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 Yahoo.com 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.