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”

 

Comments Off on IRS Extends Portability Election Option Deadline from Two to Five Years

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”

 

Comments Off on Some States Have Tough Estate and Inheritance Taxes

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”

 

Comments Off on Can a Family LLC Reduce Estate Taxes?

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?”

 

Comments Off on What If an Estate Owes Back Taxes?

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,”

 

Comments Off on Can I Avoid Paying Taxes on Social Security Benefits ?

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”

 

Comments Off on Will Moving to a New State Impact My Estate Planning?

Do Gift Taxes Count Toward Estate Taxes?

Gift Tax – With all of the talk about changes to estate taxes, estate planning attorneys have been watching and waiting as changes were added, then removed, then changed again, in pending legislation. The passage of the infrastructure bill in early November may mark the start of a calmer period, but there are still estate planning moves to consider, says a recent article “Gift money now, before estate tax laws sunset in 2025” from The Press-Enterprise.

Gifts are used to decrease the taxes due on an estate but require thoughtful planning with an eye to avoiding any unintended consequences.

The first gift tax exemption is the annual exemption. Basically, anyone can give anyone else a gift of up to $15,000 every year. If giving together, spouses may gift $30,000 a year. After these amounts, the gift is subject to gift tax. However, there’s another exemption: the lifetime exemption.

For now, the estate and gift tax exemption is $11.7 million per person. Anyone can gift up to that amount during life or at death, or some combination, tax-free. The exemption amount is adjusted every year. If no changes to the law are made, this will increase to roughly $12,060,000 in 2022.

However, the current estate and gift tax exemption law sunsets in 2025. This will bring the exemption down from historically high levels to the prior level of $5 million. Even with an adjustment for inflation, this would make the exemption about $6.2 million. This will dramatically increase the number of estates required to pay federal estate taxes.

For households with net worth below $6 million for an individual and $12 million for a married couple, federal estate taxes may be less of a worry. However, there are state estate taxes, and some are tied to federal estate tax rates. Planning is necessary, especially as some in Congress would like to see those levels set even lower.

Let’s look at a fictional couple with a combined net worth of $30 million. Without any estate planning or gifting, if they live past 2025, they may have a taxable estate of $18 million: $30 million minus $12 million. At a taxable rate of 40%, their tax bill will be $7.2 million.

If the couple had gifted the maximum $23.4 million now under the current exemption, their taxable estate would be reduced to $6.6 million, with a tax bill of $2,520,000. Even if they were to die in a year when the exemption is lower than it was at the time of their gift, they’d save nearly $5 million in taxes.

There are a number of estate planning gifting techniques used to leverage giving, including some which provide income streams to the donor, while allowing the donor to maintain control of assets. These include:

Discounted Giving. When assets are transferred into an entity (commonly a limited partnership or limited liability company), a gift of a minority interest in the entity is generally given a discounted value, due to the lack of control and marketability.

Grantor Retained Annuity Trusts. The donor transfers assets to the trust and retains right to a payment over a period of time. At the end of that period, beneficiaries receive the assets and all of the appreciation. The donor pays income tax on the earnings of the assets in the trust, permitting another tax-free transfer of assets.

Intentionally Defective Grantor Trusts. A donor sets up a trust, makes a gift of assets and then sells other assets to the trust in exchange for a promissory note. If this is done correctly, there is a minimal gift, no gain on the sale for tax purposes, the donor pays the income tax and appreciation is moved to the next generation.

These strategies may continue to be scrutinized as Congress searches for funding sources, but in the meantime, they are still available and may be appropriate for your estate. Speak with an experienced estate planning attorney to see if these or other strategies should be put into place.

Reference: The Press-Enterprise (Nov. 7, 2021) “Gift money now, before estate tax laws sunset in 2025”

 

Comments Off on Do Gift Taxes Count Toward Estate Taxes?

How Do You File Taxes If Your Spouse Dies?

About two-thirds of surviving spouses are women. While some are able to avoid major mistakes, taxes are a source of frustration, rife with potential problems. Deadlines are especially challenging, according to the article “The Death of a Spouse is Hard. Taxes Makes It Harder” from The Wall Street Journal.

The combination of emotional upheaval and needing to make complex decisions is overwhelming. Some widows need cash and are forced to sell the family home within two years to get an exemption of $500,000 on the sale proceeds. If you miss the deadline, the exemption shrinks to $250,000.

Others will convert traditional IRAs to Roth IRAs in the year their spouse dies, to capture lowered taxes on the conversion.

However, in all cases, spouses need to check withholding or estimated taxes, especially if the spouse who died was the one who made payments to the IRS. Underpayment penalties add up fast.

Here are some key things to watch for:

Filing an estate tax return. The current estate and gift-tax exemption is $11.7 million per person, so most people don’t need to pay federal estate tax. Executors don’t need to file a return if the decedent’s estate is below exemption levels. However, they should. Here’s why: filing an estate tax return will allow the surviving spouse to have the partner’s unused exemption and add it to their own. Claiming the unused exemption could have larger implications in the future when exemptions change.

Estate taxes are normally due nine months after the date of death. The IRS allows executors to claim the unused exemption for the spouse up to two years after the date of death, but the estate tax must be filed within the time period.

The year a spouse dies is the last year a couple may file jointly. Afterwards, the survivor files as a single person or if there are dependent children, as a surviving widow or widower. Be careful about the shift from joint to single filer. The surviving spouse’s tax rate may stay the same or rise when their income drops. There’s an expression for this, as it occurs so often: the widow’s penalty.

Surviving spouses may roll over inherited retirement accounts into their own names. However, if there is a significant age difference, this may not be the best strategy. New widows and widowers should consider their options carefully.

Filers must send the IRS 90% of their total tax for the year by December 31. This amount is often divided unequally between spouses. If the partner who died paid most of the withholding for estimated taxes, the survivor may need to make changes or risk underpayment penalties when taxes are paid in April. This is especially likely to occur if the spouse died early in the year.

Reference: The Wall Street Journal (Oct. 29, 2021) “The Death of a Spouse is Hard. Taxes Makes It Harder”

 

Comments Off on How Do You File Taxes If Your Spouse Dies?