State Income Taxation of Social Security Benefits

Since the onset of the pandemic, many individuals have decided to relocate. Some move to be closer to family, others for better weather. Still others change domicile for financial reasons, like the pursuit of different job opportunities or for lower taxes. I advise individuals who move to update their Estate Planning documents to conform with the rules of the new state of residence. Numerous factors impact an estate plan, many of which originate from the state of domicile. For example, it’s important to know whether the state is community property, elective community property, or a separate property state. It’s important to understand what forms of ownership the state acknowledges and the nuances of property ownership in that state. Understanding the property ownership and nuances of the state left behind may also impact Estate Planning. Finally, new residents need to understand how state and local taxation works, including whether the state imposes an income tax, gift tax, estate tax, or inheritance tax. If the state imposes an income tax, then the resident needs to determine what types of income will be subject to taxation and may be surprised to learn that their new state taxes Social Security benefits.

The federal government includes in income a portion of your Social Security retirement, disability, and other benefits if your income exceeds a certain amount. Some states follow the federal government’s lead and include these benefits in income for state income tax purposes. Let’s start, however, with those states that do not include these benefits in income. Eight states, including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming do not impose a state income tax. This means that a resident’s Social Security benefits are safe from state income tax liability. Of the remaining forty-two states, only twelve states include Social Security benefits in the calculation of taxable income. North Dakota used to tax Social Security benefits but amended its tax code in 2021 to remove Social Security benefits from the statutory definition of taxable income. Thus, less than one-quarter of the states in the United States impose a tax on Social Security benefits, some of which depend upon the resident’s income or age. Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia tax some or all their residents’ Social Security benefits.

In the states that impose taxes on these benefits, the policies and rules regarding taxation vary widely. For example, Colorado imposes a flat tax of 4.55% on Social Security benefits; however, it also allows an offsetting deduction of up to $20,000 in retirement income for those aged 55 to 64, which increases to $24,000 for those aged 65 and older. Colorado passed legislation that will allow residents to deduct all federally taxable Social Security benefits from their state income beginning in 2022. For residents in Connecticut, Kansas, Nebraska, and Vermont, if their state Adjusted Gross Income (“AGI”) is below a certain amount based upon filing status, then residents need not worry about taxation of their Social Security benefits. Nebraska began to phase out taxation of Social Security benefits in 2021, with the phase-out continuing until 2025 when at which time lawmakers will vote on whether to eliminate the tax on Social Security benefits altogether by 2030. In Missouri, if state AGI is below a threshold amount and the resident is over the age of 62, then the state will not tax Social Security benefits. Even for those Missourians whose income exceeds the threshold amount, the state may only partially tax benefits. For residents in those states whose income exceeds the set amount, the state’s department of revenue generally imposes tax at the same rate as other income.

Minnesota, Montana, and New Mexico follow the Federal guidelines to some degree by allowing Social Security benefits for those residents whose state AGI does not exceed $25,000 for single filers, or $32,000 for married filing jointly, to escape taxation. States deviate slightly from the Federal model in determining the amount of Social Security benefits subject to taxation and the rate of tax. For example, Utah uses the Federal formula to determine how much of a resident’s benefits will be subject to tax but applies its own rate of tax. In addition, Utah offers residents partial credits for those Social Security benefits taxed at the Federal level.

Rhode Island does not impose taxes on Social Security benefits for anyone who has reached full retirement age as defined by the Social Security Administration if their state AGI does not exceed $86,350 for single filers or head of household and $107,950 for married filing jointly. Finally, West Virginia has begun to phase out state income taxes on Social Security benefits for those making less than $50,000 ($100,000, if married) in 2021 by allowing residents to exclude 65% of Social Security benefits from taxable income. In 2022, West Virginia will not tax Social Security benefits for those residents with income below those amounts. If income exceeds those amounts, the benefits will be taxed according to the Federal model.

As is clear, it’s important to understand how your state views Social Security benefits. There is no uniformity in the treatment of these benefits. For each state’s specific guidelines, contact that state’s Department of Revenue or a qualified Estate Planning attorney. Regardless of whether or how your state taxes Social Security benefits, it’s important to consider the ramifications and examine ways that you might be able to reduce your tax burden. Your after-tax income will determine how you, your spouse, and your loved ones will spend your retirement. Remember that just because a state taxes Social Security benefits does not make it unsuitable for retirement. I can help you decide what’s best for your family and how to plan for your potential tax liability.

What Everyone Should Know about the New FDIC Regulations

While I recommend creating a basic estate plan, usually with a revocable trust as the centerpiece. Revocable trusts provide an easy, yet effective way to avoid probate in most states. In those states in which probate is not a concern, we use trusts to provide asset and creditor protection or to protect a beneficiary from themself. As estate plans become more complex, they tend to involve more trusts. These trusts may contain large sums of money, sometimes all in one account. I have fielded many a question from clients regarding how much of the funds in the trust were insured. If the funds are deposited in a bank or savings and loan that is insured by the Federal Deposit Insurance Company (“FDIC”), then it’s possible to answer that question although the rules can be confusing. Recently, those rules were simplified. To understand the changes fully, we must understand the protections offered under the existing framework.

Under the current rules, which remain in place until April 1, 2024, deposits are insured up to $250,000 per depositor, per ownership category, per institution. As a simple example, let’s assume that Johnny has $200,000 in BigBank and no other accounts anywhere. His entire $200,000 is covered. Now let’s assume that Johnny’s $200,000 was titled in a revocable trust, with Johnny as the sole grantor. Upon Johnny’s death, the assets will pass to his daughter, Lyla. For a revocable trust, the FDIC would insure up to $250,000 per institution, per trust beneficiary, up to a maximum of 5 beneficiaries for a total of $1,250,000. The rules look to the primary beneficiaries of the trust, which the FDIC defines as those individuals who would take upon the death of the grantor of the trust. Contingent beneficiaries and more remote beneficiaries are not considered. In our example above, then, Lyla is the sole beneficiary of the trust upon Johnny’s death meaning that the entire $200,000 would be protected. If Johnny had $500,000 in the account with BigBank, only $250,000 would be protected. He could, however, transfer $250,000 to HugeBank and that amount would be covered as well because it’s at a different institution. If Johnny had 5 children, all of whom were the beneficiaries of his revocable trust upon his death, then $1,250,000 in a revocable trust account at BigBank would be FDIC insured (5 x $250,000). If he had more than that, then he would have to transfer the overage to a new bank, keeping in mind that the FDIC insures no more than $250,000, per institution, per beneficiary, up to a maximum of $1,250,000 regardless of additional beneficiaries or funds. If Johnny were married and had a joint revocable trust, assuming that there were five beneficiaries that took upon the death of both grantors, then the FDIC would cover up to $2,500,000 at any one institution.

Let’s change the facts a bit and assume instead that Johnny’s trust is irrevocable. How does that change the analysis? If the beneficiaries of the trust can be identified and are non-contingent beneficiaries, then the FDIC insurance would work like it does for a revocable trust. If, however, some of the beneficial interests are contingent, then those contingent interests would be added together and insured up to a maximum of $250,000, regardless of the number of beneficiaries or the allocation of the funds among the beneficiaries. To demonstrate, let’s assume that Johnny has 5 children and that Lyla’s interest is the only non-contingent interest. If Johnny has $600,000 in BigBank, only $500,000 would be covered because the contingent interests would be added together and treated as one interest, notwithstanding that there are 4 contingent interest beneficiaries. Thus, $250,000 for Lyla’s non-contingent interest and $250,000 for the collective contingent interests would be covered.

Note that if the funds in an account represent both contingent and non-contingent interests, then the FDIC would separate those interests and apply the rules as described above. It’s easy to see how multiple trusts complicate these rules. Interestingly, according to the FDIC, it receives more inquiries related to insurance coverage for trusts than all other types of deposits combined. To simplify the rules, the FDIC issued new rules on January 21, 2022, with a delayed effective date of April 1, 2024.

The new rules merge the categories for revocable and irrevocable trusts and use a simpler, more consistent approach to determine coverage. Now, each grantor’s trust deposits will be insured up to the standard maximum amount of $250,000, multiplied by the number of beneficiaries of the trust, not to exceed five. It no longer matters whether the trust is revocable or irrevocable or whether the interests are contingent or fixed. These rules effectively limit coverage for a grantor’s deposits at each institution to $1,250,000 for a single grantor trust and $2,500,000 for a joint trust, assuming that there are five beneficiaries of such trusts. The streamlined rules provide depositors and bankers guidance that’s easy to understand and will facilitate the prompt payment of deposit insurance, when necessary.

While these rules do not go into effect immediately, it’s important that we begin understanding them now so that we can make any changes that may be necessary prior to the effective date. If you are concerned about FDIC coverage for trust accounts, or in general, talk with me about it. I can help you understand current coverage levels and advise you regarding any moves that you should make now or in the future to receive maximum FDIC insurance coverage.

The Intersection of Legacy Contacts and Estate Planning

Technology has obliterated Estate Planning of years past. Gone are the days of the stodgy attorney sitting in a smoke-filled room discussing arcane provisions of the Internal Revenue Code. Modern Estate Planning consists of Zoom meetings discussing cutting-edge techniques. As this article will demonstrate, technology has changed the way that we think about and approach Estate Planning. Digital assets and emerging technology require Estate Planning attorneys to change their practices. Electronic Wills have gained acceptance in certain jurisdictions, many individuals own cryptocurrency, non-fungible tokens have emerged as individuals consider their digital identity, and smartphones replaced flip phones long ago. To great fanfare in mid-December Apple released iOS 15.2 introducing the concept of the “Legacy Contact” setting. Okay, perhaps it wasn’t to great fanfare, but it certainly garnered attention in the Estate Planning world. The technology giant finally joined Google and Meta (formerly known as Facebook) in providing a way for designated parties to access the digital content of an account holder after death. Many expressed surprise that Apple took so long to release such a necessary tool.

For those who are unfamiliar with the concept of a Legacy Contact, anyone who has a Facebook account, Google account, or an iPhone can select one or more individuals (Apple allows up to five, although Google allows up to ten) to access those accounts and the digital content therein after death. Without this access, the loved ones left behind would lose the treasure trove of information contained in these accounts. While most of this information lacks monetary value, it’s priceless when considering sentimental value. Each organization has enacted different protocols regarding how much control the owner has over what gets shared after death. For example, Apple takes an “all or nothing approach” essentially allowing the Legacy Contact to access everything including messages, files, and photographs if they have the access key. Google, however, employs a more selective approach and provides options that allow the owner to tailor what gets shared after a period of inactivity, even going so far as to allow a complete wipe of the account after a certain amount of time.

Although many states have adopted some form of the Revised Fiduciary Access to Digital Assets Act (the “Act”) which gives a fiduciary access to these accounts, the Act does not apply to social media sites. To address the proliferation of these accounts, many Estate Planning attorneys began including language in their Wills and Trusts specifying that the named fiduciaries would have access to all digital assets intending that those provisions would provide the fiduciary with the required powers to dispose of the content. That did not always work. Sometimes, even with appropriately inclusive language, organizations required the fiduciary to produce a court order to access the account. Obviously, this practice caused frustration because obtaining a court order isn’t always an easy or inexpensive task. Thus, the best practice requires a proactive approach by the accountholder. The accountholder should review the policy settings for all digital assets, both monetary and sentimental, and take appropriate steps to ensure access, if desired, after death.

Most digital accounts allow set up of the Legacy Contact under “Account Information,” “Settings,” or “Inactive Account.”  As with the individuals named in your Estate Planning documents, it’s important to consider who should be named, in what capacity, and how much access you want to give that person if you have the option to limit access. Remember that not every digital platform allows you to choose what information gets shared so it’s important to review the policies and procedures for all your digital platforms and remember that the individual selected may still need to provide requested documentation or proof of their own identity. Of course, you can always provide access during life, but that creates a different issue of shared access while you are alive and actively using the account.

It’s hard to accept our own mortality; however, our digital identities give us the opportunity to continue our legacy beyond our years on earth. Even though technology moves fast enough to make your head spin, it’s vital to review the settings for your own digital assets and discuss your concerns with me.

The Evolution of our Unified Estate and Gift Tax System

Estate planning involves more than planning to avoid the estate tax, although understanding the estate tax and its impact on a plan are certainly required. Until 1916, the United States did not have an estate tax. The Revenue Act of 1916 assessed taxes on estates (“Estate Tax”) based upon the value of an individual’s assets as of the date of death when President Woodrow Wilson signed legislation creating it. The first iteration of the Estate Tax allowed an exemption of $50,000 with rates ranging from one percent (1%) to ten percent (10%) on estates over $5 million. Thereafter, the rate jumped to twenty-five percent (25%) for estates of $10 million.

Originally, the Estate Tax was imposed to fund the United States’ involvement in the first world war and even after that war ended, the Estate Tax stuck. The Revenue Act of 1924 increased the top tax rate to 40% on estates over $10 million and for the first time, added a gift tax on transfers during life (“Gift Tax”) when it became clear that wealthy individuals found a way around the Estate Tax by transferring wealth during their lifetimes. The Gift Tax was short-lived because it was repealed in 1926 while the Estate Tax rate was lowered to 1% for estates below $50,000 and 20% for those over $10 million. In the decade between 1932 and 1942, the Gift Tax was reinstated, and the Estate Tax and Gift Tax were increased while the exemption amounts were lowered. Estate Tax rates climbed to their all-time high of 77% for estates over $50 million in 1941.

After the Gift Tax became permanent, individuals again found a work-around to avoid taxation on transfers by skipping over their children and making transfers to their grandchildren. In response to this, Congress passed the Tax Reform Act of 1976 (“1976 Act”) introducing the Generation-Skipping Transfer Tax and unifying the Estate Tax, the Gift Tax, and the Generation-Skipping Transfer Tax. This unified regime exists to this day. The 1976 Act also capped the Estate Tax and Gift Tax at 70% for estates over $5 million. The Economic Recovery Act of 1981 phased in an increase in the unified tax transfer credit from $47,000 to $192,000 and a decrease in the maximum tax rate from 70% to 50% and eliminated the limits on estate and gift tax marital deductions. The Taxpayer Protection Act of 1997 phased in an increase in the amount excluded from taxes from $600,000 in 1997 to $1,000,000 in 2006.

In 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (“2001 Act”) reduced the maximum estate tax rates from 50% in 2002, to 45% where it remained until 2009 while increasing the exemption amount gradually until it reached $3.5 million. The 2001 Act repealed the Estate Tax and Gift Tax altogether in 2010. In 2011, the exemption amount was raised to $5 million and adjusted for inflation, while the top tax rate was lowered to 35%. In 2013, the top tax rate was raised to 40% which is the current rate. The Tax Cuts and Jobs Act of 2017 temporarily doubled the exclusion amount from $5 million to $10 million, as adjusted for inflation, which is the current law and which is set to sunset on January 1, 2026, if not sooner.

For a short time in 2021, it appeared that sooner had come when in September, Congress released proposed legislation containing proposals eliminating the benefits of numerous tried and true Estate Planning techniques which would have had serious ramifications for many Americans. Those changes included acceleration of the reduction in the estate tax exemption amount, taxation of formerly non-taxable transactions between grantors and grantor trusts, eradication of valuation discounts, elimination of stepped-up basis at death, and increased tax rates. Those changes were eliminated and now the Build Back Better Act seems to have become a distant memory with little chance of passage.

One of the many interesting things about the Estate Tax was that it was designed to prevent dynastic fortunes. When one-third of the top 50 wealthiest Americans on Forbes’ annual list are heirs, it seems clear that the Estate Tax has failed in that respect. With the current exemption of $12.06 million at its highest amount ever, individuals can transfer substantial assets at death or during life. Last year only 1,275 estates in the entire country owed Estate Tax, despite the historic amassing of wealth by the very richest.

For those willing to talk with me and plan for the transfer of their wealth, it’s possible to pay little or no estate taxes, essentially making the Estate Tax voluntary. If you have questions about whether your estate might be subject to Estate Tax at your death, it’s vital to talk to me about your concerns. Even if your total assets fall below the current exemption amount, you should plan for the transfer of your assets to your desired beneficiaries at your death. The new year makes a great time to plan for the future and ensure your legacy.

Double Your Gifting with Spousal Gift-Splitting

It may be possible to double your gifting by using spousal “gift-splitting.” Spouses may elect to split gifts made to others. If they do so, they must split all the gifts made by the other spouse to others for that year. For example, let’s say John made gifts of $30,000 to each of his five siblings, Aaron, Betty, Charlie, Darlene, and Ed. Let’s say the gifts qualify for the annual exclusion because they are of present interests. If John makes the gifts alone, then each gift of $30,000 would be reduced by the annual exclusion of $16,000 and would result in use of $14,000 of his applicable exclusion ($12.06 million in 2022). So, he’d have used $14,000 x 5 = $70,000 for the gifts. If John’s spouse, Mary, wished to split the gifts, she may do so. However, she must split all the gifts or none of them. So, if Mary doesn’t like Ed, she cannot choose to split the gifts to Aaron, Betty, Charlie, and Darlene, but not the gift to Ed. If she chooses to split all the gifts, she’d be treated as making a gift of ½ of $30,000, or $15,000, to each of John’s siblings. Mary’s annual exclusion would cover her half of each of these gifts and neither John nor Mary would need to use any of their applicable exclusion. Mary would consent to split the gifts by signifying such consent on John’s Form 709 for the year of the gift, thus consenting to split all his gifts for the year.

Interestingly, gift-splitting is effective only for gift tax purposes, not for estate tax purposes. This can be quite important. For example, let’s say John made the gifts to his siblings in an irrevocable trust which included Mary as a beneficiary. If Mary made a gift to a trust of which she’s a beneficiary, it could cause inclusion in her taxable estate under section 2036. However, if Mary merely splits the gift made by John, it would not cause inclusion in her taxable estate because she would only be considered to have split the gift for gift tax purposes and not estate tax purposes.

Spousal gifting can be confusing. While U.S. citizen spouses can give an unlimited amount of money to each other, a gift to a non-citizen spouse doesn’t qualify for the unlimited marital deduction. Instead, such a gift would need to qualify for the annual exclusion. In other words, it would need to be a gift of a present interest. There’s also a limit for such gifts to a non-citizen spouse. In 2022 that limit is $164,000.

Spousal gift-splitting can be a useful technique to consider as you plan your gifting strategy for 2022!

Start 2022 the Right Way

Welcome to 2022! Most of us will leave 2021 without hesitation – many had high hopes that 2021 would bring the end of COVID-19 and a return to normalcy and yet we face another variant as we usher in 2022. While things may not have gone the way we hoped in 2021, we can start 2022 prepared for anything by getting our estate plans in order.

The tumultuous events that plagued 2021 demonstrate the importance of a complete estate plan. Millions became seriously ill from the coronavirus. All too many of them died and even those who lived may be suffering long-term consequences. When they became ill, those who had their estate plan in order could focus on more important things, such as spending precious time with loved ones.

While we hope 2022 will be much better than 2021, it’s important to begin the year by creating an estate plan if you do not yet have one or reviewing the plan that you already have in place to ensure it accomplishes your goals. This will provide you and your loved ones with peace of mind for anything that 2022 brings.

Simply put, an estate plan serves as a set of instructions regarding how you want your affairs handled if something happens to you. The plan sends a message to your loved ones that you care and do not want to burden them with unclear or unstated plans. A basic estate plan consists of documents that provide instructions for what happens both during your life and at death. Those documents consist of a Property Power of Attorney, a Healthcare Power of Attorney, a HIPAA Authorization, a Will, and typically a Living Trust, also known as a Revocable Trust (a “Trust”).

First, the Property Power of Attorney allows you to appoint someone as your “Agent” to act on your behalf with respect to your financial affairs. If that Agent is unwilling or unable to act, you can appoint one or more successor Agents. Through the Property Power of Attorney, you give someone else (the Agent) powers you inherently already have yourself. The Property Power could be drafted to vest immediately meaning that the Agent would have the power to make decisions regarding your financial assets right away and without regard to your ability to make those decisions for yourself. In most states, you also have the option to make the Property Power of Attorney “springing” meaning that the Agent’s powers would “spring” into action only upon your incapacity. You may hear the term “durable” in conjunction with the Property Power of Attorney. This means that the Property Power of Attorney continues to be effective notwithstanding your incapacity. A Property Power of Attorney that is not durable does not allow your Agent to act during your incapacity.

A Healthcare Power of Attorney allows you to appoint an agent to make medical decisions for you if you are unable to do so for yourself. If you can make these decisions, then your agent cannot veto any medical decision you make. A HIPAA Authorization allows you to appoint an agent to access or receive protected health information.

It’s important to keep your Property and Health Care Powers of Attorney updated. Reviewing them often ensures that you always have trusted and capable individuals in those important roles and that you do not leave your loved ones wondering what to do upon your incapacity. The agents you select under your Powers of Attorney play a vital role in your incapacity plan and may have broad power during your life. Make sure you keep the right people in these roles.

A Will determines the distribution of your assets upon your death and allows you to select an individual or company to make the disbursements. If you do not have a Will, then your state’s intestacy laws will govern asset allocation at your death. Often, the state’s division would not match your own. In addition, state intestacy laws may appoint a stranger to handle these important decisions. Finally, the Will also allows you to nominate guardians to care for any minor children.

Regardless of whether you have a Will or your state’s intestacy laws determine property division at your death, the individual in charge will need to petition the court for permission to transact the business of your estate through a probate proceeding. Depending upon the laws of your state, probate can be a lengthy, costly, and public process. If you want to avoid probate and maintain your privacy, a Trust provides you the opportunity to do that. With a Trust, you transfer the assets to the Trust during your lifetime and manage them as the Trustee. You avoid probate altogether by using a Trust because the Trust contains provisions regarding what happens upon your death and vests a successor Trustee with power to make distributions from the Trust. The Trust also protects against incapacity by giving a successor Trustee the power to make distributions from the Trust for your benefit should you become incapacitated. Due to cases of fraud, institutions more readily recognize a successor Trustee acting on your behalf than an agent under your power of attorney.

Hopefully, 2022 will be better than 2021, and 2020 for that matter! Even a basic estate plan provides peace of mind regarding what’s in store for 2022. Resolve now to get your estate planning done this year, sooner rather than later.

Tax Planning for 2022

As 2021 draws to a close and the New Year dawns, we need to think of…tax planning! Some years Congress tweaks the laws more than other years. While 2021 held plenty of events: a coronavirus vaccine, new coronavirus variants, a new President, etc., it was a relatively quiet year for legislative changes impacting planning. At first, it seemed as though there could be substantial tax changes. But those changes were watered down, deferred, and may never materialize. Still, even in a quiet year, some things change due to inflation increases, etc.

Estate Tax Planning

Applicable Exclusion rises from $11.7 million in 2021 to $12.06 million in 2022.

GST Exemption rises from $11.7 million in 2021 to $12.06 million in 2022.

Annual Exclusion for present interest gifts rises to $16,000 in 2022.

Annual Exclusion for gifts to a Noncitizen Spouse rises to $164,000 in 2022.

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 a few years before the law is set to change, unless Congress changes things dramatically before then.

Income Tax Planning

Standard deduction amount:

Married, filing jointly, increases from $25,100 in 2021 to $25,900 in 2022

Single, increases from $12,550 in 2021 to $12,950 in 2022

Head of household, increases from $18,800 in 2021 to $19,400 in 2022

State and Local Tax (SALT) deduction cap remains at $10,000 in 2022, though proposed legislation could increase that cap significantly.

The income tax brackets creep slightly higher, as well.

As you plan for 2022, 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. Now, less than 14% of taxpayers are expected to itemize. 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. You can do this by giving to a donor-advised fund in one year. Then you can make grant recommendations from your donor-advised fund each year. This way, your tax planning won’t impact your favorite charities.

Let’s look at an example. John and Mary make $15,000 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 $25,000 of deductions and they’d be better off taking the standard deduction ($25,900 in 2022). Rather than giving $15,000 for each of three years to charity, they could give 3 x $15,000 ($45,000) in one year and they’d get a much better tax result. If they gave $45,000 in year 1 to a donor-advised fund, combined with their SALT deduction of $10,000, they’d have $55,000 of deductions instead of the standard deduction of $25,900. 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 ($25,900 in 2022). The charities would get their funds each year just as usual. John and Mary would get a much better tax result. In year 1, they’d have $55,000 of deductions instead of $25,900, an increase of $29,100. Their deductions in years 2 and 3 would not change. If John and Mary are in the highest income tax bracket, this increased deduction could save them over $10,000 in federal taxes.

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

The Sky Isn’t Falling

September usually brings the start of a new school year, cooler temperatures, football, and a time for reflection in the final quarter. This year, September brought concern, bordering on panic, over proposed changes to the Internal Revenue Code (“Code”) when Congress released legislation containing several proposals eliminating the benefits of many tried and true Estate Planning techniques. Estate Planning attorneys scrambled to understand the potential modifications to the Code that included acceleration of the reduction in the estate tax exemption amount, taxation of formerly non-taxable transactions between grantors and grantor trusts, eradication of valuation discounts, elimination of stepped-up basis at death, and increased tax rates. Former clients worried about prior transactions and anxious new clients rushed to utilize expiring techniques and the higher estate tax exemption amount. Once again as it did in 2020, the last quarter of the year threatened to overwhelm Estate Planning attorneys as they spent hours reviewing the Build Back Better Act (the “Act”), attending educational seminars, digesting articles, blogs, and opinion pieces about the Act, and calming nervous clients about the consequences of pending and prior transactions. The Act contained retroactive enactment dates giving attorneys and clients little opportunity to plan for the sweeping changes and underscoring the feeling that the sky was falling.

Estate planning went mainstream and even those with modest estates were apprehensive as newspapers and magazines published article after article scaring everyone into thinking that the Act would permanently and detrimentally alter the Estate Planning landscape. Temporary relief appeared at the end of October when the House Rules Committee released a revised version of the Act (H.R. 5376) eliminating the most egregious provisions including the higher individual and capital gains tax rates, the lower estate tax exemption amount, the rules taxing transactions between grantors and grantor trusts, and keeping both valuation discounts and stepped-up basis at death. As of this writing, the Act sits before an evenly split Senate. Critics of the Act point to rising inflation as an impediment to the Act becoming law, while proponents argue that the economic benefits that the Act would provide to lower income families would ease inflation long term. The Act seems to have stalled in 2021 even though this version reflects measured changes to the Code affecting mostly the wealthy: well-paid executives, athletes, entertainers, entrepreneurs selling a business, and non-grantor trusts.

The Act could pass sometime in 2022, but it’s likely that would require significant changes. Perhaps more likely, the Act will die altogether, although President Biden continues to express confidence that the Act will become law. Regardless of the status of the Act two things are clear: the sky is not falling and Estate Planning should be top of mind for all individuals. For clients with a taxable estate or in the top tax brackets, it makes sense to begin or complete planning sooner rather than later. Individuals can do this by utilizing the estate tax exemption amount prior to 2026, at which time it will be halved. Everyone should review their current plan with the aid of a qualified Estate Planning attorney to ensure that it still accomplishes their objectives. Your plan should focus on long-term goals rather than potential policy changes. The last three years have shown us that policy changes are inevitable; however, a flexible plan offers the best protection against future legislation and the unknown.

When you gather with family and loved ones for the holidays, talk about your collective values and how each individual views and measures success. What you learn might surprise you and cause you to reconsider your estate plan. Talk about steps everyone can take to achieve your collective and individual goals as support may come from untapped resources. Remember that when generational wealth transfer fails, it’s not always because of poor planning or failed investments, it’s often a breakdown of communication and trust. Engaging in these conversations at holiday gatherings may seem counterintuitive, but the festivities tend to reduce tension and encourage more frank discussions. You may consider creating a family statement or theme that provides an opportunity for everyone to feel included in decision-making. Consider how the plan you have implemented or failed to implement will look in six months, one year, five years, or even ten years. This may help unmotivated individuals complete Estate Planning or may cause you to revise your plan. If you have a family business or charitable intent, these suggestions may help uncover and resolve underlying issues and concerns.

After all the fuss surrounding the Act, it’s comforting to know that the Estate Planning world will continue mostly as it was. Even Jeopardy! has acknowledged that Estate Planning has gone mainstream with the following answer in the category “What Does It Prevent” on the December 9, 2021, episode: “A Living Trust: This court procedure to carry out the terms of a Will.” That answer, What is probate?, of course! The last two years have been some of the most tumultuous for Trusts and Estates attorneys and clients, alike. Let’s hope the New Year will bring a new calm to our world. 

Using Entities in Estate Planning

Estate Planning attorneys have long recommended the use of closely-held entities such as family limited partnerships (“FLPs”) and limited liability companies (“LLCs”) to provide flexibility in allocating rights to profits and capital, to shift income and property appreciation from one generation to the next, and to provide asset protection. Individuals transfer assets to the entity in exchange for membership or partnership interests, which provide management control and income distribution rights, but which may be subject to certain restrictions set forth in the governing documents. These restrictions limit new owners to a class of individuals, usually the descendants of the original members or partners, although sometimes a spouse may be included. Limitations like this insulate owners from liability, provide concentrated management in one individual, and allow the owners to carry out their business and tax objectives. The manager of an entity owes fiduciary duties to the other members which protects the business from claims of ex-spouses, creditors, outsiders, or even adversarial family members. Family entities can be used in conjunction with other estate planning techniques that leverage discounts for minority interests or freeze values by allowing appreciation to escape taxation at death.

Many states use partnerships as the default for two or more individuals in business together. Sometimes the partners have a formal agreement called a partnership agreement, and sometimes it’s just a handshake. LLCs and limited partnerships, on the other hand, require more formal intent. For example, with an LLC, the members file Articles of Organization to establish the LLC and use an operating agreement to govern the day-to-day operation. The operating agreement generally contains provisions regarding when distributions of profits will be made, who will manage the company, who can own an interest in the company and under what circumstances, the duration of the entity, and what happens upon dissolution. Often, the operating agreement will include provisions that dictate what happens upon the death of an owner. These provisions may override the provisions of an individual member’s estate planning documents, although they should work in conjunction with one another. Questions can arise though when the provisions of estate planning documents conflict with provisions in the entity agreements. Let’s review an example based on facts from a real case.

Assume that Shirley and Warren created an LLC for their family business. The operating agreement (“Agreement”) gave each sibling a 50% membership interest (“Interest”) in the company which consisted of the right to distributions, allocations, information, and the right to vote on matters before the Members. Shirley and Warren included language in the Agreement that a member could transfer all or any portion of his or her Interest by obtaining the prior written consent of all the other Members unless certain limited exceptions applied. The exceptions included a transfer of Interest outright or in trust for the benefit of another Member and/or any person or persons who are members of the “Immediate Family.” The Agreement defined Immediate Family as living children and the issue of any deceased child of a Member. If the Member failed to transfer the Interest during life in accordance with the provisions of the Agreement and failed to dispose of the Interest through the Will, then the Agreement provided that upon the death of such Member, the Interest would pass to and immediately vest in the Immediate Family of the deceased Member. Shirley and Warren ran the business together for two years until Warren’s untimely death. Warren left behind four adult children, and his estranged wife, Annette.

Upon Warren’s death, his Will was admitted to probate and Letters of Administration were issued to his son, Benjamin. The Will did not dispose of Warren’s LLC interest but instead directed that his assets be poured over to his trust which distributed everything equally to his four adult children and named Benjamin as successor Trustee. Shortly before his death, however, Warren amended his trust to include a distribution of his home to his friend, Faye. The amendment also gave Faye his Interest. Benjamin, as Personal Representative and Trustee, refused to transfer the Interest to Faye citing the provisions of the Operating Agreement. Faye sued Benjamin and won in the trial court but lost when Benjamin appealed.

The appeals court focused first on determining whether it was the terms of Warren’s estate planning documents or the terms of the Agreement that would control the disposition of his Interest. That court determined that the laws of the state where the contract was made permitted the Agreement to dictate how the Interest would pass at death. As such, the Agreement vested title to Warren’s Interest in his adult children immediately upon his death thereby overriding the provisions of his estate planning documents and his true intent.

The example above greatly oversimplifies the case; however, it provides universal lessons. First, if you have an interest in a family entity, ensure that you transfer that interest in accordance with the terms of the governing instrument. In the facts above, Warren needed to obtain Shirley’s consent to transfer his Interest to Faye. Second, make sure that your estate plan works with the governing instrument for your entity. Here, Warren would have needed to transfer his Interest to Faye during life and obtain Shirley’s consent in accordance with the terms of the Agreement, rather than relying upon his estate planning documents at his death. Finally, if you are unaware of any governing instrument, understand the impact of local law on your interest in the entity and your overall estate plan. The opinion for the case did not indicate whether Warren’s estate planning attorney reviewed the Agreement, but it’s best to start with a review of the entity documents when dealing with any closely-held entity. Remember that even if you set up the business without the services of an attorney, the business is a legal entity, as is the transfer of your interest in it.

Family entities serve a vital role in accomplishing numerous estate planning goals like asset protection, shifting appreciation and income to the next generation, centralized management, stability, and continuation of business upon death. Family entities also provide the opportunity to leverage the benefits of other techniques to achieve more significant results during life by excluding assets from the gross estate and increasing valuation discounts. To achieve these benefits, it’s vital to operate the entity in accordance with its governing documents. If you have a business, now is a great time to ensure that your estate plan and business plan work together to accomplish your goals and to explore any options that you have.

Don’t Be A Turkey – Use Your Annual Per Donee Exclusion Amount

As the Thanksgiving holiday approaches, we will gather with our family, friends, and loved ones to give thanks for our blessings and consider all that has transpired in 2021. It’s been a wild year that started with a riot in our nation’s capital, saw Elon Musk become the richest man in the world, surpassing Jeff Bezos (query whether his space expedition played a role in his fall from the top spot), the Delta variant sweep the nation, the United States end its longest sanctioned war in Afghanistan, Peter Thiel reveal the value of his Roth IRA exceeds $5 billion, and Congress flirt with legislation which would make drastic changes to the Internal Revenue Code (the “Code”), which has yet to pass. Despite the tumultuous year in which we continued to feel the impact of the COVID-19 virus with shortages and supply-chain issues, it’s easy to find reasons to be grateful. Folks have reunited with their families and loved ones and travel has begun to resume to pre-pandemic levels. This time of the year offers a special opportunity to show our loved ones just how much we care as gifts accompany the holiday season.

Let’s make this year the year we give gifts with dual purposes, 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 because they allow the donor to make gifts to multiple individuals without incurring any transfer tax consequences provided that the total gifts to an individual do not exceed the threshold amount. Code Section 2503(b) sets the amount that an individual taxpayer can gift to any other person at $15,000 for 2021. Beginning on January 1, 2022, that amount will increase to $16,000. Giving now can be a great way to reduce the value of the taxable estate without impacting the lifetime exclusion amount, $11.7 million in 2021 and rising to $12.06 million in 2022, while at the same time, providing the opportunity to divert potential appreciation on that asset to the beneficiary, thereby removing it from the donor’s taxable estate.

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 $15,000 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, that presents another opportunity to double the impact. Let’s review an example that demonstrates the effectiveness of annual exclusion gifting.

Assume that Mike and Carol recently became empty nesters after Cindy married her long-time love, Nikki, on New Year’s Eve, 2021. At the wedding Mike and Carol announced that they had spoken with their estate planning attorney who advised them to begin making annual exclusion gifts to reduce the value of their estate. Mike and Carol distributed 12 envelopes, each containing $30,000 cash, to each of Greg, Marcia, Peter, Jan, Bobby, and Cindy, and their spouses. As the clock strikes midnight, the family rings in 2022, and Mike and Carol hand out another set of envelopes, this time, with $32,000 cash.

In the example above, in twelve hours, Mike and Carol gave away nearly $750,000 without incurring any estate or gift tax consequences. Mike and Carol each gave $15,000 to each of their six children and their spouses, totaling $360,000 in 2021, and Mike and Carol each gave $16,000 to each of their six children and their spouses, totaling $384,000 in 2022, for a total of $744,000. In fact, Mike and Carol could each also gift $15,000 to a grandchild in 2021 and $16,000 to that same grandchild in 2022. The foregoing example demonstrates how quickly these gifts 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 income.

The looming holiday presents the perfect time to consider these and other estate planning issues. 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. Options may exist for use of the annual exclusion gifts in conjunction with trusts and a long-term estate plan. In this case, it really is better to give than to receive.