The Not-So Transparent Corporate Transparency Act

As part of the National Defense Authorization Act for the Fiscal Year 2021, Congress enacted the Corporate Transparency Act (the “Act”). Beginning on January 1, 2024, the Act and final regulations issued thereunder require any “Reporting Company” to provide certain information about its “Beneficial Owners” and “Company Applicants.” Failure to report this information may result in civil and criminal penalties. The Act imposes the duty to report to the Financial Crimes Enforcement Network (“FinCEN”) on any Reporting Company.

The Act contains several definitions to help determine which entities must report thereunder. The Act defines a Reporting Company as any entity formed by a filing with a secretary of state or any foreign entity that’s registered to do business in the United States by filing with a secretary of state. This intentionally broad definition means that any corporation, limited liability company, limited partnership, or limited liability limited partnership, along with any other entity formed by filing a document with a secretary of state, will be subject to the duty to report. General partnerships, sole proprietorships, and trusts do not file documents with a secretary of state upon creation and thus are exempt from reporting. The Act exempts twenty-three categories of organizations such as banks, credit unions, depositories, and securities brokers and dealers, all of which are already highly regulated. The Act exempts both tax-exempt entities and large operating companies from its reporting requirements. The Act defines tax-exempt entities as (1) any organization described in Internal Revenue Code (“IRC”) Section 501(c)(3) that’s exempt from tax under IRC Section 5012(a)(2); (2) a political organization described in IRC Section 527(e)(1); and (3) trusts described in IRC Section 4947(a)(1) or (2). The Act defines a large operating entity as any entity that employs more than twenty full-time employees.

Although the Act excludes many entities from its application, most privately-owned businesses will qualify as Reporting Companies and will have to disclose the required information timely or be subject to penalties. Every Reporting Company needs to report its legal name, any names under which it does business, a principal business address, the jurisdiction of formation, its taxpayer identification number, and its Beneficial Owners. If the Reporting Company is newly created, it also needs to report the individual who filed the formation or registration document for the Reporting Company, called the “Company Applicant” and, if different, the individual “primarily responsible for directing or controlling such filing.” The Reporting Company will need to disclose the name, date of birth, street address, a unique identifying number from a passport, driver’s license, or another such document, and a copy of that document of each Company Applicant, limited to two individuals, to FinCEN. The Act permits individuals who anticipate being Company Applicants to register for a FinCEN number that such individuals will provide to the Reporting Company instead of their personal information. The Act separates Beneficial Owners into two categories: (1) those who exercise substantial control over the Reporting Company; and (2) those who own at least 25% of the Reporting Company. For a Beneficial Owner to meet either definition, the Reporting Company needs to disclose the same information required for that of a Company Applicant.

If an individual serves as a senior officer of the Reporting Company, has authority over the removal of a senior officer or a majority of the board of directors, directs, determines, or has substantial influence over important decisions of the Reporting Company, or has any other form of substantial control over the Reporting Company, then such individual exercises substantial control. The Act defines a senior officer as anyone holding the position or exercising the authority of a president, chief executive, financial, or operating officer, general counsel, or any other officer who performs a similar function. Note that neither treasurer nor secretary is included as the Act views those roles as ministerial in nature. However, if an individual serving in a ministerial role otherwise exercises substantial control, then such individual will need to be reported as a substantial owner.

If an individual has an interest in equity, capital, profits, convertible instruments, or options, that equals 25% or more of the entity, then the Act considers that individual an owner thereunder. The Act includes both direct and indirect ownership. Trust and Estate attorneys need to advise clients that the Act considers a trustee who can dispose of trust assets that include a Reporting Company as a Beneficial Owner of that Reporting Company. Similarly, the Act includes the sole income and principal beneficiary of a trust owning an interest in a Reporting Company as a Beneficial Owner of such Reporting Company. Any beneficiary with the ability to withdraw substantially all of the assets of a trust containing an interest in a Reporting Company will also be a Beneficial Owner of such Reporting Company.

The Act has some complex provisions that have broad applicability. This provides only a brief synopsis of the most relevant provisions.

What You Need to Know About The Secure Act 2.0

It might be appropriate to say that Christmas came early for retirement advisors and consumers in 2022 when Congress passed, and President Biden signed into law, the $1.7 trillion omnibus spending bill that included Setting Every Community Up for Retirement Enhancement (“SECURE”) Act 2.0 (the “Act”). President Trump enacted the original SECURE Act in December 2019, making radical changes to retirement planning by increasing the age at which a taxpayer could contribute to their Individual Retirement Account (“IRA”), creating a new class of beneficiary called the “Eligible Designated Beneficiary” (“EDB”), and eliminating the lifetime stretch for any beneficiary who is not an EDB and instead implementing the 10-year rule. For those needing a quick refresher, EDBs consist of surviving spouses, children who have not yet reached the age of majority, chronically ill or disabled individuals, and any other individual not more than ten years younger than the participant, or appropriately structured trusts for the benefit of those individuals. EDBs are the only beneficiaries exempt from the 10-year rule, which operated like the 5-year rule from pre-SECURE Act. Thus, under the 10-year rule, a non-EDB need not worry about Required Minimum Distributions (“RMDs”) and only needed to withdraw all funds by December 31st of the year of the tenth anniversary of the participant’s death.

That changed when the United States Treasury released much-anticipated proposed regulations updating, among other things, the rules regarding RMDs from IRAs. The proposed regulations backtracked on some of the published guidance by adding the requirement of lifetime distributions to any non-EDB in years 1-9 after the participant’s death if the participant died after his or her Required Beginning Date (“RBD”). Now, any non-EDB needs to take annual distributions based upon the beneficiary’s life expectancy over the nine years following the participant’s death and exhaust the IRA by December 31st of the year of the tenth anniversary of the participant’s death if the participant reached their RBD. Thankfully, the Internal Revenue Service realized that this represented a sharp departure from the advice that many advisors were giving their clients and promulgated Notice 2022-53 that confirmed waiver of any excise taxes resulting from failure to take RMDs in either 2021 or 2022 for those years. A taxpayer who fails to take the required RMD in 2023 will incur liability for the excise tax.

SECURE 2.0 continues to build on this foundation by extending, clarifying, and expanding provisions of the original SECURE Act. First, the Act increases the age at which the participant needs to begin taking RMDs to 73 beginning in 2023 and lasting until 2032, at which time the age increases to 75. Note that there seems to be an overlap for 2032 which likely will be resolved under technical corrections. These provisions affect anyone reaching age 72 after 2022. Individuals aged 50 and over may contribute an additional $1,000 to their IRAs. That amount will be indexed for inflation beginning in 2024. In addition, the Act boosts catch-up contributions for employer plans including 401(k), 403(b), 457(b), SIMPLE IRAs, and SIMPLE 401(k) plans, also indexing them for inflation. These provisions take effect in tax years beginning after December 31, 2024.

Interestingly, taxpayers will be able to use funds from Internal Revenue Code Section 529 Plans (“529 Plans”) for something other than qualified education expenses without income tax consequences. The Act allows taxpayers to convert up to $35,000 from a 529 Plan to an IRA. The Act imposes several restrictions on the 529 Plans allowed to take advantage of this rollover as follows: the Plan must have been maintained for 15 years prior to the rollover, the amount converted for a year cannot exceed the aggregate amount contributed to the 529 Plan in the 5 years prior to the rollover, the amount must move directly from the 529 Plan to the IRA, and the amount, when added to any other IRA contribution cannot exceed the contribution limit in effect for that year. This provision becomes effective for 529 Plan distributions after December 31, 2023.

The Act provided relief to taxpayers by changing the statute of limitations for two excise taxes, the excess contributions tax and the excess accumulations tax on an IRA. Under prior law, the statute for excess contributions or RMD failures started running on the date that the excise tax return was filed. Taxpayers were unaware of the requirement to file Form 5329 leading to an indefinite statute of limitation for the imposition of excise taxes. Under the Act, the new statute of limitations for RMD failures is three years and begins to run when the IRA owner files an income tax return for failure to take the required distributions. The new statute of limitations for excess contributions is six years and begins to run when the IRA owner files an income tax return. These new limitations periods became effective upon enactment of the Act.

As most readers know, owners of ROTH IRAs have no requirement to take distributions during lifetimes; however, participants in any of a ROTH 401(k), ROTH 403(b), or ROTH governmental 457(b) accounts all were required to take lifetime distributions. The Act repealed that requirement for distribution years beginning in 2024. This provides additional planning opportunities for taxpayers considering whether to keep assets in a designated ROTH account or to roll such accounts into their ROTH IRA. Now participants no longer need to consider RMDs during their lifetime and can focus on investment choices, expenses, and asset protection.

The Act allows a surviving spouse to elect to be treated as the deceased employee for purposes of the RMD rules, effective beginning in 2024. A surviving spouse making such an election would begin RMDs no earlier than the date the deceased participant would have reached their RBD.  If the surviving spouse made the election and dies prior to their RBD, the RMD rules apply as if the spouse beneficiary was the employee providing an avenue of additional deferral for beneficiaries of the surviving spouse.

Finally, section 337 of the Act allows an IRA owner to create a trust for a disabled or chronically ill beneficiary, which are otherwise EDBs, and name a charity as a remainder beneficiary without disqualifying the trust as an EDB. Now, the trust may pay out to public charity, other than a Donor-Advised Fund, upon the death of the disabled or chronically ill individual without negative impact. This provides additional planning opportunities for clients with disabled beneficiaries.

Of course, the foregoing article only highlights a few of the many changes ushered in with SECURE 2.0. More to follow . . .

Tax Planning For 2023

As 2022 draws to a close and the New Year dawns, we need to think of…tax planning! Some years Congress tweaks the laws more than in other years. While 2022 held plenty of events: the war in Ukraine, an improved “bivalent” coronavirus vaccine addressing new coronavirus variants, the U.S. midterms elections, etc., it was a relatively quiet year for legislative changes impacting planning. Still, even in a quiet year, some things change due to inflation increases, etc.

Estate Tax Planning
Applicable Exclusion rises from $12.06 million in 2022 to $12.92 million in 2023.
GST Exemption rises from $12.06 million in 2022 to $12.92 million in 2023.
Annual Exclusion for present interest gifts rises to $17,000 in 2023.
Annual Exclusion for gifts to a Noncitizen Spouse rises to $175,000 in 2023.

In a few years, at the end of 2025, the Applicable Exclusion and the GST Exemption will revert to one-half of their current levels, in other words to $5 million, adjusted for inflation from the 2011 base year. This isn’t relevant for most Americans. However, if you have well over these amounts, you may want to consider removing these amounts from your estate while you still have the temporarily doubled Exclusion and Exemption to cover the transfers. You still have until January 1, 2026, before the law is set to change unless Congress changes things dramatically before then, which appears unlikely at least for the next two years given the closely divided Congress and Senate.

Income Tax Planning
Standard deduction amount:
Married, filing jointly, increases from $25,900 in 2022 to $27,700 in 2023.
Single, increases from $12,950 in 2022 to $13,850 in 2023.
Head of household, increases from $19,400 in 2022 to $20,800 in 2023.
State and Local Tax (SALT) deduction cap remain at $10,000 in 2023.
The income tax brackets creep slightly higher, as well.

As you plan for 2023, remember to keep your receipts for expenses and charitable contributions. With the high standard deduction amount and the cap on State and Local Tax deductions remaining at $10,000, fewer taxpayers are itemizing. In fact, the percentage of taxpayers itemizing is less than half what it was before the Tax Cuts and Jobs Act of 2017. According to the Tax Foundation, less than 14% of taxpayers itemize each year after the TCJA. Before then, over 31% of taxpayers itemized. If you give to charity, you may want to group your charitable contributions into one year and itemize them in that one year, and take the standard deduction in other years. You can do this by consolidating giving to a Donor Advised Fund (“DAF”) in one year. Then you can make grant recommendations from your DAF each year. This way, your tax planning won’t impact your favorite charities.

Let’s look at an example. John and Mary make $17,000 of charitable contributions to their church, alma mater, or other charities each year. They have state and local tax deductions above the $10,000 limit. They have a total of $27,000 of deductions and they’d be better off taking the standard deduction ($27,700 in 2023). Rather than giving $17,000 for each of three years to charity, they could give 3 x $17,000 ($51,000) in one year and they’d get a much better tax result. If they gave $51,000 in year 1 to a DAF, combined with their SALT deduction of $10,000, they’d have $61,000 of deductions instead of the standard deduction of $27,700. In years 2 and 3, they’d just have the SALT deduction of $10,000 and no charitable deduction but could still take the standard deduction ($27,700 in 2023). The charities would get their funds each year just as usual when John and Mary make the grant recommendations from their DAF. John and Mary would get a much better tax result. In year 1, they’d have $61,000 of deductions instead of $27,700, an increase of $33,300. Their deductions in years 2 and 3 would not change, because either way they’d be taking the standard deduction in those years. Depending upon John and Mary’s income tax bracket, this increased deduction could save them over $12,000 in federal taxes alone.

A little planning can produce a much better tax result. Have a happy, healthy, and prosperous 2023!

‘Tis the Season For Giving

As we wind down 2022 and begin planning for 2023, it’s a great time to consider your 2022 individual income taxes and explore ways to position yourself favorably for those taxes. There are still a few days left to make last-minute charitable gifts before December 31, 2022. While certain benefits like the special provision included in the Coronavirus Aid Relief and Economic Security (‘CARES’) Act and subsequently extended by the Taxpayer Certainty Disaster Relief Act of 2020 that allowed anyone (even those who take the standard deduction) to deduct up to $300 for donations to a qualifying charity on their federal income tax return ($600 for married couples) expired at the end of 2021, it’s still possible to take advantage of other favorable provisions designed to lower your overall tax bill if you are willing to itemize your deductions. Of course, this means that the taxpayer needs to do a little more work and “run the numbers” to determine whether itemizing makes sense for them.

Taxpayers who make donations to a supporting organization, Private Foundation, Charitable Remainder Trust (‘CRT’), or a Donor Advised Fund (‘DAF’) could take these charitable deductions as itemized deductions as noted above. A supporting organization is a charity that accomplishes its exempt purposes by supporting other exempt organizations, usually public charities. A Private Foundation is a trust or corporation dedicated to achieving a charitable mission created by a single individual, family, or corporation. A CRT is a trust in which the donor keeps an annuity or unitrust payment stream for a term of years or life and gives the remainder interest to a charity. The DAF is an account maintained by a charity that allows the donor to advise on how to distribute or invest amounts contributed by the donor held in the fund.

Of the above charitable vehicles, DAFs have continued to grow in popularity in recent years. According to the National Philanthropic Trust, the 2022 DAF Report found DAF donors granted at historic levels with grants to qualified charities of over $45 billion in 2021. That amount represented a 28.2% increase in donations from 2020, which was higher by 28.3% than in 2019. DAF grant payout rate was 27.3%, which exceeded the ten-year average payout rate of 22.2% demonstrating the popularity and power of the DAF as a charitable vehicle. Contributions to DAFs give an immediate income tax deduction to the donor while creating a reservoir of assets for distribution to charities in the future. In addition, DAFs provide an opportunity for donors to invest contributed funds and make suggestions regarding which charities should receive the distributions. Donors may change their recommendations regarding charitable distributions allowing great flexibility coupled with immediate benefits. Donors may combine DAFs with other strategies to produce even better results. For example, if a donor gave highly appreciated public stock to a DAF, the donor would receive an income tax deduction for the full value of the appreciated stock without ever paying tax on the gains. DAFs complement any charitable giving strategy already in effect and provide a great opportunity for those new to charitable giving to discover the benefits it provides.

Individuals making any of these gifts need to itemize their deductions to receive a charitable income tax deduction. The foregoing charitable opportunities present just a few of the myriad ways in which a taxpayer can remove the assets, as well as the appreciation on those assets, from their taxable estate and obtain an income tax charitable deduction. Year-end presents a wonderful time to consider these and other Estate Planning issues. Charitable contributions offer an excellent opportunity to give by doing good for the community and to receive an income tax charitable deduction for your efforts. Several communities are still reeling from the pandemic, have suffered high levels of inflation, and need our help now more than ever.

The Importance Of Having An Estate Plan

The headline read “Battle Over Anne Heche’s Estate Settled” when it should have read “Yet Another Celebrity Dies Without an Estate Plan.” Anne Heche was a well-known actress who died unexpectedly following a fiery car crash in August 2022. Anne left behind two sons, one of whom is 20, the other of whom is 13, and no estate plan. Her case was tragic and the results were completely avoidable in many ways. Because Anne failed to create even a basic Will, her estate will pass pursuant to the laws of intestacy in California through a public probate process. In addition, California State Statutes will determine who will receive her estate and how they will receive it. Anne’s 20-year-old son petitioned and ultimately won the right to administer his mother’s estate, despite several claims brought by the father of Anne’s 13-year-old son. While he has won this battle, the war is far from over and he will undoubtedly have his work cut out for him administering his mother’s estate. Anne’s death illustrates yet another of the many reasons why it’s vital to have an Estate Plan, regardless of your age or level of wealth.

Anne could have avoided this result by creating a comprehensive Estate Plan. A comprehensive Estate Plan consists of a Revocable Trust, pour-over Will, Property Power of Attorney, Health Care Power of Attorney, Living Will, and a Health Insurance Portability and Accountability Act Authorization. These documents protect a client during life and at death and, if properly structured, can protect the beneficiaries as well. During life, the plan acts as a set of instructions regarding who makes what decision, be it medical or financial if the client is unable to make those decisions. At death, these documents dictate who controls the distribution of the estate, to whom the estate will be distributed, and when and how it will be distributed to those individuals. If the client signed a Revocable Trust, then that would keep the decedent’s plan private, unlike the public fight over who would distribute Anne’s. Of course, even if Anne had a Will, that Will would be public, although it would have allowed her to select the individual responsible for administering her estate, rather than letting the court decide who would administer the estate. While she may have named her son who now holds that responsibility, it’s entirely possible that she would have chosen someone older and with more experience in dealing with such matters. Most clients would not choose an unemployed 20-year-old to serve in this role.

If Anne had created a comprehensive Estate Plan, she could have included provisions to protect her children. For example, a lifetime trust for the benefit of each son would provide continuing asset management, divorce protection, asset protection, and estate tax protection for them. Because Anne failed to create any plan whatsoever, her eldest son will receive his inheritance outright. That will allow him unfettered access to the funds and will not protect them from the claims of his creditors. Her youngest son’s inheritance will likely end up in an account administered by someone else, potentially with significant court oversight. If Anne had taken the time to create a plan, she could have decided how she wanted each son to receive his inheritance and who would be responsible for distributing the assets to that son. By failing to create a comprehensive Estate Plan, Anne deprived her sons of these benefits and saddled them with some undesirable consequences at a time when they should have room to grieve her untimely death.

Anne’s eldest son has significant responsibilities and duties in administering her estate. He needs to collect and distribute the assets of the estate while defending various lawsuits and incurring significant attorneys’ fees, all on a public stage and while grieving the loss of his mother. Make sure that the same cannot be said for your own family by creating a comprehensive Estate Plan.

Now that the Mid-terms are over, let’s talk taxes

While many commentators saw the mid-term elections as an opportunity to focus on whether the Senate would remain blue and the House would turn red, they ignored other important aspects of the mid-term elections.   According to Ballotpedia, voters in 37 states considered more than just who would take office.  Folks cast ballots for a wide range of issues, such as approving the issuance of bonds for the development of low-income housing, raising the minimum wage, and increasing taxes.  You might think that with the continued rise of inflation, voters would oppose any measure that might increase their taxes, but as we will discover, that’s not always the case.

Perhaps unsurprisingly, Massachusetts, a state that has one of the highest individual income tax collections per capita ($2,477) passed a measure that would amend their state constitution by establishing an additional 4% state income tax on annual taxable income of more than $1 million, adjusted annually for inflation.  Massachusetts imposes a state income tax and taxes on both long and short-term capital gains.  Massachusetts also imposes a state estate tax on estates that exceed $1 million.  New York is the only state with a higher individual income tax collection amount per capita ($2,656).  New York also taxes individual income and capital gains and imposes a state estate tax; however, it imposes a state estate tax on estates exceeding $6.1 million.  According to Charles Schwab, Connecticut, California, and Oregon round out the top-five states with the highest individual income tax collections per capita at $2,268, $2,135, and $2,038, respectively.  Connecticut also imposes a state estate tax on estates exceeding $9.1 million and Oregon imposes a state estate tax on estates exceeding $1 million.  Oregon, along with Missouri and Montana, allows residents to deduct a portion of federal taxes paid from state tax liability.  Alabama, Iowa, and Louisiana allow a full deduction of amounts paid at the federal level.

California voters also had the opportunity to decide whether they wanted to impose additional taxes on personal income, ultimately voting against the measure to add 1.75% tax rate on income exceeding $2 million.  While California does not impose a state estate tax, it imposes an income tax and tax on capital gains at the same rate.  Alabama, Arizona, Arkansas, Colorado, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, New Jersey, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, Rhode Island, South Carolina, Utah, Vermont, Virginia, West Virginia, and Wisconsin in addition to California, Connecticut, Massachusetts, New York, and Oregon all tax capital gains and individual income at graduated tax rates beginning at the low end of .25% in Oklahoma and topping out at the high end of 14.63%  in California.

As most everyone knows, Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming levy no personal income taxes or taxes on capital gains at the state level.  While New Hampshire does not tax income from wages, it does impose taxes on dividend and interest income.  Finally, Washington doesn’t impose taxes on personal income or capital gains, but in 2021 a bill passed that would have imposed tax on long-term capital gains above $250,000 beginning in 2022.  It was struck down in March 2022 and Washington State has appealed the ruling to the Washington Supreme Court.  A hearing date is pending.

Six states impose an inheritance tax:  Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.  Of those, Maryland has the distinction of being the sole state in the nation that imposes an estate tax in addition to the inheritance tax.  Hawaii, Illinois, Maine, Minnesota, Rhode Island, Vermont, and Washington join Connecticut, Maryland, Massachusetts, New York, and Oregon in imposing an estate tax.  The amounts on which they impose the tax vary greatly.  As noted above, Massachusetts imposes a tax on an estate with assets exceeding $1 million as does Oregon.  Rhode Island levies tax on estates with assets exceeding $1.65 million, Washington $2.2 million, Minnesota $3 million, Illinois $4 million, Vermont $5 million, Hawaii $5.5 million, and Maine $6.01 million.  The rates at which each state imposes tax range from .08% in Rhode Island to 20% in Washington, with many of the other states topping out at 16%.

Estate planning often focuses on taxes at the federal level and advanced estate planning focuses on techniques designed to freeze the value of assets or reduce the value for estate tax purposes.  For those desiring to lower their overall tax burden, it’s important to understand the impact that the taxes imposed by the individual’s state of residence and how, if at all, to reduce that burden as well as the interplay with taxes at the federal level. 

What’s Retirement Got to Do with It?

Individuals began relocating in record numbers during the pandemic. Some moved to be closer to family, others for better weather. Still, others changed domicile for financial reasons, like the pursuit of different job opportunities, for lower taxes, or because they planned to retire. Folks desiring to relocate should consider the various taxes in the desired state of residence, especially when they are at or nearing retirement. It’s no secret that taxes vary widely from state to state. Some states may impose estate, gift, inheritance, or income taxes which could affect the decision to move. States diverge in their property and sales tax rates as well.

If the desired state of residence imposes an income tax, then the individual needs to determine what types of income would be subject to taxation and how it would affect their bottom line. States most friendly to retirees exclude Social Security benefits from taxation and provide exemptions for other common forms of retirement income, such as private pensions or Individual Retirement Accounts (“IRAs”). Additionally, states friendly to retirees have lower property and sales taxes to allow those on a fixed income to make the most of every dollar.

Eight states, including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming do not impose a state income tax. This means that a retiree’s Social Security benefits, as well as other income, are safe from state income tax liability. Of course, that shouldn’t be the only financial factor considered. Of those eight states, Florida, Nevada, Tennessee, and Wyoming impose neither an estate tax nor an inheritance tax. Nevada provides another advantage with the seventh lowest median property tax rate of just over $572 per $100,000 of home value. Unfortunately, Nevada has a combined state and local sales tax rate of 8.23%. Wyoming provides both a low combined state and local sales tax rate (5.22%) and the eleventh lowest property tax rate at $605 per $100,000 of home value.

Arizona, Alabama, Colorado, and South Carolina impose a state income tax but none impose an estate or inheritance tax. Arizona, Alabama, and South Carolina all exempt Social Security benefits from state income taxes. Colorado exempts Social Security benefits from taxation at the state level if the retiree has attained the age of 65. South Carolina allows taxpayers aged 65 and over to exclude up to $10,000 of retirement income versus $3,000 for those under the age of 65. South Carolina also allows seniors to deduct $15,000 from other taxable income as well. Colorado’s combined state and local sales tax rate comes in at 7.77% and its median property tax rate is $505 per $100,000 of home value. South Carolina bests Colorado slightly with a combined state and local sales tax rate of 7.44% but has a slightly higher median property tax rate of $566 per $100,000 of home value.

Alabama may require seniors to pay a bit more in income tax than retirees in other states because it taxes IRA and 401(k) distributions. While those facts may weigh against a move to Alabama, its median property tax rate is the second lowest in the country at $406 per $100,000 of home value. It’s average combined state and local sales tax rate is a bit high at 9.24%, but it allows anyone over the age of 65 to exempt the state portion of property taxes and allows lower-income residents an exemption from all property taxes on their principal residence.

Interestingly, a recent Kiplinger article rated Hawaii and Delaware as the number 2 and number 1 states, respectively, for retirees. Even more shocking, Florida, a state known for its large retiree population failed to make its top ten list. Perhaps less shocking, New Jersey ranked as the least retiree-friendly state with its state income tax rate ranging from 1.4% to 10.75%, it’s average combined state and local sales tax rate of 6.6%, and its median property tax rate of $2,741 per $100,000 of home value. Kiplinger based their rates on the sum of income, sales, and property tax paid by two hypothetical retired couples, both with modest assets and income levels.

In addition to considering the potential estate, gift, inheritance, income, sales, and property taxes imposed by a state, individuals desiring to relocate should consider the types of ownership the state acknowledges, for example, community or separate property, and the nuances of property ownership in that state. The property ownership and nuances of the state of residence prior to the relocation may also impact Estate Planning in the new state. The decision to move involves complex considerations regarding more than just location. Of course, retirees will want to consider weather, crime, and proximity to friends and family. I can assist in demystifying these complex considerations.

Take Advantage of Your Annual Per Donee Exclusion Amount

As we gather with our family, friends, and loved ones to celebrate Thanksgiving, while year-end obligations may tempt us to rush through the meal and return to “normal,” we should not. Instead, we should stop, savor the moments together, and remember why we choose to spend our time with these individuals. This time of the year offers a special opportunity to show our loved ones just how much we care. We can do this in any number of ways, including gifting.

Let’s make this year the year we give gifts that benefit both the recipient and the donor. Annual exclusion gifts provide a benefit not only to the recipient but also to the donor. Annual per donee exclusion gifts allow the donor to make gifts to multiple individuals without incurring any transfer tax consequences provided that the total gifts to an individual are present interests and do not exceed the threshold amount. Internal Revenue Code (“Code”) Section 2503(b) sets the amount that an individual taxpayer can gift to any other person at $16,000 for 2022 (which will rise to $17,000 for 2023). Giving now allows individuals to reduce the value of their taxable estate without impacting the lifetime exclusion amount of $12.06 million in 2022 (which will rise to $12.92 million in 2023). In addition to allowing the donor to avoid the use of any applicable exclusion amount, gifts remove future appreciation on the assets gifted from the donor’s estate as well.

The Code imposes no limit on the number of annual per donee exclusion gifts per taxpayer meaning that an individual taxpayer may gift up to that $16,000 amount to an unlimited number of individuals without ever worrying about estate or gift tax consequences. Gifting the funds or assets removes them from the donor’s taxable estate without ever impacting the lifetime exclusion amount. It’s one of the few totally “free” estate planning techniques. Because annual gifts reduce the size of the taxable estate, they also reduce the potential tax liability. For married couples, the benefit doubles because each spouse can gift the annual per donee exclusion amount to the same individual, and if the recipient has a spouse, then the donors can double the impact of their gifting again. Let’s review an example that demonstrates effective use of the annual per donee exclusion amount.

Assume that Mike and Carol recently met with their attorney who suggested that they start reducing the value of their taxable estate. The pending nuptials of their daughter, Cindy, caused Mike and Carol to be preoccupied. They realized that they better act quickly to utilize their 2022 annual per donee exclusion amounts. They decided to give each of their six now-married children, Greg, Marcia, Peter, Jan, Bobby, and Cindy an envelope containing $64,000 ($32,000 from each of Mike and Carol to each child, plus an additional $32,000 for each spouse of each child) at Cindy’s wedding on New Year’s Eve 2022. As the clock strikes midnight, the family rings in 2023, and Mike and Carol hand out another set of envelopes, this time, with $68,000 cash in each envelope.

In the example above, in just a few hours, Mike and Carol gave away nearly $800,000 without incurring any estate or gift tax consequences. Mike and Carol each gave $16,000 to each of their six children and their spouses, totaling $384,000 in 2022, and Mike and Carol each gave $17,000 to each of their six children and their spouses, totaling $408,000 in 2023, for a total of $792,000. In fact, Mike and Carol could each also gift $16,000 to a grandchild in 2022 and $17,000 to that same grandchild in 2023. The foregoing example demonstrates how quickly these gifts can add up and make a huge impact on an estate. In addition to using the annual exclusion gifts, the Code gives taxpayers a tax-free pass when they pay the medical bills of another individual or pay the tuition bills of a student. The Code imposes no limit on the amount of these medical and tuition gifts, as long as the amounts are paid directly to the provider. The Code also allows contributions to charitable exempt organizations. The Code imposes no limit on the amount of these contributions for gift tax purposes, which provides another easy option for those who want to do some easy estate planning. Such contributions may also qualify for an income tax deduction, up to certain percentages of the taxpayer’s adjusted gross income.

The upcoming holiday season presents the perfect time to consider these and other estate planning issues. Options may exist for use of the annual exclusion gifts in conjunction with trusts and a long-term estate plan. Giving now, rather than waiting until death provides several estate planning opportunities in the form of tax-free distributions, reduction of the gross estate, and appreciation outside of the taxable estate, not to mention the benefit to the recipient that the donor will witness while alive. I am always available to help you explore these opportunities and more to determine whether it makes sense for your family situation.

Planning for the International Client

As the world continues to emerge from the pandemic, many find themselves taking trips that they had postponed. If the pandemic taught us anything, it’s that the world has become more interconnected than ever before. It’s common to hear messages about remote work, which means that individuals can work from anywhere. By extension, that means that there is a need to understand the ramifications for clients both at home and abroad, as well as for those clients who were not born here but reside here.

When I considers estate planning for an individual, I need to ascertain the client’s citizenship and residence. In addition, I need to understand the worldwide assets of the individual. The estate of a United States (U.S.) citizen includes the worldwide assets of the citizen, regardless of the location of such assets and the individual. Under Internal Revenue Code (“Code”) Section 2010, a U.S. citizen has a permanent exclusion of $5 million, adjusted for inflation. The Tax Cuts and Jobs Act of 2017 temporarily doubled the applicable exclusion through December 31, 2025. Thus, in 2022, a U.S. citizen has an exclusion from estate taxes of $12.06 million.

The temporary doubling of the exclusion offers unique planning opportunities for U.S. citizens, regardless of their country of residence. If clients have an estate that exceeds the applicable exclusion amount, it’s vital that they begin to plan for that now, while the exclusion remains doubled.

For anyone not a U.S. citizen, residence dictates how their estate will be taxed at death. If the individual resides in the U.S., even if they are not a citizen, whether here legally or not, the Code imposes tax on such individual, exactly the same as that of a U.S. citizen. If the person moves or changes residence, the result changes dramatically. A “green card” provides Lawful Permanent Resident Alien status to the holder. Thus, the green card holder pays taxes like a resident, whether or not physically residing in the United States. Someone who is neither a citizen nor resident of the United States pays tax only on their U.S. assets; however, the Code reduces the applicable exclusion amount to $60,000, rather than the $12.06 million enjoyed by a resident or citizen of the U.S.

Let’s look at an example. Jorge was born in Mexico and is a citizen of Mexico (and is not a citizen of the United States). Although Jorge has lived in the U.S. for decades, he has no documentation. Years ago, Jorge purchased shares of stock in prior to it going public and made millions. He used those funds to purchase a ranch in California which has grown substantially in value to $12 million. If Jorge died today while living in the U.S., his estate would escape taxation because the applicable exclusion amount of $12.06 million would cover the value of his property.

Because of Jorge’s status, he faces the threat of deportation. If removed from the U.S., he would lose resident status. If he died after deportation, but while owning the ranch, his estate would face a significant estate tax liability. While the estate tax would apply only to his U.S. assets, the ranch represents a valuable asset. His non-resident exclusion would only cover $60,000, subjecting the remaining $11,940,000 of value to tax. While the first $1 million is subject to tax at graduated rates, the estate tax would apply on the amount above that at a rate of 40%. Jorge’s estate would owe over $4 million in U.S. estate taxes. If Jorge sought the services of a U.S. attorney, that attorney may have counseled that he could avoid tax exposure by owning the ranch in a foreign corporation, or by using other acceptable estate planning techniques.

Estate planning for the international client involves understanding numerous, and sometimes convoluted provisions of the Internal Revenue Code. Similarly complicated provisions govern gift and income taxation. Often, these clients need advice regarding the tax implications in another country as well, which means that I usually seek to partner with an expert from the other country to lay the best made plans understand the tax and legal circumstances that an international cliet may pose.

Common Mistakes in Estate Planning . . . Part V

Creating an Estate Plan that includes a Revocable Trust, pour-over Will, Property Power of Attorney, Health Care Power of Attorney, Living Will, and Health Insurance Portability and Accountability Act Authorization provides numerous benefits during life and at death. During life, the plan provides directions to your family regarding your medical care and finances if you become incapacitated or are otherwise unable to articulate your wishes. At death, the plan acts as a set of instructions to your fiduciaries regarding distribution of your assets. Unfortunately, as seasoned Estate Planning practitioners know, signing the documents alone does not solve every problem or guarantee that the plan will work as intended. Sometimes, mistakes occur that undermine an Estate Plan.

An Estate Plan involves more than just the documents evidencing the plan. Effective estate planning requires an understanding of an individual’s assets and how the plan will work for those assets. It also involves knowing what assets the plan won’t cover. Under normal circumstances, any asset that passes pursuant to a beneficiary designation, such as a retirement plan, life insurance, or an annuity passes outside the Estate Plan. Sometimes, these assets make up the bulk of an individual’s wealth. Thus, coordinating beneficiary designations for those assets constitutes an integral part of comprehensive Estate Planning. For example, assume that while single, Don named his brother as the beneficiary on his life insurance policy. Upon Don’s later marriage, he updates his Estate Plan leaving all his assets to his wife but fails to update the beneficiary designation for his life insurance. Upon Don’s death some years later, his life insurance passes to his brother, rather than his wife as was his stated intent. Simply put, Don could have avoided this result by updating his beneficiary designation upon his marriage.

In addition to considering beneficiary-designated assets, it’s important to consider the overall impact that taxes will have on the plan as well as the beneficiaries themselves. Obviously, it is important to understand whether the estate exceeds the Applicable Exclusion Amount ($12.06 million in 2022) which includes determining whether lifetime gifts reduced that amount. Further, if the estate will have an estate tax liability, then it’s important to consider which assets the estate will use to pay such liability. In a situation in which the client has children from a prior relationship, this matters a great deal. While assets passing to a surviving spouse do not incur an estate tax because of the unlimited marital deduction under Internal Revenue Code Section 2056, when those assets pass from the surviving spouse to the children of the first deceased spouse, a tax liability may occur and determine which party ultimately bears the taxes matters.

Finally, it is important for the client to understand the potential income tax consequences of the plan. For example, if the client has designated a beneficiary on an Individual Retirement Account (“IRA”), that beneficiary will have to pay income taxes on the distributions from the IRA unless it’s a ROTH IRA. The income tax consequences of receiving these assets may influence the client to structure their plan another way. Perhaps they intended to make a charitable bequest and after discussing the income tax consequences of distributions from an IRA decide that using a portion of the IRA to fund that charitable bequest makes more sense for their plan.

Beneficiary-designated assets and taxes make up an important part of any estate plan. As part of the complete Estate Plan, any time a birth, death, marriage, divorce, or change in financial situation or the law occurs, we need to update the beneficiary designations and consider anew the tax implications. Mistakes happen in many ways and lead to various unintended and potentially catastrophic consequences for the loved ones of those who fail to plan. These mistakes may make an impact during the life of the individual who failed to plan, and they certainly cause problems at death. Making matters worse, these mistakes may cause lasting trouble after an individual’s death either through an unnecessary (and possibly expensive or time-consuming) probate process or by improper planning for the intended beneficiary which takes numerous forms.