to a $1M exemption.

Any thoughts on the Estate Tax? Fair? Not Fair? Let me know what you think or if you have any questions. By the way, my friends at the IRS have a nice little article titled The Estate Tax: Ninety Years and Counting which you can download.


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