Archive for the ‘bypass trust’ Tag
New Tax Impacts for Trusts with Capital Gains – Part II
Filed under: Trusts and Estates | Tags: $11950, 1040, 3.8%, B trust, beneficiary, bypass trust, California, Capital Gains, dividends, gifting trust, income, income beneficiary, interest, irrevocable trust, IRS, lawsuit, net investment income, principal, private, remainder beneficiary, revocable living trust, revocable trust, Social Security Number, tax, Uniform Principal and Income Act, UPIA
Comments (1) 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
Filed under: Trusts and Estates | Tags: 1040, B trust, bypass trust, Capital Gains, control, credit shelter trust, estate tax exemption, gifting trust, irrevocable trust, petition, portability, private, probate, revocable living trust, revocable trust, Social Security Number, tax, trust administration
Leave a comment 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.
American Taxpayer Relief Act of 2012
Filed under: General | Tags: $5 million, American Opportunity Tax Credit, American Taxpayer Relief Act of 2012, bypass trust, cancellation of debt, Capital Gains, child tax credit, code section 179, depreciation, estate tax exemption, itemized deduction phaseout, medical expenses, miscellaneous itemized deductions, net investment income, personal residence, Social Security
Leave a comment Originally published in the Cedar Street Times
January 11, 2013
The American Taxpayer Relief Act of 2012 was signed into law January 2, 2013. There was lots in the bill, but I am going to hit on a few that are notable and others that having meaning to a lot of people. I think making the Alternative Minimum Tax patch permanent and indexed for inflation was a huge victory for many taxpayers. That patch has been kicked down the road for years. The indexing will certainly alleviate concerns of a similar problem down the road. Many middle class people do not realize they were on the cusp of paying thousands of dollars more on their 2012 tax returns due in April without this fix.
The estate tax exemption being set permanently at $5 million and also indexed for inflation is huge, especially for Californians that own property. In a lot of ways, this simplifies estate planning for most individuals and will bring into question the need of the typical A-B split for many people that currently have it. Having a B trust, or bypass trust, would require additional tax work in the future, so the ability to eliminate it, could be worth the cost of amending your trust. Family dynamics may of course still dictate a B trust is prudent.
Various other temporary provisions we have been enjoying that were made permanent included marriage penalty relief for joint filers, better rules for student loan interest deductions and dependent care credit rules.
Quite a few things were extended but not made permanent. A big one was extending the exclusion from income of cancelled debt on personal residences for another year. This could be a lifesaver for those still struggling with mortgages that are “underwater.” Deductions for grade school teacher expenses and an above-the-line deduction for qualified tuition and related expenses were other items extended through 2013. More important than the deduction for tuition was the extension of the American opportunity tax credit through 2018 which saves taxpayers up to $2,500 each year as a result of education costs. Enhanced provisions of the child tax credit were also extended through 2018.
Small businesses have had the luxury of writing off high dollar amounts of many capital asset purchases through code section 179. This was slated to return to $25,000, but has been extended through 2013 at $500,000. Bonus depreciation and accelerated expensing of qualified leasehold, restaurant and retail improvements on a 15 year schedule instead of returning to a 39.5 year schedule was also extended.
Bush-era tax rates and capital gains rates have been retained for everyone but the wealthy. For people making over $400,000, their marginal bracket rose from 35% to 39.6%, and their capital gains tax went from 15% to 20%. There is also a new 3.8% medicare tax on investment income for people generally making over $200,000 and a new hospital insurance tax of .9% for people generally making over $200,000. Itemized deduction phaseouts have also returned for high income earners.
Everyday wage earners will be negatively impacted by the return of a 6.2% tax for Social Security rather than 4.2% tax we have had for the past two years, as they will see two percent less in their paychecks as a result. Another negative impact for people with high uninsured medical expenses, is that the threshold for medical itemized deductions has moved from 7.5% of your adjusted gross income to 10%. Individuals 65 and up will still enjoy the 7.5% rate for another three years.
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
Filed under: Trusts and Estates | Tags: 1041, A trust, A/B Trust, administrative trust, B trust, bypass trust, estate planning, Estate Tax, exemption trust, family trust, Inheritance Tax, living trust, stale trust, subtrust funding, survivor's trust, trust
Leave a comment 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.
Travis H. Long, CPA, Inc. Blog 