Haste makes waste. Or, in the case of estate planning, it can lead to other problems and, possibly, financial loss. Notably, if you don’t take enough time to choose the best executor for your estate, this “wrong call” can cost your family.
You may think that there’s not much to the job, but an executor’s responsibilities are extensive. As your personal representative, he or she will be entrusted with several significant duties, including collecting, protecting and taking inventory of your estate’s assets; filing the estate’s tax return and paying its taxes; handling creditors’ claims and the estate’s claims against others; making investment decisions; distributing property to beneficiaries; and liquidating assets, if necessary.
Whom should you choose as executor? Usually, it comes down to a decision between a family member or close friend and a professional.
Your first thought might be to choose a family member or a trusted friend. But this may be a mistake for one of these reasons:
- The person may be too grief-stricken to function effectively,
- If the executor stands to gain from the will, there may be a conflict of interest — real or perceived — which can lead to will contests or other disputes by disgruntled family members,
- The executor may lack the financial acumen needed for the position, or
- The executor may hire any necessary professionals, but they might not be the professionals you’d hire.
To avoid these risks, you might instead consider choosing an independent professional as executor, particularly if the professional is familiar with your financial affairs.
Form a team of executors
Finally, it’s common to appoint co-executors — one person who knows the family and understands its dynamics and an independent executor with the requisite expertise. Whether you decide to use co-executors or only one, be sure to designate at least one backup to serve in the event that your first choice is unable to do so.
© 2021 Covenant CPA
A generous gift and estate tax exemption means only a small percentage of families are currently subject to federal estate taxes. But it’s important to consider state estate taxes as well. Although many states tie their exemption amounts to the federal exemption, several states have exemptions that are significantly lower — in some cases $1 million or less.
Moving out of state isn’t necessarily the answer
One way to avoid this tax burden is to retire in a state that imposes low or no estate taxes. But moving to a tax-friendly state doesn’t necessarily mean you’ve escaped taxation by the state you left. Unless you’ve cut all ties with your former state, there’s a risk that the state will claim you’re still a resident and are subject to its estate tax.
Even if you’ve successfully established residency in a new state, you may be subject to estate taxes on real estate or tangible personal property located in the old state (depending on that state’s tax laws). And don’t assume that your estate won’t be taxed on this property merely because its value is less than the exemption amount. In some states, estate taxes are triggered when the value of your worldwide assets exceeds the exemption amount.
Establishing residency in your new state
If you’re relocating to a state with low or no estate taxes, learn about the steps you can take to terminate residency in the old state and establish residency in the new one. Examples include acquiring a residence in the new state, obtaining a driver’s license and registering to vote there, receiving important documents at your new address, opening bank accounts in the new state and closing old ones, and moving cherished personal possessions to the new state.
If you own real estate in the old state, consider transferring it to a limited liability company or other entity. In some states, interests in these entities may be treated as nontaxable intangible property.
Before putting up the “for sale” sign and moving to lower-tax pastures, consult with us about addressing your current and future states’ estate taxes in your estate plan.
© 2021 Covenant CPA
Estate planning pitfalls exist if a significant portion of your wealth is concentrated in a single stock
Estate planning and investment risk management go hand in hand. After all, an estate plan is effective only if you have some wealth to transfer to the next generation. One of the most effective strategies for reducing your investment risk is to diversify your holdings.
However, it’s not unusual for affluent people to end up with a significant portion of their wealth concentrated in one stock. There are several ways this can happen, including the exercise of stock options, participation in equity-based compensation programs, or receipt of stock in a merger or acquisition.
Ease risk by diversifying
To reduce your investment risk, the simplest option is to sell some or most of the stock and reinvest in a more diversified portfolio. But this may not be preferable if you don’t want to pay the resulting capital gains taxes. Or it may not be an option if there are legal restrictions on the amount you can sell and the timing of a sale. And in some cases, you may simply wish to hold on to the stock.
To soften the tax hit, consider selling the stock gradually over time to spread out the capital gains. Or, if you’re charitably inclined, contribute the stock to a charitable remainder trust (CRT). The trust can sell the stock tax-free, reinvest the proceeds in more diversified investments, and provide you with a current tax deduction and a regular income stream. (Be aware that CRT payouts are taxable — usually a combination of ordinary income, capital gain and tax-free amounts.)
Ease risk without selling the stock
What if you don’t want to sell the stock? You have a few options, including:
- Using a hedging technique, such as purchasing put options to sell your shares at a set price.
- Buying other securities to rebalance your portfolio. Consider borrowing the funds you need, using the concentrated stock as collateral.
- Investing in a stock protection fund. These funds allow investors who own concentrated stock positions in different industries to pool their risks, essentially insuring their holdings against catastrophic loss.
Contact us to learn about additional asset-protection strategies so that you can preserve the greatest amount of your wealth for your heirs.
© 2021 Covenant CPA
Your estate plan may include a power of attorney for property that appoints another person to manage your investments, pay your bills, file your tax returns and otherwise handle your property if you’re unable to do so. But not all powers of attorney are created equal. Thus, it’s a good idea to periodically review your power of attorney with your advisor to ensure that it continues to serve its intended purpose. Questions to consider can include:
When does it take effect? If you live in a state that permits “springing” powers of attorney, your attorney-in-fact (that is, the person who holds your power of attorney) is authorized to act only on the occurrence of the event stated in the power of attorney. Typically, the power is designed to “spring” when you become incapacitated. If a power of attorney isn’t a springing power, the attorney-in-fact can act at any time after you’ve executed the document.
Is it durable? A durable power of attorney is one that continues in force after you’ve become incapacitated. Some states’ laws presume that a power of attorney is durable, but others don’t, in which case a power may be unenforceable unless it expressly states that it’s durable.
Is it powerful enough? Careful planning is required to ensure that your attorney-in-fact has the authority he or she needs to carry out your wishes. There are certain powers that you should expressly include to ensure such authority. For example, you must specify whether your attorney-in-fact has the power to make gifts or to make estate planning decisions, such as transferring assets to a trust.
Is it too old? Your attorney-in-fact’s ability to act on your behalf depends on whether third parties are willing to honor the power of attorney. Sometimes banks and others are reluctant to rely on a power of attorney that’s several years old. Therefore, consider signing a new one every two or three years.
If you have questions regarding power of attorney, please contact us. We’d be pleased to help answer your questions.
© 2021 Covenant CPA
If your estate includes significant real estate investments, the manner in which you own these assets can have a dramatic effect on your estate plan. One versatile estate planning option to consider is tenancy-in-common (TIC) ownership.
What is tenancy-in-common?
A TIC interest is an undivided fractional interest in property. Rather than splitting the property into separate parcels, each owner has the right to use and enjoy the entire property.
An individual TIC owner can’t sell or lease the underlying property, or take other actions with respect to the property as a whole, without the other owners’ consent. But each owner has the right to sell, mortgage or transfer his or her TIC interest. This includes the right to transfer the interest, either directly or in trust, to his or her heirs or other beneficiaries.
Someone who buys or inherits a TIC interest takes over the original owner’s undivided fractional interest in the property, sharing ownership with the other tenants in common. Each TIC interest holder has a right of “partition.” That is, in the event of a dispute among the co-owners over management of the property, an owner can petition a court to divide the property into separate parcels or to force a sale and divide the proceeds among the co-owners.
How is it used in estate planning?
Here are two ways TIC interests can be used to accomplish your estate planning goals:
Distributing your wealth. If real estate constitutes a significant portion of your estate, dividing it among your heirs can be a challenge. If you transfer real estate to your children, for example — as joint tenants — their options for dealing with the property individually will be limited. What if one child wants to hold on to the real estate, but the other two want to cash out? Transferring TIC interests can avoid disputes by giving each heir the power to dispose of his or her interest without forcing a sale of the underlying property.
Reducing gift and estate taxes. Fractional interests generally are less marketable than whole interests. Plus, because an owner must share management with other co-owners, they provide less control. As a result, TIC interests may enjoy valuation discounts for gift and estate tax purposes.
Get an appraisal
If you’re considering using TIC interests as part of your estate plan, it’s critical to obtain an appraisal to support your valuation of these interests. Keep in mind that appraising a TIC interest is a two-step process: an appraisal of the real estate as a whole, followed by an appraisal of the fractional interest. In some cases, it may be desirable to use two appraisers: a real estate appraiser for the underlying property and a business valuation expert to quantify and support any valuation discounts you claim. Contact us with questions.
© 2021 Covenant CPA
As many states continue to struggle with the current surge in COVID-19 cases, the “new normal” demands continued social distancing in many areas of life. What does this mean for estate planning? Clearly, estate planning is as important today — or arguably more important — than ever. But how do you plan your estate and execute critical documents if you’re uncomfortable with face-to-face meetings or are required to self-quarantine?
Fortunately, many estate planning activities may be able to be done from the safety of your own home. Here are some options to consider, but keep in mind that requirements vary significantly from state to state, so it’s important to discuss your plans with your estate planning advisor.
Most planning can be done remotely
There are definite advantages to meeting with your advisor in person to talk about creating or updating your estate plan. But these discussions can be conducted in video conferences or phone calls, and document drafts can be transmitted and reviewed via email, secure online portals or even “snail mail.”
Traditionally, estate planning documents are executed in an attorney’s office in the presence of witnesses and a notary public. In-office document signings may still be possible with appropriate precautions, but there are other options that may allow you to avoid traveling to an attorney’s office.
The options available depend in part on the type of document being signed:
Wills. In most states, a typewritten will (as well as a modification or codicil to an existing will) must be signed in the physical presence of at least two witnesses. Typically, those witnesses must be disinterested — that is, they don’t stand to inherit or otherwise benefit under the will. But some states permit family members or other interested parties to serve as witnesses. In those states, it may be possible to conduct a will signing at home (with instructions from your attorney) and have members of your household witness it.
What about notarization? Wills are usually notarized as a best practice, but in most states it’s not required. However, wills are often accompanied by a self-proving affidavit, which must be notarized.
Another option in some states is a “holographic,” or handwritten, will, which generally doesn’t require witnesses or notarization.
Trusts. In many states, you can sign a trust document without witnesses or notarization, and it may even be possible to sign it electronically. One potential strategy for avoiding traditional will-signing requirements is to sign a holographic “pour over” will that transfers all assets to a revocable trust, which can accomplish many of the same objectives as a traditional will.
Monitor legal developments
Requirements for signing estate planning documents have been evolving in recent years, and the COVID-19 pandemic may accelerate the process more. A few states permit electronic wills (e-wills) and online notarization, which makes it possible to execute these documents without the need for physical interaction with anyone. These technologies are still in their infancy, but they’re being considered by lawmakers in many states. Contact us with any questions regarding your estate planning documents.
© 2021 Covenant CPA
An irrevocable trust has long been a key component of many estate plans. But what if it no longer serves your purposes? Is it too late to change it? Depending on applicable state law, you may have several options for fixing a “broken” trust.
How trusts break
There are several reasons a trust can break, including:
Changing family circumstances. A trust that works just fine when it’s established may no longer achieve its original goals if your family circumstances change. Some examples are a divorce, second marriage or the birth of a child.
New tax laws. Many trusts were created when gift, estate and generation-skipping transfer (GST) tax exemption amounts were relatively low. However, for 2021, the exemptions have risen to $11.7 million, so trusts designed to minimize gift, estate and GST taxes may no longer be necessary. And with transfer taxes out of the picture, the higher income taxes often associated with these trusts — previously overshadowed by transfer tax concerns — become a more important factor.
Mistakes. Potential errors include naming the wrong beneficiary, omitting a critical clause from the trust document, including a clause that’s inconsistent with your intent, and failing to allocate your GST tax exemption properly.
These are just a few examples of the many ways you might end up with a trust that fails to achieve your estate planning objectives.
How to fix them
If you have one or more trusts in need of repair, you may have several remedies at your disposal, depending on applicable law in the state where you live and, if different, in the state where the trust is located. Potential remedies include:
Reformation. The Uniform Trust Code (UTC), adopted in more than half the states, provides several remedies for broken trusts. Non-UTC states may provide similar remedies. Reformation allows you to ask a court to rewrite a trust’s terms to conform with the grantor’s intent. This remedy is available if the trust’s original terms were based on a legal or factual mistake.
Modification. This remedy may be available, also through court proceedings, if unanticipated circumstances require changes in order to achieve the trust’s purposes. Some states permit modification — even if it’s inconsistent with the trust’s purposes — with the consent of the grantor and the beneficiaries.
Decanting. Many states have decanting laws, which allow a trustee, according to his or her distribution powers, to “pour” funds from one trust into another with different terms and even in a different location. Depending on your circumstances and applicable state law, decanting may allow a trustee to correct errors, take advantage of new tax laws or another state’s asset protection laws, add or eliminate beneficiaries, and make other changes, often without court approval.
Seek professional guidance
The rules regarding modification of irrevocable trusts are complex and vary dramatically from state to state. And there are risks associated with revising or moving a trust, including uncertainty over how the IRS will view the changes. Before you make any changes, talk to us about the potential benefits and risks.
© 2021 Covenant CPA
A charitable remainder trust (CRT) allows you to support a favorite charity while potentially boosting your cash flow, shrinking the size of your taxable estate, and reducing or deferring income taxes. In a nutshell, you contribute stock or other assets to an irrevocable trust that provides you — and, if you desire, your spouse (or others you designate) — with an income stream for life or for a term of up to 20 years. At the end of the trust term, the remaining trust assets are distributed to one or more charities you’ve selected.
When you fund the trust, you’re entitled to claim a charitable income tax deduction equal to the present value of the remainder interest (subject to applicable limits on charitable deductions). Your annual payouts from the trust can be based on a fixed percentage of the trust’s initial value — this is known as a charitable remainder annuity trust (CRAT). Or they can be based on a fixed percentage of the trust’s value recalculated annually — in what’s known as a charitable remainder unitrust (CRUT).
Generally, CRUTs are preferable for two reasons. First, the annual revaluation of the trust assets allows payouts to increase if the trust assets grow, which can allow your income stream to keep up with inflation. Second, donors can make additional contributions to CRUTs, but not to CRATs.
The fixed percentage — called the unitrust amount — can range from 5% to 50%. A higher rate increases the income stream, but it reduces the value of the remainder interest and, therefore, the charitable deduction. Also, to pass muster with the IRS, the present value of the remainder interest must be at least 10% of the initial value of the trust assets.
The determination of whether the remainder interest meets the 10% requirement is made at the time the assets are transferred. If the ultimate distribution to charity is less than 10% of the amount transferred, there’s no adverse tax impact related to the contribution.
NIMCRUTs can provide an income boost
By designing a CRUT with a “net income with makeup” feature — known as a NIMCRUT — you can reduce or even eliminate payouts early in the trust term and enjoy larger payouts in later years when you’re retired or otherwise need an income boost.
Each year, a NIMCRUT distributes the lesser of the unitrust amount (say, 5%) or the trust’s net income. The trustee can invest the trust assets in growth investments that produce little or no income, allowing the trust to grow tax-free and deferring distributions to later years. The deferred payouts accumulate in a “makeup account.”
When you’re ready to begin receiving an income, the trustee shifts the assets into income-producing investments. You can use the funds in the makeup account to increase your distributions beyond the unitrust amount (up to the amount of net income).
Handle with care
CRTs, CRATs and CRUTs require careful planning and solid investment guidance to ensure that they meet your needs. Contact us to discuss your options before taking action.
© 2021 Covenant CPA
In some cases, it may be desirable to move a trust to a more favorable jurisdiction. But moving a trust from one state to another can present significant risks, so don’t attempt to do so without considering all the benefits, limitations and risks, and obtaining professional advice.
Reasons to move a trust
There are many reasons for moving a trust to another jurisdiction, such as:
- Avoiding or reducing state income taxes on the trust’s accumulated ordinary income and capital gains,
- Taking advantage of trust laws that allow the trustee to improve investment performance,
- Extending the trust’s duration,
- Obtaining stronger creditor protection for beneficiaries, and
- Reducing fees and administrative expenses.
Many people retire to states with more favorable tax laws. But just because you move to a state with lower income or estate taxes doesn’t mean your trusts move with you.
For individual income tax purposes, you’re generally taxed by your state of domicile. The state to which a trust pays taxes, however, depends on its situs.
Can your trust be moved?
Moving a trust means changing its situs from one state to another. Generally, this isn’t a problem for revocable trusts. In fact, it’s possible to change situs for a revocable trust by simply modifying it. Or, if that’s not an option, you can revoke the trust and establish a new one in the desired jurisdiction.
If a trust is irrevocable, whether it can be moved depends, in part, on the language of the trust document. Many trusts specify that the laws of a particular state govern them, in which case those laws would likely continue to apply even if the trust were moved. Some trusts expressly authorize the trustee or beneficiaries to move the trust from one jurisdiction to another.
If the trust document doesn’t designate a situs or establish procedures for changing situs, then the trust’s situs depends on several factors. These include applicable state law, where the trust is administered, the trustee’s state of residence, the domicile of the person who created the trust, the location of the beneficiaries and the location of real property held by the trust.
The actual process of moving the trust may entail creating a new trust to which the existing trust’s assets are transferred, merging the existing trust into a new trust or modifying the existing trust to designate the new state as its situs.
Depending on the trust’s terms and applicable state law, the move may require court approval or the unanimous consent of the trust’s beneficiaries.
Understanding the risks
Depending on your circumstances, moving a trust can offer tax savings and other benefits. Keep in mind, however, that the laws governing trusts are complex and vary considerably from state to state. We can help you determine whether the benefits outweigh the risks.
© 2021 Covenant CPA
Many people, when planning their estates, simply divide their assets equally among their children. But “equal” may not necessarily mean “fair.” It all depends on your family’s circumstances. Specifically, providing for grandchildren is one area where equal treatment may inadvertently result in unfairness.
Consider this scenario
Bob has two adult children, Ted and Carol. Ted has two children and Carol has four. Suppose Bob’s estate plan calls for his $8 million estate to be divided equally between his two children.
When he dies, Ted and Carol each receive $4 million. But after they die, Ted’s two children receive $2 million each from their grandparent’s inheritance, while Carol’s four children receive only $1 million each. (This assumes, of course, that Ted and Carol each preserve the full amount of their inheritances.)
To help ensure that Bob’s grandchildren are treated equally, he can purchase a life insurance policy, with the proceeds divided equally among his grandchildren. Alternatively, he can arrange policies on the lives of Ted and Carol designed to provide equal amounts to each grandchild. One advantage of this approach is that, because Ted and Carol are younger, the available death benefits would be greater. Bob could use gifts or loans to help Ted and Carol pay the premiums.
Life insurance allows Bob to provide more for his grandchildren, on an equal basis, while still dividing his other assets equally between his children. Depending on how Ted and Carol spend their inheritances, Ted’s children may still receive more than Carol’s on a per capita basis, but the additional assets provided by life insurance will likely make Bob’s estate plan appear “more fair” in the eyes of his grandchildren.
If you have concerns about how to properly address certain family members in your estate plan, please contact us. We’d be happy to assess your situation and offer the proper guidance.
© 2021 Covenant CPA