Tax Planning

Federal law imposes taxes on an individual's estate. However, three permissible deductions/credits can provide relief:

1. For married couples, at the death of the first spouse, there is an unlimited marital deduction for qualifying property left to the surviving spouse.
2. The law allows a full deduction from the estate for amounts distributed to a charitable beneficiary.
3. The law permits individuals, or in marriage, each spouse, an exemption against taxes payable against their estate. This federal estate tax exemption presently allows individuals to distribute $5.49 million tax-free to personal beneficiaries. In other words, federal law permits $5.49 million to be distributed to heirs free from estate taxes, ($10.98 million for married couples). Amounts above this threshold are essentially taxed at a rate of 40%. For more information on the bypass trust (click here).

Please note that legislation enacted in 2001 incrementally increased this exemption from $1 million in 2001 to $3.5 million in 2009. This legislation eliminated all federal estate taxes in the year 2010. Legislation enacted in December 2010 reinstated the estate tax and set the exemption amount at $5 million (indexed for inflation); but this legislation was temporary and scheduled to sunset on December 31, 2012. On January 1, 2013, Congress passed legislation that left the exemption unchanged ($5.25 million in 2013) and raised the estate tax rate from 35% to 40%. The 2017 exemption indexed for inflation is $5.49 million.

It is very hard to predict what action Congress will take in the near future. Therefore, at this time, we encourage individuals to be conservative in their estate planning, and assume an exemption in the range of $1 - $5 million.

Certain estate assets carry with them adverse income tax implications for personal beneficiaries, in addition to any estate tax obligation. For estate planning purposes, it is very important to identify these tax-encumbered items. They are summarized below:

• Tax-deferred retirement funds, such as traditional IRAs (not Roth IRAs), 401(k)s and 403(b)
• Series EE and HH Savings Bonds (to the extent that income has not been reported annually)
• Stock options (those which have not expired at the time of death)
• Deferred income and other accrued but not realized income such as partnership income, royalties, etc.
• Accounts Receivable from a trade or business

In the list above, the first item, tax-deferred retirement accounts, deserves special consideration. This is because the ramifications of income tax on these accounts can be significant. As you are probably aware, any withdrawals made from these accounts during your lifetime are taxed as ordinary income. Moreover, if death occurs before funds are withdrawn from these accounts, any distribution to personal beneficiaries is subject to an income in respect of decedent (IRD) tax. Basically, the funds are taxed as ordinary income before distribution to your beneficiaries, with a deduction given for any estate taxes paid. Because of this, we recommend that any charitable giving in your estate plan be funded first through these assets.

To accomplish this, at the time of death, tax-deferred retirement assets (or any tax-encumbered assets in the list above) can be given outright to charity or distributed to charity through a testamentary charitable remainder trust agreement. These two options are detailed below:
 

If retirement assets are given to a charity at the time of death of the surviving spouse, the IRD tax is eliminated, since the charitable organization is tax-exempt. Further, because the retirement assets are gifted directly to charity, a full estate tax deduction can be taken for the amount of the assets. In this arrangement, assets are distributed directly to charity instead of to personal beneficiaries. To accomplish this, you need only designate your spouse as primary beneficiary on the accounts and your charitable organizations as the secondary beneficiaries. If you are single, you may name charitable organizations as the primary beneficiaries.
 

A testamentary charitable remainder unitrust (TCRUT) eliminates the IRD tax on retirement assets and a portion of the assets from the estate for federal estate tax purposes, while at the same time providing income for heirs. When retirement assets are used to fund a TCRUT, the assets benefit personal beneficiaries for life or for a specific term of years, and then the remainder passes to charity.

With a testamentary charitable remainder unitrust (TCRUT), the donor selects the payout percentage (5% or more) and a period of time for the unitrust to make distributions to personal beneficiaries. Actual payments are determined by this payout percentage and the value of the assets in the trust. Many donors choose to pay the unitrust amount to family members for a period of time that would pay out an amount equal to the initial value of the property. For example, a trust that pays 7% for fifteen years will pay family members a total income equaling approximately the initial fair market value of the property. In this way, the donor is able to double the total benefits from the property: once to the family through income payments, and once to the charities through distribution of the principal after all income payments are completed.

One advantage of the testamentary charitable remainder unitrust is that the amount remaining in the trust grows tax-free. For example, if a person selected a 6% payout trust and the trust investments earn 8%, there would be 2% growth tax-free each year. This tax-free growth could substantially increase the value of the trust over time, and since the selected 6% payout is based on this value, distributions to personal beneficiaries would increase proportionally. The ability of the unitrust to increase both in principal and in income payments over a period of years is frequently referred to as an inflation hedge. However, please understand that this benefit does not come without risk. In the above example, if the growth in the trust falls short of the payout (6% in this instance), income payments to beneficiaries will actually decline with time.

In assessing the utilization of TCRUTs, we generally recommend that this option only be considered if at least $100,000 is available to fund this trust; otherwise administrative expenses will likely negate much of the benefit.