Author Archives: Robert Mondo

The first advanced planning strategy is to use a Roth IRA to maximize the deferral on an inherited IRA. Prior to the SECURE Act, beneficiaries could take distributions over their life expectancy. For those dying after 2019 with IRAs, the SECURE Act applies. Under the Act, most beneficiaries must withdraw the assets from an inherited IRA by the end of the period ending at the end of the year that includes the 10^th anniversary of the IRA participant’s death, i.e., the so-called “10-year rule.” With a traditional IRA, the problem is that if the beneficiary waits until the last year for maximum deferral, they’d have a large bump in income which would push them into higher tax brackets. For example, let’s say Mary inherits a traditional IRA with $1 million. If she waits until the last year, most of the IRA would be taxed at the highest marginal income tax rate. Conversely, if Mary inherits a Roth IRA, she could allow it to grow tax-free until the end of the “10-year rule.” Mary could withdraw the entire IRA in the last month of the period because distributions from a Roth IRA are not included in taxable income.

The other advanced planning strategy is to use a Roth IRA to reduce estate taxation. The value of an IRA is included in the taxable estate of the IRA owner. However, with a traditional IRA, income taxes would be owed on the balance upon withdrawal. But this does not reduce the value for estate tax purposes.

Let’s look at an example: Tom Taxpayer is in the maximum income tax bracket of 37% and lives in a state without a state income tax. Tom has a taxable estate and has an IRA of $1 million. If Tom converts the $1 million IRA to a Roth IRA, he’d pay $370,000 in income taxes, thus reducing his taxable estate by that amount. That reduction in his taxable estate would save him the estate tax on the $370,000 income tax paid upon conversion, or $148,000 with an estate tax of 40%. Of course, the payment of the income tax upon the conversion to a Roth IRA also would mean that the beneficiary who receives the IRA won’t have to pay income tax upon withdrawal.

Thus, the conversion to a Roth IRA can allow a full utilization of the 10-year rule and can act to reduce the taxable estate while providing an income tax benefit to the recipient.

An Individual Retirement Account (IRA) is a savings vehicle in which a deduction may be taken upon contribution (with limitations). The maximum contribution in 2021 is $6,000, and those age 50 and over may contribute an additional $1,000. While the assets are in the IRA, the income is not taxable. However, when distributions are taken in retirement, those distributions are included in taxable income.

A Roth IRA is almost the reverse of a traditional IRA. A taxpayer contributing to a Roth IRA does not get a deduction for the contribution. The earnings grow tax-free. And when the distributions come out, they are generally not taxable.

A taxpayer only qualifies to contribute to a Roth IRA if their taxable income is within certain limits. Married taxpayers filing a joint return may contribute the full amount if their income is below $198,000 in 2021. There is a phaseout and then the taxpayer cannot contribute anything if their income is $208,000 or higher. For an unmarried taxpayer, they may make a full Roth IRA contribution if their income is below $125,000 in 2021. There is a phaseout up to $140,000 and then no contribution is allowed.

While eligibility to contribute to a Roth IRA depends upon the taxpayer’s taxable income, anyone may convert their IRA to a Roth IRA. When they do a conversion, the amount of the traditional IRA is income taxable.

Let’s look at a quick example: John normally has income of $300,000 per year. He was furloughed until 2022 due to the pandemic. He has no income in 2021. He has a traditional IRA of $50,000. He could convert his traditional IRA to a Roth IRA and would pay tax at relatively low rates since his income is lower in 2021.

If a taxpayer doesn’t qualify to contribute to a Roth IRA, they may be able to contribute to a traditional IRA (deductible or nondeductible) and then convert that IRA to a Roth IRA.

One of the key factors in converting (or contributing) to a Roth IRA is whether the tax rate at the time of conversion (or contribution) will be lower than the expected tax rate at the time of distribution.

An Estate Plan includes various different moving parts. The Revocable Trust may be the keystone of the plan, but it’s important to consider how the other parts of the plan will work with…or against…the plan.

Let’s look at a simple example. John had three children and he wished to leave his assets to them equally. He had $6 million in various assets. John hired an attorney to help him with a Revocable Trust leaving everything equally to his three children. The Trust was wonderfully drafted. He had a Pourover Will which poured into the Trust. Would this achieve his goal?

Not necessarily. Some of John’s $6 million in assets might not be controlled by either the Trust or the Pourover Will. Let’s say John had an IRA. The IRA beneficiary designation would control who would receive that asset. If the IRA beneficiary designation were to John’s Trust, the IRA would pass according to the terms of John’s Trust. All too often, retirement accounts and other assets have beneficiary designations which predate the Trust and haven’t been updated. Often when the IRA is established, it has only a small amount. In John’s case, he opened the IRA with $5,000. He named the person he was dating at the time, Betty. He never changed that beneficiary designation. He never even thought about it years later when his spouse died and he did a spousal rollover of her retirement plan into his own IRA. Nor did he think about it when he left his job and rolled his 401k into his IRA. Now he has $3 million in his IRA. At his death, that asset would pass according to the beneficiary designation, to Betty.

Betty could take the $3 million and not look back. She’d be under no legal obligation to give it to John’s children. In that case, John’s children would be out half their inheritance. If Betty is cooperative, she might disclaim the $3 million IRA and it would pass to the contingent beneficiary. In John’s case, he didn’t name a contingent beneficiary. So, we’d look to the custodial agreement. In John’s case, the agreement provides, if the primary beneficiary isn’t there, and there’s no contingent beneficiary, the assets would go to his estate.

Passing through the probate process, the assets would pass pursuant to John’s Pour Over Will to his Trust. This would get the assets to John’s three children. However, the IRA would have been unnecessarily diminished by the expenses of the probate process.

This turmoil could have been avoided if John had coordinated the Estate Plan. John could have changed the beneficiary designation on his IRA. He could have named his children outright, if appropriate, or he could have named his Revocable Trust. Without coordinating the Estate Plan, a large portion of the assets could go in unintended ways, just like in this example.

Trust distribution standards may be very broad. In fact, the trustee could be given the authority to distribute to the beneficiary in the trustee’s sole discretion. This type of discretionary trust can provide asset protection if the trustee isn’t the beneficiary. However, if the beneficiary is the trustee, it would subject the trust assets to the beneficiary/trustee’s creditors (at least in most states). It would also cause inclusion in the beneficiary/trustee’s taxable estate. After all, the trustee would have a “general power of appointment” under Section 2041 of the IRC because the trustee could appoint the assets to themself as beneficiary. Conversely, if the beneficiary isn’t the trustee, they’d have no way to force any distributions by the trustee, which is why such a trust typically provides asset protection. Typically, a creditor stands in the shoes of the debtor.

However, the regulations to Section 2041 carve out an exception when the trustee is acting under an “ascertainable standard.” Certainly, if the trust mandated the trustee to distribute $1,000 per month to themself as beneficiary, that would not be a general power of appointment because it would be “ascertainable.” However, the limits of ascertainability are far broader.

Treas. Reg. 20.2041-1(c)(2) provides “a power is limited by [an ascertainable] standard if the extent of the holder’s duty to exercise and not to exercise the power is reasonably measurable in terms of his needs for health, education, or support (or any combination of them).” The regulation goes on to provide that the terms “support” and “maintenance” are synonymous. Many trusts are drafted with this “safe harbor” language from the regulations, “health, education, maintenance and support,” sometimes referred to as the “HEMS” standard. While the HEMS standard is an ascertainable standard according to tax law, it’s still very flexible and it’s difficult to say exactly what is required. But, it would allow a beneficiary to go to court to enforce the standard.

Let’s look at a typical example of the difference between a fully discretionary standard and a HEMS standard. Mary is the trustee of a trust and John is the beneficiary. If the trust provides for Mary to make distributions to John in her sole discretion, she would not be required to distribute anything to John. On the other hand, if the trust provides a HEMS standard, then Mary would need to make distributions to or for John’s benefit at least for a minimum level. But, Mary could decide to provide that minimum or more. For example, Mary could determine that John only needs a studio apartment in a working-class neighborhood. Conversely, she could determine John needs a larger home in a nicer neighborhood. Mary would have a similar level of discretion in other areas, as well. She could distribute enough for John to scrape by or enough for him to live more comfortably.

A HEMS standard, while ascertainable, isn’t specific. It provides a range in which the trustee may operate. If a dispute arose over the limits of that range, the court would be the final arbiter.

More to follow . . .

A revocable trust is usually treated the same as the individual who created the trust. For federal income tax purposes, a revocable trust is a “grantor trust” under section 676 of the Code. Therefore, all items of income and expense of the trust flow through to the grantor.

However, for some purposes, a revocable trust may not be treated the same as the grantor. Here are two examples.

First, let’s say John has an IRA and he makes it payable to his friend, Carlos. At John’s death (on or after January 1, 2020), Carlos would ordinarily have to take all the assets out of the IRA by the end of the year that includes the 10^th anniversary of John’s death, the so-called “10-year rule.” If John named Carlos’ revocable trust, the result would be different. In that case, assuming Carlos were still alive at John’s death, Carlos’ trust would not qualify as a “look through” trust because it would not have been irrevocable by the date of John’s death. As a result, the IRA would need to pay out under the “5-year rule” applicable when a non-individual is the beneficiary.

Here’s another example of how a revocable trust and the individual may not be treated the same. Under Missouri law, a purchaser owes sales tax on a vehicle upon purchase. If that vehicle is stolen or destroyed and there are insurance proceeds, those offset the price of the replacement vehicle purchased and thereby reduce the sales tax. In a recent case, the Missouri Supreme Court held that a revocable trust wasn’t the same as an individual for purposes of the Missouri sales and use tax. In Collison, a couple (in their individual names) owned a vehicle and purchased a replacement vehicle in their trust. The Court didn’t allow the insurance proceeds the couple received from their first vehicle to be applied against the price the trust paid for the replacement vehicle.

While revocable trusts are treated the same as the grantor for federal income tax purposes, they may not be treated as the same for other purposes.

The Achieving a Better Life Experience (ABLE) Act allowed accounts to help people with disabilities (and their families) save and pay for disability-related expenses. ABLE allows states to create tax-advantaged savings programs for eligible people with disabilities. Distributions from ABLE accounts are tax-free if used for qualifying disability expenses.

ABLE accounts may be used by those who were disabled before age 26. Regulations issued in 2020 allow such individuals to roll money from qualified tuition programs — 529 plans — into ABLE accounts.

Contributions aren’t federally tax-deductible. However, distributions and earnings are tax-free to the beneficiary if they are used to pay such qualifying disability expenses as:

• Housing
• Education
• Transportation
• Health
• Employment training and support
• Assistive technology
• Personal support services.

In addition to the annual contribution limit of $15,000, a designated beneficiary who works also may contribute his or her compensation up to the federal poverty level for a one-person household (but not if his or her employer contributed to a 401(a) defined contribution plan, 403(b) annuity contract, or 457(b) eligible deferred compensation plan). In 2021that’s $12,880 (except for Alaska and Hawaii).

Amounts in ABLE accounts aren’t considered “available resources” for Medicaid purposes. Further, amounts up to $100,000 are ignored for purposes of Supplemental Security Income (SSI). This is critically important. It allows the disabled beneficiary to have some resources without jeopardizing their benefits. Can you imagine if you could only have $2,000 to your name without being penalized? Without an ABLE account, that would be the terrible position such individuals would be in.

An ABLE account allows for dignity for the disabled beneficiary, in addition to the many other benefits available. The question isn’t whether a disabled beneficiary should have a SNT for their benefit or whether they should have an ABLE account. The question is why shouldn’t they have both? An ABLE account is a nice supplement to a SNT.

The estate tax exclusion is currently at an all-time high of $11.7 million. This consists of the permanent exclusion of $5 million, adjusted for inflation from the 2011 base year, and then doubled by the Tax Cuts and Jobs Act. However, the Tax Cuts and Jobs Act, which doubled the exclusion, only doubled it temporarily. The exclusion will revert to $5 million (adjusted for inflation) after 2025. So, it’s expected the exclusion on January 1, 2026 will be around $6 million. (In 2021, if you remove the doubling currently in effect, it would be $5.85 million.)

As we know, there are several proposals out there which would reduce the exclusion. The “For the 99.5% Act” would reduce it to $3.5 million, effective January 1, 2022. These proposals may not pass due to the razor-thin majorities in the House and Senate. But the exclusion will go down in 2026, even if no legislation passes.

If you were to utilize their current exclusion of $11.7 million, there’d be no tax due even when the estate tax exclusion drops. In other words, there is no “clawback.” It would be best for you to utilize the full exclusion. Let’s say you only uses $6 million. Come 2026, they would have used all of their exclusion available at that time and they would have no exclusion remaining due to the prior gift. So, it’s really only to the extent they give in excess of $6 million that you’re capturing some of the historically high exclusion.

What assets are the best to gift? Those with an income tax basis near their current fair market value, but which are expected to increase in value. Why is that? If the client gifts loss assets, the loss could not be harvested by the donee typically. If you gift assets which have significant appreciation, you’d lose the step-up in basis at your death. Let’s say you have $1 million of XYZ stock with a basis of $50,000. If you were to sell the XYZ stock today, you’d pay capital gains on $950,000, the difference between their basis in the XYZ stock and the sales price. If you gift the XYZ stock, it’d have a carryover basis in the hands of the donee. However, if you were to hold the asset until your death and it were included in your taxable estate, there’d be a step-up in basis to fair market value. In other words, the capital gains would be wiped out.

So, to the extent you can gift cash or other assets with income tax basis near fair market value, that would be the best use of the exclusion. And, if you utilize your full $11.7 million exclusion, you would have captured the full doubled exclusion whereas if they only gift a lesser amount, you’d be leaving exclusion on the table. You really aren’t dipping into the doubled portion of the exclusion until and to the extent your usage of the exclusion exceeds what the exclusion will be in 2026.

Currently, federal law taxes capital gains at a maximum rate of 20%, plus a 3.8% surcharge on net investment income, for a total of 23.8%. However, under proposals, to the extent a taxpayer’s income is above $1 million, their capital gains would be taxed at the highest rate for ordinary income. That cap for ordinary income would revert to the law prior to 2017, i.e., 39.6%. The surcharge on net investment income of 3.8% would be on top of that for a total of 43.4%. This assumes no state or local taxes.

Thus, for someone who could keep their income below $1 million, their capital gains would be 23.8% or lower. However, to the extent that income is above $1 million, it would be taxed at a marginal rate of 43.4%. That’s nearly double the rate of taxation. So, if they can spread out taxation of the gain over multiple years, they may be able to reduce their taxable income so it fits under that $1 million threshold and gets taxed at the lower level.

A Charitable Remainder Trust (“CRT”) is just such a tool. With a CRT, the donor gets an upfront deduction for the actuarial value of the remainder interest expected to go to charity. This must be a minimum of 10% of the value of the contribution. The value of the income interest could be as much as 90%. So, if a donor contributes $1 million to a CRT and the actuarial value of the interest going to charity is $100,000, the donor can take a $100,000 charitable deduction in the year of the donation to the CRT (subject to typical AGI percentage limitations).

Perhaps the best attribute of a CRT is that it is a tax-exempt entity. So, if the donor contributes appreciated assets and the CRT sells them (without a prior commitment to do so), the CRT doesn’t pay tax on the gain. However, when distributions go out to the donor or other income beneficiary, those distributions are flavored by the income the CRT has earned.

The impact of this is to defer gains so the donor might pay tax on them at a much lower rate of taxation. The impact of this deferral can be even greater in some circumstances. For example, let’s say your client, Tom Taxpayer, is approaching retirement. Tom has accumulated a great deal of stock at a very low basis. In his final year of employment, Tom contributes $1 million of stock to a CRT. He gets an income tax deduction in his final year of employment when his income is high and the deduction is more valuable. The CRT sells the stock but doesn’t pay tax on the gain because it’s tax-exempt. When Tom receives payments from the CRT in his retirement, he’s in a lower income tax bracket and pays tax at lower rates.

The current estate tax exemption is $11.7 million. This is a record high. The “permanent” exclusion is $5 million and is adjusted for inflation from a 2011 base year. Then the Tax Cuts and Jobs Act temporarily doubled it. At the end of 2025, the doubling goes away. So, in 2026, the exemption will be back to only $5 million, and with inflation adjustment it’s expected to be around $6 million at that time. Transfers above the exemption are currently taxed at a rate of 40%. However, those who use their exemption before it drops won’t be penalized. So, if they use the larger exemption before it drops, they won’t lose it.

There’s legislation pending in Congress which would lower the exemption even faster and even lower than current law provides. The “For the 99.5% Act” introduced in the Senate by Sens. Bernie Sanders (I-VT) and Sheldon Whitehouse (D-RI) would reduce the exemption effective January 1, 2022. For transfers at death, the exemption would go down to $3.5 million and wouldn’t be inflation-adjusted. Only $1 million of the exemption would be able to be used during life. Under the legislation, transfers above the exemption would incur a tax at rates beginning at 45% and going to as much as 65%, for those with over $1 billion. This proposed legislation increases the taxes on the less wealthy than it does on the wealthy. We get what we vote for. Thanks boys!!

However, clients could use the exemption this year and avoid the reduction in the exemption. For example, let’s say a person has $15 million. They could give away $11.7 million this year and retain $3.3 million. At their death, they’d only owe tax on the $3.3 million in their estate. If married, they could take advantage of a Spouse And Family Exclusion (SAFE) Trust, (sometimes called a Spousal Lifetime Access Trust (SLAT)). Such a trust is set up by one spouse for the benefit of the other spouse and their children. If there are sufficient differences in the trusts, each spouse could even set up such a trust for the other spouse. By doing this, a couple could utilize their exemptions but still have access to the assets.

For example, Bill and Mary had $30 million, $15 million each, and wanted to take advantage of the current exemption. Bill gifted $11.7 million into a trust for the benefit of Mary and his children. Likewise, Mary gifted $11.7 million into a trust for the benefit of Bill and her children. Each spouse now only has $3.3 million left in their estate.

If the trusts are designed to avoid the “reciprocal trust doctrine,” neither trust would be included in either of their estates at death. So, the terms of the trusts should vary somewhat. While the trusts avoid inclusion and estate taxation, this is a double-edged sword. While gifting to an irrevocable trust such as a SAFE trust avoids estate taxation, it’s only inclusion in the taxable estate that provides a step-up in basis at death. Thus, you can have your cake, but you cannot eat it, too.

Under current law, estate taxation starts at 40%, whereas long-term capital gains rates generally cap out at 23.8% for federal purposes. Thus, if the assets gifted would have been subject to federal estate taxation, the taxpayer usually would be better off to have them removed from the estate, even if it means losing a step-up in basis.

Also, if Bill sets up the trust for Mary, in the above example, there’s a risk Mary might not set up a trust for Bill since the trusts aren’t set up contemporaneously due to the reciprocal trust doctrine. Of course, each situation is different, and you’d want to explain the tradeoffs to your clients.

Whether you choose to use a SAFE trust or some other method, utilizing the current exemption can make a great deal of sense.

Every year there are numerous tax proposals. These proposals run the gamut. We start paying attention when there’s a change in power in Washington, D.C., especially when there’s not divided government.

Right now, Democrats control the House by a narrow margin and the Senate is evenly divided, with Vice President Harris able to cast a deciding vote if the chamber is split. So, while a tax change is certainly possible, it’s not at all certain.

A recent proposal by Senators Sanders (I-VT) and Whitehouse (D-RI), “For the 99.5% Act,” would dramatically alter the Estate Planning landscape. Here’s a summary of the Act from Senator Sanders. Here are some of the changes the Act would make:

• Lower the amount that can be passed to $3.5 million at death, with only $1 million available during life. These amounts would not be inflation-adjusted. Today’s amount is $11.7 million and is inflation-adjusted. (However, even under current law, the exemption drops in half after 2025.)
• Amounts in excess of the exemption are taxed at rates from 45% to 65%. The current rate is 40%. Amounts from $3.5 million to $10 million would be taxed at 45%, from $10 million to $50 million would be taxed at 50%, from $50 million to $1 billion would be taxed at 55%, and amounts in excess of $1 billion would be taxed at 65%.
• Change the rules for Generation-Skipping Tax exemption so that assets cannot be left in a trust which avoids estate taxes for more than 50 years.
• Change the rules for Grantor Retained Annuity Trusts so that they aren’t nearly as attractive as a way of transferring value to others.
• Limit valuation discounts, such as minority discounts. Such discounts are often used to pass as much as possible with the least possible use of exemption or the least possible tax.

The Act might change considerably or might not pass at all. But, if it passes in its current form, it would dramatically alter Estate Planning. So, what can you do? I encourage you to plan under the current rules. For example, you could use the current, historically high exemption while it is available. You could use strategies to take advantage of discounting while they’re available.