Set up the right way, trusts are a great way to protect assets. But beware of the pitfalls.
By ERIN MCCARTHY
Updated Nov. 9, 2014 4:46 p.m. ET
For many investors, trusts are an ideal way to keep portfolios safer for the long term.
The hard part is knowing what kind of trusts to set up and how to do it.
Trusts can protect assets from taxes and legal threats, and provide income for family and descendants for years to come. But if a trust isn’t set up correctly, it can be ignored by the courts. Safeguards set up for family members may no longer exist, or planned tax savings may no longer be in effect.
Here’s a look at several kinds of trusts, which ones work best for whom, and mistakes to avoid.
Irrevocable Life Insurance Trust What It Is: This is used to buy life insurance on behalf of the person establishing the trust. The trust owns the insurance and pays the premium, and the benefits are paid into the trust. That way, the death benefit is isolated from estate tax, says Joan Crain, wealth strategist at BNY Mellon Wealth Management.
Life-insurance payouts can raise the risk that the insured’s estate will be taxable. And if the estate is already taxable, the payouts make the taxes worse, says Robert Weiss, the global head of J.P. Morgan Private Bank’s Advice Lab.
With a trust, the payouts won’t increase the beneficiary’s estate. The death benefit can be paid immediately or stay in trust for generations. The insured can put more than one policy into a single trust, or create multiple trusts for different beneficiaries. Policies in a trust also have some creditor protections.
Best for: The trusts are ideal for someone younger, who can obtain life insurance at affordable rates, and wants to protect any large insurance benefits from facing estate taxes.
Mistakes Often Made: Mr. Weiss says he has seen people set up a trust but never put the policy into it; others pay the premiums from their personal assets rather than from the trust. In such cases, those payments are not protected from any wealth-transfer taxes.
Granter Retained Annuity Trust What It Is: Also known as GRATs, these trusts are typically short term, most commonly two to five years, and allow people to transfer their wealth to family members with little to no exposure to wealth-transfer taxes.
The granter places assets—such as cash, stocks or bonds—into the trust and each year receives an annuity payment. At the end of the trust’s term, if the trust’s assets have outperformed a “hurdle rate” set by the IRS—also known as the 7520 rate—those excess returns are distributed to the trust’s beneficiaries or into another trust, free of gift and estate tax, J.P. Morgan says.
In recent years, low interest rates have resulted in an especially low hurdle rate, giving people more confidence their assets will outperform.
Best for: GRATs are ideal for granters who want to pass on assets to their own children while avoiding a hefty wealth-transfer tax. Through these short-term trusts, investors often try to take advantage of market volatility, placing assets in the trust that are expected to perform well in the next few years.
Mistakes Often Made: One critical point: The granter must survive the term of the trust. If the granter dies before the trust reaches the end of its term, the trust collapses and the assets are returned to the granter’s estate.
Dynasty TrustWhat It Is: These trusts allow families to use wealth-transfer tax exemptions of up to $5.34 million per person to place assets into trust and let them grow untouched. “The idea there is that you’re creating a family resource that’s a pool for future generations,” says Carol Kroch, managing director of wealth and philanthropic planning at Wilmington Trust Co.
Best for: They are for individuals thinking very, very long term. Then later, the trust can make tax-free distributions to the granter’s children, grandchildren or future generations. The trust can specify whether beneficiaries will have access to its income or principal, and when. Such trusts can provide a great deal of tax savings.
Mistakes Often Made: Not all states allow dynasty trusts. Delaware, Pennsylvania, Rhode Island, Idaho and Louisiana are among the states that do.
Also, granters should use the trusts for assets they are confident will appreciate. If they use a wealth-transfer tax exemption to fund a trust with a stock that falls in value, the exemption ends up being wasted, Mr. Weiss says.
Qualified Personal Residence TrustWhat It Is: A homeowner can place a residence in this trust—often a second home—to transfer the property later without paying full transfer taxes. The granter pays gift tax when the home goes into the trust, but on a reduced value of the house, since they reserve the right to live in it for the term of the trust, according to BNY Mellon Wealth Management. The value of the home for gift-tax purposes is the fair market value minus the present value of the granter’s right to use it during the length of the trust (calculated using an IRS formula), J.P. Morgan says.
The trust lasts a certain number of years, and when it ends, the beneficiaries—often children—will own the residence. Any appreciation of the home since being placed in the trust is transferred to beneficiaries free of gift and estate tax. If the granter dies before the trust’s term ends, the home is transferred back to the granter’s estate.
Best for: People with vacation homes who know they want to give them away to their children or other family members down the line.
Mistakes Often Made: These trusts are most beneficial when interest rates are higher, since that results in a lower gift-tax value on the residence when it is placed in the trust.
Revocable Living TrustWhat It Is: This is a trust created to hold and protect assets during an individual’s lifetime. While it doesn’t provide any tax savings, it does protect assets from probate. The individual creating the trust can also assign a successor trustee in the case of his/her death or incapacitation, which is a critical benefit, says Ms. Crain.
Best for: A revocable living trust makes sense for someone middle-aged or older who has money or investments that “they wouldn’t want the court to take over if there’s something that happens to them,” Ms. Crain says. It also could be a good fit for someone seeking privacy, as a living trust is shielded from public scrutiny, rather than the estate being settled through probate, she adds.
Mistakes Often Made: Some investors don’t put all the assets they should in the trust, so those assets are not protected from probate, Mr. Weiss says.
Charitable Remainder TrustWhat It Is: Here, a granter puts assets into a trust and takes at least a 5% income interest, or assigns it to another beneficiary. What is left at the end of the trust’s term goes to charity, and the granter receives an income-tax deduction for that amount, says Ms. Kroch of Wilmington Trust. The beneficiaries pay income taxes on the distributions.
Best for: These trusts are ideal for an investor who has assets that have already grown, since assets in the trust can be sold without incurring capital gains taxes, advisers say.
Mistakes Often Made: Ms. Kroch advises working with a trusted professional, as the rules are very detailed.
Ms. McCarthy is a reporter for The Wall Street Journal in New York. Email email@example.com.
Looking back over 2014, many business owners saw a welcomed uptick in sales and growth. This growth has important tax consequences and business owners should now take time to review their year-end tax planning. For many business owners, this is a routine project. Others may have done some year-end planning in past years but not in recent years. Year-end tax planning presents the opportunity to explore situations that could maximize tax savings and should not be overlooked. This communication explores some of the year-end planning considerations that affect businesses in general. Of course, every business is unique. Our office can review your business and together we can design a year-end tax strategy.
Utilizing expensing and bonus depreciation
Many business owners are familiar with the benefits of Code Sec. 179 expensing and bonus depreciation. For tax years beginning in 2012 and 2013, the Code Sec. 179 dollar limitation was $500,000 (indexed for inflation) and the investment limitation was $2 million (indexed for inflation). Also, for tax years beginning in 2012 and 2013, taxpayers could elect to treat up to $250,000 of qualified real property as Code Sec. 179 property. In addition, Code Sec. 179 expensing was allowed for off-the-shelf computer software.
These enhanced amounts expired after 2013. However, these enhancements are likely to be extended by Congress although the timeframe is uncertain.
Similarly, bonus depreciation has generally expired under current law. Bonus depreciation applied to qualified property acquired after December 31, 2007 and placed in service before January 1, 2014 (January 1, 2015 for certain property with a longer production period and certain noncommercial aircraft). Bonus depreciation could be extended for two years (with retroactive application for 2014). If bonus depreciation is extended, a 50 percent bonus depreciation allowance is the most likely percentage.
Uncertainly over the ultimate fate of enhanced Code Sec. 179 expensing and bonus depreciation impacts 2014 year-end planning, particularly as business owners contemplate purchases of equipment and supplies. Businesses considering qualified purchases need to weigh the benefits of making these purchases before year-end or postponing these purchases after 2014. Because enhanced Code Sec. 179 expensing and bonus depreciation are likely to be extended (and made retroactive to January 1, 2014), businesses may be able to take advantage of these incentives in 2014 and 2015.
Planning with expired business tax breaks
Every two years, many temporary business tax breaks come up for renewal and 2014 is no exception. The extension of many of these incentives in the American Taxpayer Relief Act of 2012 (ATRA) has expired. The research tax credit, special expensing rules for film and television productions, the credit for employer-provided child care facilities and services, and others expired after December 31, 2014. Like enhanced Code Sec. 179 expensing and bonus depreciation, it appears that taxpayers will not know the fate of these incentives until late in 2014 or in early 2015. Congress could, as it has in the past, renew these incentives in a comprehensive bill or it could proceed piecemeal.
Along with the business incentives highlighted above, other business tax breaks also expired after 2013, including:
• Work Opportunity Tax Credit
· Employer wage credit for activated military reservists
· Railroad track maintenance credit
· Recognition period for S corporation built-in gains
· Indian employment credit
· Accelerated depreciation for business property on Indian reservations
· Election to expense mine safety equipment
· Credit for new energy efficient homes
· Enhanced deduction for charitable contributions of food inventory
· Empowerment zone tax benefits
· Credit for electricity produced from renewable resources
· Cellulosic biofuel producer credit
· Energy efficient appliance credit for manufacturers
· Incentives for biodiesel, renewable diesel and alternative fuels
· 15-year straight line recovery for qualified leasehold improvements
· 15-year straight line recovery for qualified restaurant property
· 15-year straight line recovery for qualified retail improvements
The expired tax breaks affect a wide variety of businesses. Businesses may have utilized one or more of the expired tax incentives in past years. Some past strategies may continue to be valuable. Our office can help ascertain the effectiveness of these strategies at year-end 2014.
Gearing up for Affordable Care Act requirements
Few laws have had, and continue to have, such an impact on tax planning as the Affordable Care Act. The health care reform law affects every business in some way. While small employers (employers with fewer than 50 full-time employees, including full-time equivalent employees) are exempt from the Affordable Care Act’s employer mandate, small business should not overlook other provisions that could generate tax savings. Mid-size and larger businesses do fall under the employer mandate and other requirements; however, mid-size employers are exempt from the employer mandate for 2015. Employers qualify as mid-size if they employ on average at least 50 full-time employees, including full-time equivalents, but fewer than 100 full-time employees, including full-time equivalents. Mid-size employers also must satisfy other requirements to qualify for the transition relief. Under current rules, transition relief is only available for 2015 but it could be extended.
Business owners need to plan for how seasonal and other workers may affect their liability for the employer mandate. Seasonal workers, on-call employees, student workers, and others must be taken into account to determine the number of the employer’s full-time employees. The rules are complex but they cannot be ignored.
Mid-size and larger businesses are responsible for new information reporting requirements under Code Sec. 6056. These employers must tell the IRS if they offer health insurance to employees, among other criteria. The Code Sec. 6056 reporting requirements are effective for health insurance coverage offered, or not offered, in 2015. Small employers that are exempt from the employer mandate are also exempt from Code Sec. 6056 reporting.
Owners of small businesses should not overlook a tax credit that helps offset the cost of providing health insurance to employees. The small employer must have fewer than 25 full-time equivalent employees (FTEs) for the tax year; average annual wages of its employees for the year must be less than $50,000 per FTE; and the employer must pay the premiums under a qualifying arrangement. If the number of FTEs exceeds 10 or if average annual wages exceed $25,000, the amount of the credit is reduced until it phases-out.
The Treasury Department is expected to unveil a new retirement savings arrangement before the end of 2014. The new accounts are called myRa. These accounts will be offered through employers that elect to participate. Account holders will be able to build savings for 30 years or until their myRA reaches $15,000, whichever comes first. After that, myRA balances will transfer to private-sector Roth IRAs. Small business owners should explore the benefits of offering myRAs to their employees. As more details are released, business owners can weigh the value of these new accounts. At the same time, business owners can explore other retirement savings vehicles, including SIMPLE IRA plans, SEP plans, and payroll deduction IRAs.
If you have any questions about the year-end planning considerations we have reviewed, please contact our office.
As 2014 draws to a close, businesses should review their tax planning strategies and techniques. CCH has prepared this sample 2014 year-end tax planning client letter for businesses that practitioners can email to clients. (10/14/2014)
As you know, the alternative minimum tax (AMT) system was originally enacted to ensure that all taxpayers, particularly higher-income taxpayers, pay at least a minimum amount of federal income tax. The AMT generally imposes a minimum tax on taxpayers who have substantially lowered their regular tax liability by taking advantage of tax-favored and preference items, including deductions, exemptions, and credits.
In recent years, a growing number of middle income taxpayers were affected by the AMT. However, since the AMT exemption amounts are now indexed for inflation, many middle-income taxpayers are no longer impacted. For those taxpayers who remain subject to the AMT, the permanent indexing provides some certainty for planning purposes.
Depending on the amount of your "taxable excess," AMT rates ranging from 26 to 28 percent may be imposed on tax preference and adjustment items. In view of the serious risk of AMT exposure, careful planning to reduce your overall tax bill is critical.
Although the AMT is a significant concern, tax planning should not focus solely on eliminating AMT liability. Due to the complexity of the interrelationship of the AMT and regular tax systems, concentration on lowering minimum tax liability alone could easily result in an unwanted increase in your regular income tax liability.
In general, the best way to handle AMT liability is careful planning involving the coordination of future regular income tax and AMT, using accurate projections of income, expenses, and deductions over multiple years with several alternative scenarios. An overall plan must then be devised to manage your AMT liability without raising regular tax liability.
We believe that a thorough analysis of your current and projected tax situation could minimize or eliminate your exposure to AMT liability. Please contact our office to make an appointment to discuss this important tax planning opportunity.
We know that you have worked hard for your money and would like to reap the benefits to the greatest extent possible. Your ultimate goal is to sustain a successful wealth-building strategy while avoiding unnecessary and expensive tax consequences. We are interested in helping you achieve these objectives.
For the last few years, there has been talk of major tax reform that would place an increased tax burden on higher income individuals. Included in these discussions is the so-called “Buffet Rule,” which would impose a minimum tax rate of 30 percent on adjusted gross income (AGI) over $1 million. Most tax professionals predict that tax reform has little chance of becoming law in 2014, but it is wise to weigh your options carefully with higher tax rates looming on the horizon.
Although there is more certainty afforded for 2014 tax planning due to the many permanent tax incentives provided by the 2012 Taxpayer Relief Act, higher income individuals like you must carefully structure your financial transactions in order to minimize your tax burden.
Some of the issues that may impact your tax planning strategy for 2014 include:
· your marginal tax rate;
· personal exemption and itemized deduction phaseouts;
· additional 0.9 percent Medicare tax on wages and self-employment income over threshold amounts;
· net investment income tax of 3.8 percent for taxpayers with modified AGI exceeding threshold amounts;
· increased capital gain rate of 20 percent for taxpayers in the highest tax bracket;
· a decreased gain exclusion (from 100 percent to 50 percent) for small business stock acquired in 2014 or later and held for more than 5 years;
· the individual mandate to carry minimum essential health coverage;
· foreign account disclosure and reporting requirements and related enforcement penalties;
· in-service rollovers to designated Roth accounts without the imposition of a 10-percent additional tax on early distributions;
· unless retroactively extended by Congress, the exclusion from income of IRA distributions to charity of up to $100,000 is not available for 2014;
· strict rules about deducting passive activity losses (PALs); and
· alternative minimum tax (AMT).
As you can see, the more complex issues faced by higher-income individuals create a challenging planning environment for the 2014 tax filing season. We would like to meet with you to discuss the options that are best suited to meet your personal financial goals while minimizing your tax liability. Please contact our office at your earliest convenience to make an appointment.
ClientRelate customers who have run the search associated with the 2014 Planning: Tax Issues for Higher-Income Individuals Service can send this letter to clients appearing on the search results list. (04/21/2014)
BY DONALD JAY KORN
NOV 6, 2014
Charitable remainder trusts are back in style.
"The CRT is becoming popular again," says Rob O'Dell, co-founder of Wheaton Wealth Partners, which has offices in Wheaton, Ill. and Naples, Fla.
Clients who create CRTs donate assets -- usually appreciated -- to the trust, and then receive an income stream from those assets while they're in the trust. The trust can sell assets without owing tax on their sale, so creators receive income from the trust at the pretax value of the sold assets. When the trust expires -- either after a set number of years or when the donor dies -- the trust's remaining --assets pass to a designated charity or charities.
Donating assets to a CRT can remove them from the donor's estate. Moreover, transferring appreciated assets to a CRT not only defers tax on the gain, it provides a current partial tax deduction for the future charitable contribution.
IN & OUT OF FAVOR
"In the 1990s," O'Dell recalls, "CRTs were fantastic for income tax and estate planning. Estate tax exemptions were low and the tech boom was happening."
Following the 1990s boom in CRTs came a "lost decade" for the trusts, says O’Dell. The estate tax exemption was expanded, reducing that tax, and a lower tax rate on long-term gains made it less appealing to donate appreciated assets. Between 20015 and 2012, the number of CRTs fell to fewer than 106,000 from more than 116,000, according to the number of tax forms filed.
"We had clients with CRTs who dismantled them," O'Dell says.
Now, with a market rebound and higher taxes on gains, CRTs may offer income tax relief for some. "We have clients implementing CRTs to diversify out of equities that have produced good returns," O'Dell says.
CRTs can be used for more than equities, says Bryan Polley, an investment consultant with Allodium Investment Consultants in Minneapolis. His clients include a couple that owned a Minneapolis property worth $6 million; they faced a large capital gain on a sale.
"They wanted to make a substantial gift to a specific charity with the proceeds," says Polley, "so we discussed a CRT with them. Eventually, they gifted half of the property to a CRT and retained the other 50%. A developer agreed to buy the property from both parties, for $3 million apiece."
As a result, the clients received $3 million in cash as well as an immediate tax deduction.
The CRT's $3 million was invested in a diversified portfolio, Polley reports, and the couple will receive lifetime income from the CRT. After their deaths, the money remaining in the CRT will be distributed to their favored charity.
Polley says that for clients such as these, with highly appreciated assets and a clear charitable intent, the use of a CRT is "perfect."
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.