Archive for the ‘Trusts and Estates’ Category

Prince’s Million Dollar a Mile Mistake

Originally published in the Cedar Street Times

June 10, 2016

Unless you have been living under a rock, you have certainly heard by now that musician, Prince Rogers Nelson, passed away on April 21, 2016.  Unfortunately, he did no advance estate planning which means it is going to be an expensive, public, and litigious affair that will probably last for years.

I have seen estimates of his net worth in the media ranging from $250-$800 million.  Obviously, there is all the easy stuff to value – cash, stocks, bonds, real estate, and personal property.  But putting a value on things like his future royalties on music sales, video sales, his brand image, licensing of his lyrics or music to other artists to cover his songs, etc. is quite a task.

And what about the purported 2,000 or so unreleased songs he is said to have.  How many hits are in there?  Do you think an appraiser is going to sit in a room and listen to songs or read sheet music and put a value on each of them?  And once they come up with a dollar figure, then they have to discount it to the present value, so they would really need to consult their crystal ball for future interest rates, etc.

At one point in my career I worked with the family of a famous deceased musician, and I can tell you first hand that a lot of future value will be determined by how well his heirs maintain or expand the “Prince business machine” that will continue to promote his music and keep it alive, and keep people buying it.  And if the estate gets split up between multiple heirs that do not know each other, there will certainly be a decrease in value.  The last I checked, there was a sister, three half-siblings, and two people claiming to be his son, one of which is in prison, all vying for a piece of Prince’s estate.  So you might have to work with all of these people to buy the rights you need!

Prince certainly is not the first musician to have his estate valued, and there are accepted norms of how appraisers come to values, but I can tell you this much, whatever number they come to will not even be close to correct!  And there will certainly be a lot of negotiating between IRS appraisers and appraisers hired by Bremer Trust, the wealth management firm appointed to handle his estate.

And by the way, all of this is supposed to be done and estate taxes calculated and paid within nine months…in a perfect world.  The Form 706 United States Estate (and Generation-Skipping Transfer) Tax Return, which will list every single asset in his estate, (right down to the change in his pockets) with descriptions, values, and support for valuations is due January 21, 2017.  It is the mother of all tax returns.

The administrator of the estate can file a six month extension for the return, and the IRS can grant an additional year to pay the tax, but interest will start accruing on any unpaid tax after January 21st.  In situations with reasonable cause, the IRS can grant additional one year extensions for up to four and sometimes up to 10 years to pay the tax.  Although, they could also be assessed additional penalties.  The estate could also do an installment agreement for up to 14 years to pay the tax over time.

The extensions of time to pay, although not granted easily, are  designed to protect the interests of the heirs and the IRS.  With a massive estate and so many unknown quantities and litigation, you would have to have a fire sale to generate enough cash to pay the estate tax within nine months.

So how much estate tax will be paid?

The federal return will provide for a $5.45 million exemption for people dying in 2016.  That assumes that he made no lifetime gifts over the annual exclusion amount (currently $14,000 per person per year, and less in prior years).  It would be silly to assume someone of his wealth made no large gifts to individuals during his lifetime.  From what I have read about Prince, he probably made quite a few.  Any gifts he made in excess of the annual exclusion amounts would reduce his $5.45 million exemption.  For simplicity, though, let’s assume he made none.  So the first $5.45 million is tax free.  The rate of tax then slides from 18 percent on value in excess of $5.45 million to the top rate of 40 percent on everything over $6.45 million.  So for the first $6.45 million of his estate, a tax of $345,800 will be paid, and then 40 percent on everything over that.

Let’s assume his estate ends up being valued at $550 million and there ends up being $50 million in litigation and estate expenses leaving $500 million potentially taxable.  His federal estate tax would be $197,765,800.

Ahh, but Prince lived in Minnesota!  He was unfortunate enough to make his home in one of the 19 states (plus Washington DC) that have their own estate and/or inheritance tax.

Due to his residency the estate will also need to file a Form M706, the Minnesota equivalent of the federal Form 706. Minnesota will have a $1.6 million exemption.  The rate of tax then slides from ten percent on value in excess of $1.6 million to the top rate of 16 percent on everything over $10,300,000.  So for the first $10,300,000 of his estate a tax of $1,080,000 will be paid, and $1,600,000 for each additional $10,000,000.  So his Minnesota estate tax will be $79,432,000.

The Minnesota estate tax paid will fortunately be an additional deduction on the federal return.  So 40 percent of $79,432,000 will reduce the federal estate tax bill by $31,772,800, resulting in a $165,993,000 balance.

That will bring his total estate tax bill to $245,425,000, or roughly 49 percent, leaving his heirs with $254,575,000 to split up.

Besides all of the typical and sometimes fancy estate planning that could have been done to avoid costly litigation, and perhaps save tax through things like irrevocable life insurance trusts and other tricks up an estate planners sleeve,  I wonder if he ever simply considered setting up shop 45 miles away across the St. Croix river in Wisconsin?  It might have saved his estate $47 million – that is over $1 million per mile!

Although most people do not have $245 million estate tax bills for their heirs to worry about (or any estate tax at all), planning in advance and understanding the rules surrounding your tax and financial life is always important.  Sometimes even little things, learned early, can make a big difference.  And building a relationship with someone that can keep you on the right track is certainly of value.

Prior articles are republished on my website at www.tlongcpa.com/blog .

Travis H. Long, CPA, Inc. is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. Travis can be reached at 831-333-1041. This article is for educational purposes.  Although believed to be accurate in most situations, it does not constitute professional advice or establish a client relationship.

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Gifts Given and Received – Taxable?

Originally published in the Cedar Street Times

December 27, 2013

I remember when I was growing up, every year for Christmas, my grandfather would send a check to my brother and I for $75 each.  That seemed like an incredible amount of money to me at the time, and it really boosted my treasury each year!  One of those years, I can remember going to the bank with my mom to cash the check, and wanting to see what $75 felt like in my own two hands; I asked the teller to give it to me…all in ones.  She smiled, pulled some crisp ones from under her drawer, and counted them out for me.  I had never felt a wad of bills like that in my hands!  I tried folding them over, but I could not get them all in my pocket it was so thick, so I put them in lengthwise, and they just about stuck out the top of my pants pocket – I was a rich man!

After a week or so, we came back and deposited about half of them back into my bank account.  My dad had always encouraged us to save half of whatever we received or earned when we were growing up.  I admit, that ratio did not quite remain when I got into high school, and discovered a new and expensive hobby called, girls, but saving was ingrained in me.  When I left for college I had a measurable chunk of change in my bank account.

Throughout those years, it never occurred to me to wonder about the tax implications of the gifts I received.  Now, however, I think a lot about those things!

I do not know anyone that would hesitate to put a gift of $75 into his or her bank account.  But if you throw two or three zeroes on the end, then I definitely get questions from people wondering if it they will have to pay tax.  As the recipient of a gift, whether it is $75 or $75 million dollars, you do not have to pay taxes or report the receipt of the gift (with one exception that I can think of to be explained later).  If you receive something other than cash, such as stocks, real estate, or tangible property, you could have tax if you sell it.  The catch is that when you receive noncash gifts, you also receive the giftor’s cost basis, and when you sell you have taxable gain on the difference between the sales price and the cost basis.  For example, if someone gives you a share of stock worth $100, and that person bought it for only $10, you have to pay tax on the $90 gain if you sell it.

If you put yourself in the shoes of the person giving the gift, there are different rules you need to follow.  As long as you give less than $14,000 (2013 and 2014) a year in combined cash or noncash items to any one person, you have nothing to worry about, except providing the person evidence of your cost basis if the items are noncash items.  (You are doing a disservice if you do not provide proof of cost basis, since the person you give the noncash items to could potentially be held liable for tax on the entire amount of the gift if they sell it, and cannot prove your cost basis – this is often overlooked.)  You could give $14,000 to every person on earth each year and not have to file a gift tax return.

If you give $14,001 to just one person, then you have to file a Form 709 United States Gift Tax Return.  The portion in excess of $14,000 per person is then subtracted from your combined gift and estate tax exemption (currently $5.25 million and indexed for inflation).  For most people this is just an informational filing as they will never reach the limits, but it is required (and limits have gone up and down in the past).  If you exceed the limits, however, the person giving the gift has a tax liability at a rate as a high as 40 percent.  The only possible time I can think of that the IRS could pursue the recipient of a gift for taxes would be if the giftor gave away so much money that he or she had a tax liability and could not pay it.  The IRS in that case, could pursue the person receiving a gift for tax.

Keep in mind that a gift is different from inheriting when someone passes away.  You generally do not have tax on inherited amounts either, with the exception of tax liability on any earnings the assets you are entitled to accumulate between the date of the peron’s passing, and the date you receive the property.  Your cost basis with inherited assets is also generally more favorable as the cost basis you receive is typically the fair market value at the date the person passed away, and not their old, often lower, cost basis.

Crafty minds will sometimes think of schemes to call income a gift since gifts are not taxable.  Be careful of this – substance over form will rule the day.  Yes, it would be nice if I would do your tax preparation for free, and you also happen to be kind enough to give me money, but it ain’t gonna fly!

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

New Tax Impacts for Trusts with Capital Gains – Part III

Originally published in the Cedar Street Times

November 29, 2013

During the past two columns I laid the groundwork of some of the basics on revocable and irrevocable trusts, I discussed the new tax rates that affect many trusts, and I discussed the distinction between income and principal transaction and their relations to capital gains.

In a short summary of the past two articles, revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return.  Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns.  There are commonly two types of beneficiaries of irrevocable trusts: 1) current beneficiaries – who often receive the trust accounting income (and principal to an extent if needed) during their lifetime, and 2) remainder beneficiaries – who receive the principal upon the death of the current beneficiary.

The trust document has the power to define what type of revenues get classified to trust accounting income or principal, thus determining which beneficiary ultimately receives the money.  If the trust document does not define how a particular revenue is to be treated, as is often the case with capital gains, then the state’s principal and income act governs.  In California this means capital gains are considered a principal transaction and would not go to the current beneficiary. Federal tax rates on the highest income bracket earners have effectively risen by up to 8.8% on capital gains and 4.6% to 8.4% on other types of income. For irrevocable trusts, the highest bracket sets in at only $11,950 of income, so taxation to the trust is not generally desirable!

Picking up from that point in the last article, we can now discuss how that affects taxation.  If trust accounting income is supposed to go to the current beneficiary, then for tax purposes that income will be “pushed out” of the trust and reported on the tax returns of the current beneficiary instead of the trust.  To the extent that revenues are considered principal transactions, and are therefore slated for the remainder beneficiaries down the road, the trust pays the taxes instead.  Capital gains used to be taxed at the same rate whether the income was pushed out to the current beneficiary, or taxed in the trust.  Now, with the potential 8.8% additional tax on capital gains taxed to the trust, it matters a lot!

If there is a genuine concern that the remainder beneficiary should ultimately receive the money from gains due to appreciation, then the 8.8% additional tax would be worth it.  For many grantors that set up trusts, however, a big concern is minimizing the tax impact, and they would rather structure the trust to distribute the gains to the current beneficiary to save taxes.  This would be especially true when there is a close relation between the current beneficiary and the remainder beneficiary, such as a parent and a child, and even more so if there is a presumption that the parent will eventually give the money to the child anyway either during life or upon death.

If you are in the process of setting up a trust, I think this subject is an essential conversation that should be had between you, your attorney, and your tax professional.  The attorney can draft language to allow the trustee the power to allocate the gains on sales to trust accounting income.  It is worth mentioning that the underlying Treasury Regulation 1.643(a)-3 examples and Private Letter Ruling 200617004 place heavy emphasis on consistency by the trustee.  In other words, you cannot flip back and forth each year between allocating capital gains to income or principal; you pick a method and stick with it. I think there will be resistance from some attorneys out of habit, or rote concern for the remainder beneficiaries in considering something like this.  It is true, it may not always be the right choice, but I think given the changed landscape, it could be right for many people.

If you already have a trust, but have no explicit language in the trust document allowing for capital gains allocation to income, Treasury Regulation 1.643(a)-3 provides some leeway to do so anyway if done consistently.  But it is questionable whether you can begin treating capital gains as income if you have not been doing so in the past.  Perhaps a one-time change with a signed statement by the trustee of the intent from that point going forward would add credence.  Another approach would be to amend the trust document providing the power to allocate capital gains to income from that point forward.  If the grantor is still alive and consents to the change along with all of the beneficiaries, amending the “irrevocable trust” should not generally be a problem.  If the grantor is not living, but all the beneficiaries agree, you may be able to successfully petition the court.

Of course you do all this, and the tax rates could just change again.

Please keep in mind there are many other rules and exceptions surrounding the ideas discussed in this article which I have not space to mention.  Consulting with qualified professionals regarding your specific situation is always your best course of action.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

New Tax Impacts for Trusts with Capital Gains – Part II

Originally published in the Cedar Street Times

November 15, 2013

Two weeks ago I laid the groundwork of some of the basics on revocable and irrevocable trusts in order to start discussing new implications due to law changes in 2013.  Revocable trusts such as the common revocable living trust most people use for estate planning is disregarded for tax purposes as separate from the owner – in other words all of the income generated by its assets gets reported on your personal 1040 tax return.  Irrevocable trusts, such as a bypass trust commonly used in estate planning, or a gifting trust, are treated as separate tax paying entities, get their own taxpayer identification number, and file their own tax returns.

In early 2013 new laws were passed that increased the personal income tax rates from 35 percent to 39.6 percent on people in the highest tax bracket ($400,000 filing single or $450,000 married filing joint).  It also raised the capital gains rate to 20 percent for these same people (up from 15 percent).  In addition, a new 3.8 percent Medicare surtax is assessed on net investment income (think interest, dividends, capital gains, among others) for people making over $200,000 single or $250,000 filing joint.  Most people do not make $450,000 or even $250,000 a year, so this seems innocuous to many.

However, many people making less than these thresholds do have irrevocable trusts – most commonly after a spouse has passed away.  The problem with irrevocable trusts is that the thresholds to be impacted are so much lower.  Once your trust has just $11,950 (2013) of income, you have hit the top bracket and will be subject to the 39.6 percent income tax rate, 20 percent capital gains rate, and the 3.8 percent Medicare surcharge!  One stock sale could easily put you in the top bracket!  This effectively means an 8.8 percent tax increase on capital gains and 4.6 percent to 8.4 percent increase on other types of income.  That is a big hit every year, and will be something new to battle.

If you can avoid having the income taxed to the trust, and instead have it distributed out and taxed to the beneficiaries, you can probably save a chunk of taxes since it will be taxed at the lower rates on the beneficiary tax returns – assuming your individual beneficiaries are not in the top tax bracket!

Whether or not you have discretion or are required to distribute income to beneficiaries is defined in your trust document.  Even the very definition of “income” itself, for trust accounting purposes, is governed by your trust document primarily and the state’s principal and income act, secondarily.  The proper allocation of income and expenses to trust accounting income or principal is very important to beneficiaries (whether they realize it or not), since trust accounting income generally goes to one beneficiary, and the principal often goes to a different beneficiary down the road…so it determines the amount the beneficiaries receive.  Many common irrevocable trusts are written to require the distribution of trust accounting income each year to the current beneficiaries with rights to dip into principal as needed to maintain an ascertainable standard of living.  Upon death, the remaining principal goes to the remainder beneficiaries.

The California Uniform Principal and Income Act does not define capital gains as income, but as a principal transaction – basically an asset changing form – for instance from real estate to cash.  I hardly ever see trusts that even mention capital gains, much less defining it as a part of income.  In the absence of trust language, the principal and income act governs, therefore many trusts in California are not permitted to distribute capital gains to the beneficiaries.

It is amazing to me how many trust tax returns I have seen over the years that violate this – often because the preparer does not really understand trust taxation rules.  I have even run into cases where the prior preparer has never even asked for the trust document, and thus relies on the default settings in their tax software in conjunction with “the way we’ve always done it” to govern!  This would be analogous to creating a detailed shopping list and asking your neighbors to go shopping for you; in lieu of taking your list, they go on the internet and print out a list of common things people buy, and then supplement it with things they have bought for other neighbors in the past! Chances are pretty good; you will not get what you need!  Enforcement of correct trust income tax preparation comes much more often by threats of lawsuit against the trustee than by IRS audit. Keep in mind the remainder beneficiary’s attorney would be happy to sue the trustee for shorting his client’s share by not following the terms of the trust.

In two weeks we will conclude our discussion.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

New Tax Impacts for Trusts with Capital Gains – Part I

Originally published in the Cedar Street Times

November 1, 2013

In order to discuss the new challenge trustees have regarding capital gains, let us first review some basics regarding revocable and irrevocable trusts.

A revocable living trust is a trust created during your lifetime that spells out what you want to happen with, and who you want to control, your assets if you become incapacitated or pass away.  This is the most common type of trust, and many people set these up because it has many advantages over just having a will upon death: the chief reasons are that it provides more control, has more tax advantages, it is more private, it is faster, and it is less expensive than the default court process called probate.

I would say the one major drawback of a trust administration process compared to probate is that you do not have the standardized court oversight and genuine closure that you have with the probate process.  If there are difficult problems with trust administration, it often stems from that fact that most people appoint one of the recipients of their assets (beneficiaries) as the person responsible for carrying out the trust terms (the trustee).

Money does strange things to people, and I have witnessed it lead to families ripped apart when the non-trustee siblings start questioning the integrity of the sibling appointed as trustee.  Generally, beneficiaries want their money yesterday!  And they do not understand that it still takes a good bit of time, effort, and expense to handle everything.  That said, I would still choose to have a trust 98 percent of the time, instead of just a will.  If there are concerns about the solidarity of the beneficiaries, a corporate trustee could always be a solution.

Another characteristic of a revocable living trust is that it can be changed or even scrapped at anytime while you are alive – hence the name “revocable.”  As a result of this control feature, of being able to terminate the trust and retain the assets, the trust is disregarded as a separate taxpaying entity, and you just report all the eligible income and expenses of the trust on your personal 1040.  Everything gets reported under your Social Security Number instead of having a separate taxpayer identification number.

Now let us turn the tables and speak about irrevocable trusts.  These are trusts that generally cannot be changed once they are created.  (Of course, nothing is set in stone, and well drafted trusts with trust protector language can assist in making changes, or if all the beneficiaries agree and the court approves a petition, changes or even revocation of an irrevocable trust are possible!)

An example of  an irrevocable trust would be your revocable living trust after you pass away.  At that point, your wishes regarding the disposition of your assets are irrevocable – locked-in as you specified – and the trustee must carry out your wishes.  Often a revocable living trust will contain provisions to set up other trusts.  For married couples, it has been very common to create an irrevocable trust called a bypass trust, (aka credit shelter trust, ‘B’ Trust, etc.).

Prior to some new “permanent” laws passed in January ($5 million indexed-for-inflation estate tax exemption with portability), it was important for estate inheritance tax reasons for many people to create bypass trusts. For most people estate inheritance tax will not be a concern now, but bypass trusts, or similar types of trusts, can still be important for controlling where the deceased spouse’s assets end-up, especially in blended family situations with children from prior marriages.  In other words, dad doesn’t want mom to disinherit the children he had from a prior marriage once he dies!

Another type of common irrevocable trust is a gifting trust.  These are commonly created by a parent or a grandparent to permanently move assets out of their estate and into a trust for the benefit (or future benefit) of a child or grandchild with certain stipulations and protections governing the assets in the trust.  We saw a lot of these set up in 2012 due to the uncertainty of the estate tax laws and the possibility of missing an opportunity to save estate inheritance tax down the road.

Due to the fact that you have relinquished a lot of control with an irrevocable trust, and it will no longer be included in your estate, the taxing authorities view this trust as a separate tax paying entity.  This means it has its own tax return each year and gets its own taxpayer identification number.

In two weeks we will begin discussing the new tax rate changes and their impacts on trusts.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Ask Your Husband if He is Still Married to Someone Else!

Originally published in the Cedar Street Times

December 14, 2012

As professionals dealing with trust and estate issues, CPAs and attorneys talk a lot about making sure your beneficiary designations are up-to-date on any kind of retirement assets you may own, as they generally trump your estate plan.  There are many sad stories of widows or widowers losing assets to their deceased spouse’s ex-wife or ex-husband simply because they did not update the beneficiary designation forms.  But sometimes, even that is not enough.

At a tax seminar I attended last week, we discussed an interesting court case which makes you think you can never be too careful.  The case goes something like this: Wayne and Cleta Lee were married in the state of Washington in 1979.  In the early 1990s, Wayne moved to Mississippi.  They never got a divorce, but they went their separate ways.  In 1995, Wayne decided to marry a woman in Mississippi named Lois, but he did not bother to divorce Cleta.

Wayne was an electrical worker and was entitled to a pension when he retired in 1997.  On the pension application he listed himself as married and Lois as his wife.  He designated her specifically as the beneficiary and even attached a copy of the marriage certificate.  They both signed the application and he started receiving his pension.   In January 2007 Wayne passed away and Lois started receiving pension benefits in February.  Later that month, his first wife from Washington applied for pension benefits from the company as well!

The case eventually went to court and the district court ruled in favor of Lois since she was specifically identified in the pension application as the beneficiary for spousal benefits.  Cleta appealed and the case went to the U.S. Court of Appeals.  The U.S. Court of Appeals cited Employee Retirement Income Security Act (ERISA) rules and state laws and said the district court made its decision on the wrong basis.  They overturned the ruling and have now sent it back to the district court to determine the legal spouse.  They said the benefits go to the legal spouse at the time of his passing regardless of who was specifically named as the spouse.  If the district court determines Cleta to be the legal spouse, which the U.S. Court of Appeals hinted at quite heavily, Lois will lose out on her pension benefits.  (IBEW Pacific Coast Pension Fund v. Lee (2012) U.S. Court of Appeals for the Sixth Circuit, Case No. 10-6433)

So for all of you with spouses that have multiple wives or husbands, you may want to have a little chat!  Obviously the scary situation would be if you never knew your spouse was not officially divorced from a prior marriage, or worse, never knew they were married before.

Does this mean we will be advising clients in the future to have background checks done before picking out a ring?  I sure hope not.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Tax Changes on the Horizon?

Originally published in the Cedar Street Times

October 19, 2012

Unless you have been hiding under a rock, you are sure to have heard the hubbub surrounding potential tax increases in 2013.  These tax increases do not require Congress to take action, but to gridlock and do nothing, which is why they stand a much better chance of actually occurring than a concerted effort to raise taxes. Most of the increases are the result of the expiration of the temporary tax decreases dubbed “The Bush Tax Cuts,” passed in 2001 and 2003 while George W. Bush was in office.  There was also a two percent reduction in payroll taxes a few years ago that was meant to be a temporary stimulus for the economy.  The Tax Policy Center estimates that nearly 90% of American households will face an average tax increase of $3,500 if the tax cuts expire.

If current legislation stays in place, ordinary income tax brackets will jump 3-5%, depending on your bracket.  Capital gains tax will increase 5-15%, depending on your bracket, and there will be a new Medicare surtax, generally for people making over $200,000, of another 3.8% on net investment income.

Alternative Minimum Tax (AMT) is another big issue that could affect most Americans.  AMT is a parallel tax calculation that runs alongside the normal system, cutting out common deductions, and if it results in a higher overall tax liability, you pay the incremental difference as additional tax.

Estate and lifetime gift tax will also get hit hard.  Currently, there is a $5,120,000 exemption for the combined estate and gift tax.  If you have a taxable estate above that and you pass away by December 31, the excess will be taxed at a top rate of 35%. Next year, this exemption reverts to $1,000,000 with a maximum tax rate of 55% on your taxable estate above that figure.

This certainly presents questions for you, your tax professional, and your estate planner to analyze.  If you knew ordinary tax rates, capital gains, and estate tax rates were going to rise next year, you would likely try to push expected income from next year to this year, sell your stocks now that could result in a gain in the future, and gift money from your estate to your heirs.  It is not quite this simple, and you should get professional assistance, but it is something to think about now rather than December 31st.

Related to the estate and gift tax issue, on Saturday morning, October 27th, I will be presenting with local attorney, Kyle A. Krasa, and local investment advisor, Henry Nigos, in a free seminar titled “Opportunities and Clawbacks – Taking Advantage of the Once-in-a-Lifetime 2012 Estate/Gift Tax Rules” from 10:00 am to 11:30 am at 700 Jewell Avenue, Pacific Grove.  The seminar is sponsored by Krasa Law – please RSVP at 831-920-0205.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Donating Your Bald Eagles and Blue Jeans

Originally published in the Pacific Grove Hometown Bulletin

August 1, 2012

If you missed the July 22 issue of the New York Times, you missed a great article about estate tax the IRS is trying to levy on a piece of art that includes a genuine stuffed bald eagle.  The IRS has valued the piece of art at $65 million and wants the heirs of New York art dealer Ileana Sonnabend to pay approximately $29.2 in estate tax.

The rub, however, is that it is illegal to sell the piece of art due to the 1940 Bald and Golden Eagle Protection Act.  The heirs and their appraiser are of course contending the value is $0 since they cannot legally sell it – how can it have value?  The IRS Art Advisory Panel reportedly called it a “stunning work of art” and is contending that it could be sold illegally on the black market and therefore has value.  It sounds to me like our government wants to have it both ways – you cannot sell it but, we are still going to tax you as if you could.  I think our tax policy should promote legal activities!

The end of the article mentions a possible charitable donation instead.  I suppose this could be an option for the heirs.  Unfortunately, the estate tax would not be eliminated, since the heirs would be the donors and not the decedent.  They would also have to be able to absorb a $65 million donation in a six year period against their income.  IRS law allows you to make a charitable contribution up to 50% of your income each year which can be carried over for up to five more years.  After that, you lose the rest permanently.  One strategy for large noncash gifts is to give a partial interest in the item each year and loan the rest to the charitable organization.  This way, you do not lose any of the valuable deductions.

It is important to remember that current IRS law requires an appraisal for donations over $5,000.  This would also include multiple gifts during the year of similar items that add up to over $5,000.  So if you are taking lots of trips with household items and blue jeans, just make sure it does not go over $5,000 during the year.  It is hard to get an appraisal on a pair of jeans you donated eight months ago.  Oh, and be sure to get your charitable gift receipt!

Regarding the bald eagle art – I sure am glad Mrs. Sonnabend did not leave it in her will to me –   sounds more like a white elephant from my perspective!

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

The Stale Trust Funding Dilemma

Originally published in the Pacific Grove Hometown Bulletin

November 17, 2011

 

The Stale Trust Funding Dilemma

By Kyle A. Krasa, Esq. and Travis H. Long, CPA

A very common Estate Planning technique for married couples is an “A/B Trust.”  The ideas behind the A/B Trust are to preserve the Estate Tax Exemption of the first spouse to die and to retain a degree of control over the deceased spouse’s share of the estate, protecting the deceased spouse’s beneficiaries from the whims of the surviving spouse.  Upon the death of the first spouse, the trust sub-divides into an “A Trust” (also known as a “Survivor’s Trust”) and a “B Trust” (also known as an “Exemption Trust,” a “Bypass Trust,” or a “Family Trust”).

Many surviving spouses who have A/B Trusts either do not realize that upon the death of the first spouse they need to physically split the assets between the A and B Trusts or consciously neglect to split the assets because they feel it’s unnecessary, expensive, or time consuming.  Occasionally, a surviving spouse with an A/B Trust will realize years after the death of the first spouse that the A/B split was never completed.  Alternatively, the surviving children of a deceased couple who had an A/B Trust where no A/B split was completed upon the death of the first spouse realize the estate was never settled.  In both cases, the A/B split should have been done upon the death of the first spouse and the task at hand is to figure out how to handle the situation.

The question becomes whether the assets should be split between the A and B Trusts now, correcting the mistake of neglecting to split the assets upon the first spouse’s death (known as “stale trust funding”), or whether the A/B provisions of the trust can be ignored.

Many people upon first blush will want to ignore the A/B provisions of the trust.  After all, trying to correct a mistake made many years ago will undoubtedly create additional legal fees, accounting and tax preparation fees, time, effort, and complications.  It is much easier to sweep these problems under the proverbial rug.  However, there are many legal and tax issues that must be carefully considered before deciding to ignore what can be a significant problem.

First, the tax purpose of the A/B split is to preserve the first spouse’s Estate Tax Exemption.  If the estate is larger than one spouse’s Estate Tax Exemption, by not performing a stale A/B split, you will be forgoing perhaps hundreds of thousands of dollars in Estate Tax savings.

Second, the beneficiaries of the B Trust might be different than the beneficiaries of the A Trust.  If you ignore the A/B split, are you disenfranchising the B Trust beneficiaries?

Third, the Trustee has a fiduciary duty to carry out the terms of the trust and is thus legally required to perform the A/B split if that is what the trust dictates.  The Trustee could face serious legal consequences by ignoring the law.

Fourth, the trustee could be held liable for tax returns that were not properly filed.

Normally, an administrative trust tax return is filed for any income generated by the decedent’s assets between the date of death and the date the A and B sub-trusts are funded.  After that point, the A trust income gets reported on the surviving spouse’s 1040, and the B trust income is reported on a form 1041 tax return each year going forward.

What happens when the funding is not done for years?  Most people in these situations continue to report all the income on their 1040s after their spouse passed away, as if nothing had happened. This is incorrect.

So, do you have to go back and file tax returns for the B trust for all those years?  The IRS generally takes the position that since the B trust was never funded, there are no tax returns needed for that trust.  Once you fund the trust, then you start filing returns for it, even if years later.  However, at the same time, the IRS views the decedent’s share of assets as having belonged to an administrative trust since the date of death – still waiting to be properly distributed.  This administrative trust should have had tax returns filed every year.  It is further complicated when those assets are used, retitled, sold, and mixed with other assets improperly.

There are generally three different approaches to solving the return filing problem.  The first is to go back and file tax returns for the administrative trust dating back to the date of death.  This is the safest route, but is probably the most expensive, and may be impossible depending on the records available.  You also have the problem of potentially amending all your 1040s that were not properly prepared as a result.

The second approach some practitioners use is to essentially file blank 1041s dating back to the date of death and include a statement with each return that all the income was reported on the surviving spouse’s 1040.  The problem with this is that the amount of tax owed, besides being paid on behalf of the wrong taxable entity, is rarely the same.  Filing blank 1041s clearly brings the issue front and center to the IRS, but, it could also bring closure to the issue.

The third approach some practitioners take is to not file any administrative trust returns for the past, and just start filing returns for the B trust going forward.  This approach has risks because required returns are never filed, and therefore the statute of limitations never begins.  The issue could theoretically pop-up at any time in the future without the appearance of being forthright.

It is clear there are many issues to consider in a stale trust administration.  If you find yourself in this situation as a surviving spouse or you think you may be the future beneficiary of funds from a stale trust, it would behoove you to seek qualified professional advice to determine if or to what extent you could be affected, and what your options are.  The most common reaction is to ignore it and hope it goes away or think someone else will deal with it later.  Unfortunately, if there is an issue, it almost always resurfaces upon the death of the second spouse, at which point it gets more expensive to handle, is more likely to cause fighting between beneficiaries, or creates an irreversible financial disaster for the beneficiaries.  Fortunately, there are solutions if you act today!

Prior articles are republished on our websites atwww.krasalaw.com and www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

KRASA LAW is located at 704-D Forest Avenue, PG, and Kyle can be reached at 831-920-0205.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

My Spouse Passed Away Years Ago – I Should be Filing Tax Returns for a Trust?

Originally published in the Pacific Grove Hometown Bulletin

November 2, 2011

There is a widespread misunderstanding that if you and your spouse had set up a living trust, nothing needs to be done when the first spouse passes away except remove the deceased spouse’s name from bank accounts and real estate deeds.  If you were under this impression, you may be leaving a big headache for your heirs and subjecting half of your estate to 35 or 55 percent inheritance tax, unnecessarily.  I am sure your heirs would be quite upset to learn you inadvertently “adopted” Uncle Sam, and are making the federal government one of the largest beneficiaries of your estate!

Most trust documents in California set up for married couples have a traditional “A-B” trust formula.  Due to community property laws, typically half the assets belong to each spouse no matter who earned them or whose name is on the account or deed.  Assuming the husband passes away first, the wife’s half goes to the A trust for her to do as she pleases, and she reports all income related to these assets on her personal 1040/540 tax returns.  The husband’s half goes to the B trust.  The husband typically gives his wife the right to use the income generated by the assets in his B trust, and if she does not have enough income from her other assets, she can dip into its principal for her health, education, or maintenance.

The B trust is special because the wife generally has limited control over where those assets go when she passes away.  The husband typically determines this in the trust document – after all, it was his half.  As a result of her limited control, she is not considered the owner of the B Trust assets and they are not included in her taxable estate when she passes away!  Starting in 2013, the estate tax exemption reverts back to a measly $1 million; in California, that might be the value of the family home!  In order to get this special tax-exempt treatment, the B trust needs to be “funded” (assets properly divided and retitled to new accounts), and you have to file 1041/541 tax returns for it each year thereafter.

Estate taxes aside, the other significant reason to properly set up the B trust and file returns is “remainder beneficiaries.”  These are the people or organizations the husband said would receive the remaining assets in the B trust upon the wife’s passing.  Any of these beneficiaries could sue her if she does not segregate the assets and properly follow the terms of the B trust.  This is often important if there are children from two marriages, or the deceased spouse wanted to make sure mom did not remarry and give all the money to the new spouse instead of his own children.

A final reason is that the IRS can care as well.  Most people that fail to fund and file returns for the B trust, treat all the assets as their own, and report all the income on their personal tax returns.  The overall tax is never exactly the same compared to filing 1041s even if income is supposed to go to the surviving spouse.  Another problem is that capital gains typically do not go to the surviving spouse and are taxed to the trust (although at similar rates).  A hard line auditor could say, “Yes, you paid tax, but the trust did not.”

If you failed to fund your B trust, confront the issue by seeking competent professional advice so you can determine if you need to do something and what your options are.  If there is a potential impact, it will surely resurface in your estate.  If it is not addressed before you pass, it will either get more complicated/expensive to handle or create an irreversible consequence.

In the next article I will expand on this by discussing the tax aspects of “stale” trust funding.  Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.