How Charitable Giving Benefits the Giver

Appreciated assets – A charitable donation tax deduction feels good in a few ways. Not only do you feel good about giving to a good cause, but you’re also cutting your tax bill. However, before you start writing checks or making online donations, you should know what rules to follow to ensure your good-hearted gifting is giving you tax deductions, explains the article “Charitable Donation Tax Deductions: An Additional Reward for the Gift of Giving” from Kiplinger.

First, you’ll need to itemize to claim a charitable tax deduction. If you took the standard deduction on your 2020 or 2021 tax return, you could also claim up to $300 for cash donations to charity. This deduction wasn’t available to taxpayers who claimed itemized deductions on Schedule A. This deduction wasn’t extended past 2021, so you can’t claim a charitable donation tax deduction on your 2022 tax return. For 2022 and beyond, you’ll have to itemize if you want to write off gifts to charity.

If your standard deduction is a little higher than your itemized deduction, consolidate charitable deductions from the next few years into the current tax years, known as “bunching.” This lets you boost your itemized deductions for the current year, so they exceed your standard deduction amount. Consider using a Donor Advised Fund, where you can make one large contribution to a fund and deduct the entire amount as an itemized deduction in the year you make it. Just be sure your donations align with your estate plan.

How do you know what donations are deductible? Contributions of cash or property are generally deductible. If you donate property, the deduction is equal to the property’s fair market value. If you give appreciated property, you may have to reduce the fair market value by the amount of appreciation when calculating the deduction. If the property has decreased, your deduction is limited to the current fair market value.

There are certain requirements and limitations for charitable tax deductions. For gifts of $250 or more, you must have a written acknowledgment from the charity stating the amount of a cash donation and a description of any donated property, but not value, and whether or not you received any goods or services in return for your contribution. At certain valuation points, you’ll need to file certain forms and if you donate a car, boat, or airplane worth more than $5,000, you may need to have the property appraised also.

Just because your donation was used for a good cause doesn’t mean you can deduct it. Only contributions to certain charitable organizations are deductible. For instance, if a neighbor starts a Go Fund Me page, those donations, while greatly appreciated, are not tax deductible.

The IRS makes it easy to determine if any donations are tax deductible with the Tax Exempt Organization Search tool on its website to find out if an organization is tax-exempt.

For seniors who are at least 70 ½ years old, you can transfer up to $100,000 directly from a traditional IRA to charity through a Qualified Charitable Distribution (QCD). The charitable donations made by eligible Donor Advised Fund, Qualified Charitable Distribution, QCD, Required Minimum Distribution, Standard Deduction, Fair Market Value, Appreciated, Estate Planning Attorney, Adjusted Gross Income, Tax Exempt Organizationeniors via a QCD aren’t deducible. However, you can still save on taxes, since QCDs aren’t included in taxable income.

QCDs also count towards senior’s Required Minimum Distribution, without adding to your adjusted gross income.

Reference: Kiplinger (Nov. 28, 2022) “Charitable Donation Tax Deductions: An Additional Reward for the Gift of Giving”

 

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IRS Announces New Lifetime and Gift Tax Exemptions

Federal Tax Exemption – There’s big news from the IRS for people who use gifting as part of their estate planning. The annual exclusion increased from $16,000 in 2022 to $17,000 in gifts in 2023, without needing to use up lifetime gift and estate tax exclusion or paying a gift tax. The article “Lifetime Estate and Gift Tax Exemption Will Hit $12.92 Million in 2023” from Forbes provides details.

The “unified credit,” aka the lifetime estate and gift federal tax exemption, will also jump to $12.92 million in 2023, up from $12.06 million in 2022. Couples may combine their exemption, so a wealthy couple making gifts in 2023 can pass along $25.84 million.

Here is another way to look at what this change means. If you’ve already maxed out on non-taxable gifts, you can give an extra $1.72 million to heirs in 2023, in addition to making $34,000 per couple ($17,000 x two) in annual gifts to every child, grandchild, siblings, niece or nephew or anyone you’re feeling generous towards.

In addition to making these generous $17,000 gifts, you can also pay an unlimited amount towards someone else’s tuition or medical expenses without any impact to your lifetime exemption. An important detail: the payments must be made directly to the school or the medical provider.

The estate tax is still 40%, but the $12.92 million per-person lifetime exemption is just one of many strategies used to transfer wealth. Others include the use of GRATs and other trusts to leverage the exemption. The bear market provides numerous planning opportunities.

Keep in mind the $12.92 million Federal Tax Exemption is not forever. Under the 2017 Tax Cuts and Jobs Act, the lifetime exemption will sunset in the start of 2026, and the decrease will be more than half its current value.

Whether the estate and gift tax exemption will actually drop so dramatically depends on the politics of Congress and the White House and the budget and deficit pressures of the year. An early version of the Build Back Better proposal would have cut the exemption in half but did not win enough votes to pass.

Another reason to make these lifetime gifts sooner rather than later? As of 2022, seventeen states and the District of Columbia still have state estate taxes and/or inheritance taxes. For wealthy families, these exemptions can make a big difference in estate tax liabilities.

Reference: Forbes (Oct. 18, 2022) “Lifetime Estate and Gift Tax Exemption Will Hit $12.92 Million in 2023”

 

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IRS Extends Portability Election Option Deadline from Two to Five Years

The Internal Revenue Service recently issued a change to the rules regarding portability of a deceased spouse’s unused exclusion (DSUE), expanding the time period from two years to five years. As explained in the recent article “IRS Extends Portability Election” from The National Law Review, portability allows spouses to combine their exemption from estate and gift tax. Here’s how it works.

A surviving spouse may use the unused estate tax exemption of the deceased spouse to lower their tax liability. Let’s say Spouse A dies in 2022, when the estate tax exemption is $12.06 million. If, during Spouse A’s lifetime, they had only used $1 million of their exemption amount, Surviving Spouse B may elect portability to claim $11.06 million DSUE, as long as they file for the exemption within five years of the decedent’s date of death.

Prior to the rule change, the surviving spouse only had two years to claim the DSUE. The due date of an estate tax return is still required to be filed nine months after the decedent’s death or on the last day of the period covered by an extension, if one had been secured.

The IRS had previously extended the deadline to file for portability to two years. However, over time, the taxing agency found itself managing a large number of requests for private letter rulings from estates failing to meet the two year deadline. It was noted many of these requests for portability relief occurred on or before the fifth anniversary of a decedent’s date of death, which led to the current change.

How do I Elect Portability?

To elect portability, the executor (or personal representative) of the estate must file an estate tax return on or before the fifth anniversary of the decedent’s date of death. This estate tax return is a Form 706. The executor must note at the top of Form 706 that it is filed pursuant to Rev. Proc. 2022-32 to elect portability under Sec. 2010(C)(5)(A).

Eligibility to elect portability is not overly burdensome for most people. The decedent must have been a U.S. citizen or resident on the date of their death and the executor must not have been otherwise required to file an estate tax return. This means the decedent was under the estate tax exemption at the time of their death. With the current estate tax exemption now at $12.06 million for an individual, most people will find themselves well under the limit.

This new regulation expands the number of people who will be able to take advantage of the exemption and will help families pass wealth on to the next generation without incurring the federal estate tax. Speak with your estate planning attorney to be sure to elect portability when the first spouse passes, in order not to lose this exemption.

Reference: The National Law Review (Aug. 1, 2022) “IRS Extends Portability Election”

 

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Some States Have Tough Estate and Inheritance Taxes

For now, most people don’t have to be scared of federal estate taxes. In 2022, only estates valued at $12.06 million or more for an individual ($24.12 million or more for a married couple) need to pay federal estate taxes. Even better for the very wealthy, there’s no federal inheritance tax for heirs who reside in such lofty economic brackets, notes the recent article titled “States with Scary Death Taxes” from Kiplinger.

By definition, estate taxes are paid by the estate and based on the estate’s overall value, while inheritance taxes are paid by the individual who inherits property, assets, or anything else of value. This isn’t to say “regular people” don’t need to worry about death taxes. We do, because states have their own estate taxes, and a few still have such taxes.

A number of states eliminated estate taxes in the last ten years or so, in an effort to keep retirees from leaving and heading to places like Florida, where there’s no estate tax. However, a dozen states and the District of Columbia still have estate taxes, six states have an inheritance tax and one has both an estate and inheritance tax: Maryland.

Here’s how some state taxes look in 2022:

Connecticut has an estate tax, with an exemption level at $7.1 million. However, there is no inheritance tax. The Nutmeg state is the only state with a gift tax on assets gifted during one’s life.

The District of Columbia has an estate tax, with an exemption level of $4 million.

Hawaii’s estate tax exemption level is $5.49 million., one of the higher state estate tax exclusions, and is not adjusted for inflation.

Illinois’s estate tax is $4 million, but there’s no inheritance tax. It’s known as one of the least taxpayer friendly states in the country for retirees.

Iowa is phasing out those taxes, but this doesn’t take effect until 2025. In the meantime, there’s no estate tax, and if the estate is valued at less than $25,000, there’s no tax. No taxes are due on property inherited by a lineal ascendent or descendent, but for other family members, the taxes range from 8%—12%.

There’s no estate tax in Kentucky. However, depending upon your relationship to the person who died and the value of the property, the inheritance tax is 4% to 16%.

Maine has an estate tax exemption of $5.87 million, but no inheritance tax.

Maryland’s has both an estate tax exemption of $5 million and a flat 10% inheritance tax.

Massachusetts has no inheritance tax and a $1 million estate tax exemption.

Minnesota has a low estate tax exemption of $3 million. Any taxable gifts made three years prior to death are included.

New York, New Jersey, Rhode Island, Oregon, Vermont and Washington have no inheritance taxes, while Pennsylvania has no estate tax but does have an inheritance tax.

It’s not necessary to move purely to avoid estate or inheritance taxes. An experienced estate planning attorney uses strategic tax planning as part of an estate plan, minimizing tax liability and preserving assets.

Reference: Kiplinger (July 29, 2022) “States with Scary Death Taxes”

 

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Can a Family LLC Reduce Estate Taxes?

Family LLCs are used to protect assets, reduce estate taxes and more efficiently shift income to family members, reports the article “Handling Estates Like An LLC Can Reduce Taxes” from Financial Advisor. The qualified business income and pass-through entity tax deductions may add significant benefits to the family.

What is a Family LLC? They are holding companies owned by two or more individuals, with two classes of owners: general partners (typically the parents) and limited partners (heirs). Contributed assets of the general partners are no longer considered part of their estate, and future appreciation on the assets are not counted as part of their taxable estate.

Consider the LLC as three separate pieces: control, equity and cash flow. Because of the separation, you can maintain control of the personal/business assets, while at the same time transferring non-controlling equity of the assets to someone else via a gift, a sale, or a combination of the two.

An added benefit—transfers of non-controlling equity can qualify for a discount on the value for tax reporting, minimizing any gift or estate tax consequences of the transfer. Discounting business entities with very liquid assets is generally not advisable. However, illiquid assets could warrant a discount as high as 40%.

These types of structures are complicated. Therefore, you’ll need an estate planning attorney with experience in how Family LLCs interact with estate planning. The LLC must be properly structured and have a legitimate business purpose.

It’s important to note that if a real estate or operating business is put into an LLC and taxed as a pass-through entity instead of a sole proprietorship, they may be eligible for the 20% discount under Section 199A, or for the pass—through entity tax workaround for the limitation of the deductibility of state taxes for individuals and trusts.

Every state has its own rules about income qualifying for a state income tax deduction on the federal level. If you have an entity in place, you’ll want to speak with your attorney to determine if a pass-through entity on the state level will be advantageous. If so, this election may allow for a state income tax deduction on the federal level.

Your estate planning attorney will help you get a qualified appraisal of the assets, since the IRS will require an accurate value of the transfer for reporting purposes, especially if a discount is being contemplated. This is a complex matter, but the estate planning and tax advantages to be gained make it worthwhile for families with a certain level of assets to protect.

Reference: Financial Advisor (April 4, 2022) “Handling Estates Like An LLC Can Reduce Taxes”

 

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What If an Estate Owes Back Taxes?

If grandma did not finish up all of her duties as the executor of her husband’s estate before she passed away, it would be wise to speak with an experienced estate planning attorney.

An estate planning attorney can help with the issues with estate administration, says nj.com’s recent article entitled “My grandmother’s estate owes back taxes. What next?”

The fiduciary appointed to administer an estate—called an executor or personal representative—is responsible to make certain that all creditors are paid before making distribution of estate assets.

An executor of an estate is the person designated to administer the last will and testament of the decedent. His or her primary duty is to carry out the instructions to manage the affairs and wishes of the decedent.

An executor is appointed either by the testator of the will (the one who makes the will) or by a court, in situations where there is no will (also known as intestacy).

If there is a probate proceeding, the executor is required to officially notify creditors of it pursuant to the state probate statutes.

If there are not enough assets to pay all creditors, state statutes give a priority regarding how creditors are paid.

Funeral expenses and taxes are typically paid first.

Note that if the creditors are not paid, and money is distributed to beneficiaries, the creditors may seek the return of those distributions from the beneficiaries.

However, the executor’s individual assets would not be responsible for payment of estate debts. It is just the assets that are received from the decedent.

As far as taxes, the IRS is still legally entitled to the money owed by the decedent. The federal government will usually go to great lengths to collect it, even if the will instructs the remaining assets to be distributed elsewhere.

Reference: nj.com (Feb. 3, 2022) “My grandmother’s estate owes back taxes. What next?”

 

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Can I Avoid Paying Taxes on Social Security Benefits ?

No one likes Social Security benefits being taxed. While a dozen states levy a tax on Social Security benefits, there’s no getting away from federal income taxes. A recent article from Investopedia, “Which States Don’t Tax Social Security Benefits,” explains it all.

If you really want to, it is possible to pay zero Social Security taxes. However, this requires staying below the minimum income threshold.

The twelve states that tax Social Security benefits are:

Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia.

Of these, only Minnesota and Utah add an additional Social Security tax using the same income thresholds as the federal government.

However, retirees are advised not to base their choice of retirement location just on this annoying tax. More important factors to be considered include your overall cost of living, quality of healthcare services, geographic proximity to family and friends, available recreational activities, crime rates and climate.

Social Security benefits taxes are not news. These benefits have been taxed since 1983. Taxes depend on the household’s combined income, aka Adjusted Gross Income (AGI), nontaxable interest and half of the couple or individual’s Social Security benefits and filing status. Regardless of the result, the IRS won’t subject 85% of the total benefit to taxes.

However, remember that income from other retirement sources may also be subject to federal income taxes. It’s not just Social Security. Pension payments are either fully or partially taxable, based on how much after-tax dollars went into the accounts.

The only way to avoid having Social Security benefits taxed by federal or local taxing authorities is to remain way below the minimum income threshold, or using tax-free Roth account withdrawals, Qualified Longevity Annuity Contracts (QLACs, which are getting new attention due to recent legislation) or living on a shoestring. Most people have to live with some level of taxation on their benefits.

Nine states don’t have a state income tax, which includes Social Security income. If taxes are your key reason on choosing where to live, consider Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming for your retirement location. Remember that if a state doesn’t have the benefit of income taxes, funds have to come from somewhere, or the level of services to be provided on a local and state level may be reduced.

Reference: Investopedia (Jan. 25, 2022) “Which States Don’t Tax Social Security Benefits,”

 

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Will Moving to a New State Impact My Estate Planning?

Since the coronavirus pandemic hit the U.S., baby boomers have been speeding up their retirement plans. Many Americans have also been moving to new states. For retirees, the non-financial considerations often revolve around weather, proximity to grandchildren and access to quality healthcare and other services.

Forbes’ recent article entitled “Thinking of Retiring and Moving? Consider the Financial Implications First” provides some considerations for retirees who may set off on a move.

  1. Income tax rates. Before moving to a new state, you should know how much income you’re likely to be generating in retirement. It’s equally essential to understand what type of income you’re going to generate. Your income as well as the type of income you receive could significantly influence your economic health as a retiree, after you make your move. Before moving to a new state, look into the tax code of your prospective new state. Many states have flat income tax rates, such as Massachusetts at 5%. The states that have no income tax include Alaska, Florida, Nevada, Texas, Washington, South Dakota and Wyoming. Other states that don’t have flat income tax rates may be attractive or unattractive, based on your level of income. Another important consideration is the tax treatment of Social Security income, pension income and retirement plan income. Some states treat this income just like any other source of income, while others offer preferential treatment to the income that retirees typically enjoy.
  2. Housing costs. The cost of housing varies dramatically from state to state and from city to city, so understand how your housing costs are likely to change. You should also consider the cost of buying a home, maintenance costs, insurance and property taxes. Property taxes may vary by state and also by county. Insurance costs can also vary.
  3. Sales taxes. Some states (New Hampshire, Oregon, Montana, Delaware and Alaska) have no sales taxes. However, most states have a sales tax of some kind, which generally adds to the cost of living. California has the highest sales tax, currently at 7.5%, then comes Tennessee, Rhode Island, New Jersey, Mississippi and Indiana, each with a sales tax of 7%. Many other places also have a county sales tax and a city sales tax. You should also research those taxes.
  4. The state’s financial health. Examine the health of the state pension systems where you are thinking about moving. The states with the highest level of unfunded pension debts include Connecticut, Illinois, Alaska, New Jersey and Hawaii. They each have unfunded state pensions at a level of more than 20% of their state GDP. If you’re thinking about moving to one of those states, you’re more apt to see tax increases in the future because of the huge financial obligations of these states.
  5. The overall cost of living. Examine your budget to see the extent to which your annual living expenses might increase or decrease in your new location because food, healthcare and transportation costs can vary by location. If your costs are going to go up, that should be all right, provided you have the financial resources to fund a larger expense budget. Be sure that you’ve accounted for the differences before you move.
  6. Estate planning considerations. If this is going to be your last move, it’s likely that the laws of your new state will apply to your estate after you die. Many states don’t have an estate or gift tax, which means your estate and gifts will only be subject to federal tax laws. However, a number of states, such as Maryland and Iowa, have a state estate tax.

You should talk to an experienced estate planning attorney about the estate and gift tax implications of your move.

Reference: Forbes (Nov. 30, 2021) “Thinking of Retiring and Moving? Consider the Financial Implications First”

 

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