This is the third article in a series discussing various tax planning opportunities that should be considered in the wake of the recent elections.  For the prior articles see:

Postponing Sales Until 2017; and

Should you Accelerate Charitable Gifts to 2016?

President-Elect Trump has made it clear that he intends to repeal federal estate taxes.  In light of the Republican majorities in the House and Senate, prognosticators believe that estate tax repeal will occur in the near future.  Assuming that estate taxes are repealed, there are numerous questions.

First, when will the repeal occur?  The last time that estate taxes were repealed in 2001, the repeal did not actually occur until 2010.  If there is a repeal with a delayed effective date, you will still owe taxes if you are unfortunate enough to die before the repeal becomes effective.

The second issue is whether repeal will be permanent.  Federal estate or inheritance taxes have been repealed four times in the past (1802, 1870, 1895, and 2010).  Each time the tax was repealed, it was later reenacted in a different form.  The most recent reenactment actually occurred in 2001, by the same Congress that repealed the tax for 2010.  They actually voted for the tax to reappear in 2011!  Based on history, I do not expect that repeal will be permanent.  It is easy to imagine a day when the 99.9% who will not have to pay the tax again decide that it is fair for our wealthiest taxpayers to pay a tax upon death.  Of course, this is grossly unfair to the 0.1%, but it was unfair every other time that estate taxes were enacted.

The third issue is whether the revenue loss from estate tax repeal will be replaced, in whole or in part, by a loss of stepped-up basis, or, even worse, capital gains tax upon death.  Under current law, the income tax basis of assets gets changed to the fair market value of the assets owned upon death.  The asset can be sold by one’s heirs soon after death without paying capital gains tax.  If stepped-up basis is removed, the tax will need to be paid when assets are sold after death.  When the tax was repealed in 2010, stepped-up basis was removed, though there was a limited amount of basis step-up granted.  Unlike estate taxes, which currently only are paid by 0.1% of decedents, stepped-up basis benefits the families of all decedents who own appreciated assets.

A more troubling possibility is a capital gains at death tax system, which is used in Canada.  This system would impose a capital gains tax on the built-in gains on assets owned at death.  If you lose stepped-up basis, at least you can postpone the date upon which the tax will be incurred.  If taxes are imposed at the time of death, the ability to postpone the tax will be lost.

Several clients have asked us whether they should alter their estate planning in light of the proposed repeal of estate taxes.  In my opinion, it is premature to alter your estate planning based upon the assumption that you will die in a year in which estate taxes do not exist.  As a general rule, if there are sensible strategies to remove assets from your taxable estate, I recommend that you implement these strategies.  As always, you should favor strategies that are flexible so that you can take advantage of future opportunities.

I have learned from experience that significant changes in Washington create tax planning opportunities.  Tax laws always change significantly when the party affiliation of the President flips.  It might seem prudent to wait for the laws to change before making major decisions.  However, waiting for certainty may result in foregone opportunities.

In the last few days, I have received numerous calls from clients about various tax issues that are impacted by the results of the election.  I plan to write a series of articles detailing the types of issues that my clients are confronting.

The first decision involves the timing of the sale of a significant asset.  One client was planning to sell real estate in December.  Another client was planning to sell his business in December.  These clients both contacted the buyer about postponing the sales until January of 2017.  They are hoping that income tax rates will be lower for sales in 2017.  If rates are reduced in 2017, will be the rate decrease be made retroactive to January 1, 2017?  There is precedent for making this type of a change.  However, there is also precedent for making a change effective during the middle of a year.  Postponing sales until January seems like a sensible strategy, though waiting longer might provide a better result.

This is the third article of a series regarding 2014 Trust and Estate Planning

For the prior articles, see:

[Link to PART 1:  Introduction]

[Link to PART 2:  65 Day Rule for Trust Distributions]

The previous article highlighted the opportunity of making a distribution from a trust by March 6th in order to reduce income taxes.  The problem for some of our clients is that they don’t want the beneficiary to get their hands on a large sum of money.  One trust would like to make a distribution of $265,000 in order to reduce overall income taxes.

Several of our clients have utilized asset protection trusts to capture income tax savings in a manner that does not result in their children receiving a lot of cash.  These clients have been able to persuade their child to establish an asset protection trust with the parent as the trustee.  The child’s trust (typically established by the child’s parent or grandparent) then makes a distribution directly to the asset protection trust

The asset protection trust uses the social security number of the child as its taxpayer identification number.  The trust income tax rules treat the distribution from the child’s trust to the asset protection trust as a distribution to the child.  The income will be taxed on the child’s Form 1040 where it will enjoy a lower tax rate than if the child’s trust had not made a distribution.

You can use an asset protection trust even if it is established after March 6.  First, make a distribution to the child on March 6 and have the child deposit the distribution in a savings account.  After the asset protection trust is established, the child will then move the funds to the asset protection trust.  This technique is not as good as the direct trust-to-trust transfer, because the child has access to the funds for some period of time.

Minors are not able to establish asset protection trusts.  However, there are other techniques that can be used to make a distribution to a minor in order to reduce income taxes.  All of these techniques have flaws, but the flaws should be evaluated against the potential income tax savings.

Since 2010, the Federal estate tax exemption has been $5 million or higher. When a person dies and does not use all of his or her estate tax exemption, his spouse is able to add the unused exemption to his or her exemption if an estate tax return is filed, which elects to carry over the decedent’s unused exemption to the surviving spouse. This election is referred to as a portability election.

The IRS previously ruled that the portability election could only be made on a timely filed estate tax return, either nine months after the decedent’s death or 15 months if an extension is requested. A lot of surviving spouses who might benefit from electing portability neglected to file a timely estate tax return. Fortunately, the IRS has published Revenue Procedure 2014-18, which gives an extension until the end of 2014 to file the estate tax return to make the portability election. The Revenue Procedure will only help for a decedent who died between January 1, 2011 and December 31, 2013 and whose estate was below the estate tax filing threshold.

The Revenue Procedure will also help the surviving spouse of a same-sex marriage. Prior to the Windsor decision by the Supreme Court, a federal law known as the Defense of Marriage Act (“DOMA”) did not allow the surviving spouse of a same-sex marriage to make the portability election. Now that the Supreme Court has ruled DOMA to be unconstitutional, the surviving spouse is allowed to make a portability election. The new Revenue Procedure will allow an estate tax return to be filed in 2014 so that the surviving spouse can benefit from portability, even if the deadline for filing the return has already passed.

 

On Thursday, August 29, 2013, the IRS issued Revenue Ruling 2013-17 regarding the tax treatment of same-sex spouses. Effective immediately, same-sex spouses will be treated the same as a heterosexual married couple for federal tax purposes. The District of Columbia and 13 states now allow same-sex spouses to become legally married. Prior to the issuance of the Revenue Ruling, the IRS did not recognize a same sex marriage for purposes of federal tax laws. The change in policy does not apply to civil unions or registered domestic partnerships.

There are numerous tax ramifications to this change. One consequence is that same-sex couples are now required to file a joint income tax return, even if they live in a state that does not recognize same-sex marriages. For 2012, they have an option to file as two single persons or as a married couple. However, if they want to file as two single persons, they must file or amend their 2012 income tax returns on or before September 16, 2013. If they file their 2012 income tax returns after September 16, 2013, they are required to file as a married couple. Due to the so called "marriage penalty," it is hard to predict whether it is better to file together or separately. In general, if there is a wide disparity between the amounts of income earned by the spouses, it will be better to file a joint return. If the spouses earn approximately the same amount of income, it will probably be better to file as two single persons.

In addition to the very quick decision that must be made with respect to 2012 income tax returns, a decision also needs to be made about filing claims for refund. If it would result in a tax refund, the spouses can amend their tax returns for 2011 and 2010, and perhaps 2009 (depending upon when their 2009 tax returns were filed), to file their returns as married filing joint. They do not have to amend their returns if it would cause additional taxes to be paid.

A gift or bequest to your spouse now qualifies for the federal gift or estate tax marital deduction. If taxes have been paid on a gift or bequest to a same-sex spouse within the last 3 years, or if gift tax exemption has been used, you should consider filing a refund claim. If your Will makes a bequest to a trust for your spouse, you should consider modifying the trust to qualify for the estate tax marital deduction. If you are not married, have an estate of more than $5.25 million, and plan to make a bequest to a same-sex partner, you should consider getting married in one of the states that allows same-sex marriages.

Portability allows a surviving spouse to benefit from his/her spouse’s unused federal estate tax exemption. A portability election is made by filing a federal estate tax return within 9 months after the decedent’s death, or within 15 months after the decedent’s death if an extension is requested within the first 9 months.

A number of estates of decedents who died in the first few months of 2011 failed to take advantage of the portability election due to confusion over this new provision and delayed IRS guidance. In light of the confusion, the IRS has decided to allow certain estates to make the election even if they missed the deadline.

Estates of decedents who died during the first six months of 2011 may make the portability election as long as they file Form 706 within 15 months after the date of the decedent’s death. For example, if the decedent died on January 2, 2011, a Form 706 needs to be filed no later than April 2, 2012. This limited group of estates could make the election even though an extension of time to file was not requested. 

At this time, we do not know for sure that the surviving spouse will benefit from portability. As the law is currently written, the surviving spouse will only benefit if he or she dies before December 31, 2012 and would otherwise owe federal estate taxes. Generally, this means that they must have an estate over $5.12 million. Current law eliminates the benefit of portability for surviving spouses who die on January 1, 2013 or later. Even though very few will benefit from the law as currently written, we are still recommending that you make the portability election. President Obama’s budget proposal recommends that portability be extended permanently. Furthermore, portability has widespread support in both houses of Congress.

If you are the Executor of the estate of a married person who died after December 31, 2010, you should consider filing Form 706 to make the portability election even though a Form 706 does not otherwise have to be filed.

See below for a helpful tax tip from the IRS.

Taxpayers sometimes need tax returns from previous years for loan applications, to estimate tax withholding, for legal reasons or because records were destroyed in a natural disaster or fire. If your original tax returns were lost or destroyed, you can obtain copies or transcripts from the IRS. Here are 10 things to know if you need federal tax return information from a previously filed tax return.

  1. There are three options for obtaining free copies of your federal tax return information – on the web, by phone or by mail.
  2. The IRS does not charge a fee for transcripts, which are available for the current and past three tax years.
  3. A tax return transcript shows most line items from your tax return as it was originally filed, including any accompanying forms and schedules. It does not reflect any changes made after the return was filed.
  4. A tax account transcript shows any later adjustments either you or the IRS made after the tax return was filed. This transcript shows basic data, including marital status, type of return filed, adjusted gross income and taxable income.
  5. To request either transcript online, go to www.irs.gov and use our online tool called Order A Transcript. To order by phone, call 800-908-9946 and follow the prompts in the recorded message.
  6. To request a 1040, 1040A or 1040EZ tax return transcript through the mail, complete IRS Form 4506T-EZ, Short Form Request for Individual Tax Return Transcript. Businesses, partnerships and individuals who need transcript information from other forms or need a tax account transcript must use the Form 4506T, Request for Transcript of Tax Return.
  7. If you order online or by phone, you should receive your tax return transcript within five to 10 days from the time the IRS receives your request. Allow 30 calendar days for delivery of a tax account transcript if you order by mail.
  8. If you still need an actual copy of a previously processed tax return, it will cost $57 for each tax year you order. Complete Form 4506, Request for Copy of Tax Return, and mail it to the IRS address listed on the form for your area. Copies are generally available for the current year and past six years. Please allow 60 days for actual copies of your return.
  9. The fee for copies of tax returns may be waived if you are in an area that is declared a federal disaster by the President. Visit www.irs.gov, keyword “disaster,” for more guidance on disaster relief.

Visit www.irs.gov to determine which form will meet your needs. Forms 4506, 4506T and 4506T-EZ are available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Estates of decedents who died in 2010 were given a very valuable option. They can elect to not be subject to estate taxes and have carryover basis for income tax purposes. Alternatively, they can elect to be subject to estate taxes yet receive a stepped-up basis for the assets owned by the decedent.

Those who choose to be subject to the estate tax system are required to file a Form 706 by September 19, 2011 if the estate is larger than $5 million. The IRS has just announced that these estates may obtain a six-month extension of the time to file to March 19, 2012 by requesting an extension on Form 4768.

Those who choose to be in the carryover basis system will be required to file a Form 8939. Originally, the IRS said that Form 8939 would be due on November 15, 2011. That deadline has been extended until January 17, 2012.

One of the reasons the IRS extended these dates is because of their delay in providing the appropriate forms. We only recently received the Form 706 and the accompanying instructions. We have yet to receive Form 8939.

All of the estates with whom we are working know which system they plan to elect. All of the estates under $5 million are electing the estate tax system so that they can have stepped-up basis for income tax purposes without having to file Form 8939. These estates do not have to file any forms to make this election. Only 1 of the estates that were above $5 million are choosing the estate tax system. The rest are choosing the carryover basis system. The 2 month extension until January 17, 2011 is very welcome news for these estates, especially since we have yet to see the Form 8939.
 
If you are uncertain of the best tax system, you should file the Form 4768 no later than September 19, 2011. This will buy you 4 months of time to make the decision. You will not be precluded from electing the carryover basis system if you file the Form 4768.

If you file Form 4768, you should also request an extension of time for payment of any estate taxes that would be owed. If you eventually file a Form 706 and owe taxes, the extension of time to pay will cause you to owe interest during the interim. However, late payment penalties will be avoided, and the interest rate is very low.
 

As April 15th draws near, a lot of us are thinking about income taxes. The Tax Foundation has concluded that the average American had to work from January 1st to April 12th to pay federal and state income taxes that will be owed in 2011.

The average Tennessean reached tax freedom day on March 27th, 2011. Only Mississippi reached tax freedom day before Tennessee. I am somewhat surprised that Mississippi beat us since Mississippi has a state income tax that applies to all types of income. Tennessee’s income tax only applies to dividends and interest. Our favorable income tax laws have been an important factor for a lot of high income individuals who have migrated to Tennessee.  

After reading the previous article regarding accelerating income to 2010, one of my clients called me to discuss a large charitable gift that he is planning to make in December of 2010. He wanted to confirm that postponing deductions until 2011 is a good idea.

As a general rule, it will be advisable to postpone the payment of deductible expenses and charitable contributions until 2011 if tax rates are higher in 2011. However, there are additional considerations with deductions. The Internal Revenue Code limits deductions in various ways.

For example, you can only deduct charitable contributions up to a certain percentage of your income for the year. If you accelerate a lot of income to 2010 and postpone your charitable gifts until 2011, you may find that you will not be able to deduct the entire amount of the contribution in 2011. You are allowed to carry over any excess charitable contribution deductions for five years. However, the farther away in time that you benefit from the deduction, the less utility it has on a present value basis.

I recommended that my client ask his CPA to run some pro forma calculations in order to understand the tax ramifications of postponing his charitable contribution until January of 2011. Most CPAs have software that can calculate estimated taxes based upon the scheduled law for 2011.

Postponing deductions until 2011 might be a good strategy. However, you should confirm it with your CPA prior to making this decision.