Only two things are certain

Transcription

1 Death & Taxes

2 Only two things are certain

3 Topics we will cover Types of Tax: Estate, Gift, Inheritance, GST & Income Estate Planning Alternatives Preparing the Fiduciary Return Preparing the Estate Tax Return Preparing the Gift Tax Return

4 Estate Tax Assessed upon value of decedent s holdings FMV determined at DOD or AVD (can be elected only if valuation decreases tax liability) NOTE: AVD cannot be elected at death of 1 st spouse if marital exemption used to eliminate estate tax liability $5 million exemption (portable between husband/wife in 2011 & 12) Form 706 due 9 months after DOD; can be extended 6 months (Form 4768) Tax liability must be paid 9 months after DOD

5 History of Estate & Gift Taxes Taxes imposed & repealed in 1800 s to finance wars Taxes in 1900 s imposed to prevent the accumulation and transfer of large estates Estate Tax enacted in 1916 introduced DOD valuation, funeral & administrative expenses, small estate exemption & graduated rates Gift Tax temporarily introduced in 1918 (repealed in 1926) & re-introduced in 1932

6 History (cont d) 1948: 50% marital deduction introduced (later increased to 100%) 1976: Estate & gift tax exclusions merged & converted to the Unified Estate & Gift Tax Credit (a.k.a. applicable exclusion) 1981: The annual gift tax exclusion raised to $10, : GST enacted in its current form 1997: Applicable exclusion raised to $1M, then raised incrementally to $3.5 million by 2009 (unlimited by 2010), finally re-set to $5M in 2010 & 2012

7 History of Estate Tax Rates

8 The only difference between death and taxes is that death doesn t get worse every time Congress meets. -Will Rogers

9 Gift Tax Gift = Transfer for inadequate consideration Payments to 3 rd parties Interest-free loans Below-market sales Irrevocable transfers to trust Creation of joint tenancies NOTE: Payment for tuition & medical expenses; direct transfer to political organization Gift Assessed on value of property transferred when complete

10 Example of Below-market Loan (Gift Tax) Dad loans Son $200,000 to make down-payment on home. The loan is to be repaid in 5 years, without interest IRS presumes that Son should have been charged a fair rate of interest (computed at applicable federal rate) Dad is liable for gift tax on interest that should have charged but wasn t Dad also liable for income tax on imputed interest while Son may claim deduction for interest paid If Dad later forgives Son s debt, he will be liable for gift tax on loan principal

11 Gift Tax (cont d) $13,000 annual exclusion ($5 million lifetime exclusion) NOTE: Gift-splitting available to citizen spouses, but must file individual returns Form 709 due April 15 th if: Gift > $13K Future interest Over $136K to non-citizen spouse Partial interest to charity Gift tax is cumulative tax on each successive gift is computed on total value of all gifts made

12 When is gift complete? (Gift Tax) Transferred Real property Mutual funds Stocks and bonds Withdrawn Bank, savings, credit union accounts Brokerage accounts U.S. government bonds

13 Inheritance Tax Legacy or Succession Tax charged to heir Assessed by state in which decedent was domiciled (not resident) State may assess Pick-up Tax instead (calculated as percentage of federal tax liability) NOTE: Since federal credit for state tax repealed in 2004, many states no longer assess pick-up tax

14 Generation-Skipping Tax Assessed on value of property transferred to skip person ( 2 generations below transferor ) NOT skip persons: Grandchild, if transferor s child is deceased Spouses & former spouses Charitable trusts Reported on Form 709 if made during lifetime; Form 706 if made at death $5 million exemption (not portable) Rate = top estate tax rate (35%), not graduated NOTE: GST often exceeds estate tax that would have been computed at graduated rates if property had been transferred & taxed at each generation

15 Income Tax Report income attributable to decedent on Form 1040; income attributable to estate on Form Marginal tax rates for estate are comparable to those for individual taxpayers, but effective tax rate is higher since brackets are narrower 10% 15% 25% 28% 33% 35% Single <8,375 <34,000 <82,400 <171,850 <373,650 >373,650 Married Joint <16,750 <68,000 <137,300 <209,250 <373,650 >373,650 Estates/Trusts N/A <2,300 <5,350 <8,200 <11,200 >11,200

16 What s due when January 1 st June 14 th Date of Death December 31 st Form 1040 Individual Income Tax Return due for 165 days Max. Tax Rate: 35% on inc > $374K Personal Exemption: $3,700 Standard Deduction: $5,800 Form 1041 Fiduciary Income Tax Return due for 200 days Max. Tax Rate: 35% on inc > $11K Personal Exemption: N/A Standard Deduction: N/A Form 706 Estate Tax Return due if assets valued > $5M in 2011 Max. Tax Rate: 35% of Net Estate

17 When a man on his deathbed was asked what he wanted done with his ashes after being cremated, he answered: Just put them in an envelope and mail them to the IRS. Make sure to write on the envelope, Now you have everything!

18 Review of Estate Planning Options Intestacy Statutes Apply if decedent dies without will Will - Specifies decedent s wishes, but cannot supersede statutory rights of heirs or used to dispose of non-probate assets Revocable Trust Used to transfer assets to beneficiaries without probate & ensure grantor s assets can be managed in event grantor is disabled/incapacitated Joint Tenancy Allows property to pass directly to surviving coowner (1/2 basis step-up) Estate can also be reduced by gifting or donating assets

19 Marital Estate Planning A-B Trust Use A Trust to temporarily shelter property at death of 1 st spouse (unlimited marital deduction) Use B Trust to permanently shelter assets up to decedent s applicable exclusion amount A-B-C Trust Used to pass property to surviving spouse & preserve estate assets for third-party beneficiaries Qualified Domestic Trust Used to defer estate tax due upon death of 1 st spouse until death of surviving non-citizen spouse

20 Special Needs Third-party trusts established by relative or court-appointed guardian for benefit of disabled beneficiary without jeopardizing eligibility for Medicaid Property may not be bequeathed to pet, but can be transferred to trust with human beneficiary responsible for animal s care

21 Fiduciary Duties Personal Representative must act on behalf of another Executor: Named in will to manage affairs of decedent Administrator: Court-appointed to manage affairs of decedent Trustee: Named in trust document Guardian: Charged with care of another Conservator: Court-appointed to manage affairs of living person Custodian: Must safe-guard assets Duty of Loyalty avoid conflicts of interest & self-dealing Duty of Care act prudently & cannot delegate fundamental responsibilities

22 Selecting Fiduciary Executor/trustee faces a job which requires honor, honesty & integrity Select 1 0r 2 successor representatives State law may require personal representative to be licensed or registered NOTE: Bank employees, investment advisors, attorneys, CPAs & EAs still exempt from registration in CA if acting within scope of employment/practice

23 Planning Documents Power of Attorney allows one person (principal) to authorize another (attorney-in-fact) to act on his behalf Durable remains effective after principal is incapacitated Springing become effectives when principal becomes disabled Healthcare used to appoint an agent to make health care decisions Only valid during lifetime Form 2848 used for federal tax matters Will Supplements used to provide instructions not included in will/trust (e.g. identify personal property to be given to specific individuals) Ethical Wills used to bequeath values & beliefs

24 The Fiduciary Return (Form 1041) Must file if gross income > $600 (estate) or any taxable income (trust) Trusts must use calendar year; estates may use fiscal year 6-month extension available (Form 7004) No estimated tax payments due for 1 st 2 years after DOD (estate) or tax liability < $1,000 (trust) Exemptions Estate: $600 Simple Trust: $300 Complex Trust: $100

25 Trust Income (Form 1041) Accounting = amount income (not remainder) beneficiaries entitled to receive from trust as per law or document usually dividends & interest but not capital gains NOTE: If CGs taxed to trust, then trust s basis increased Income Distribution Deduction = used to determine how allocation of tax between beneficiary & trust NOTE: Beneficiary liable for tax on lesser of DNI or actual distribution received Distributable Net Income (DNI) = max amount taxable to beneficiaries; excess treated as tax-free distribution of principal Tax-exempt Income = Life insurance benefits, muni bond interest, personal injury comp., inc from discharge of debt

26 Example of Accounting Income (Form 1041) Trust earned $3,000 interest & $2,000 CGs & paid fiduciary fees of $600 Trust instrument allocates interest/dividends to income, CGs to principal & requires costs to be allocated equally Instrument also requires all income be distributed to beneficiary each year The beneficiary will receive: $3,000 Interest Fiduciary fees (50%) $2,700 Accounting Income

27 DNI (Form 1041) Taxable Income + Tax-exempt Income - Allocated Expenses + Personal Exemption + Capital Losses - Capital Gains (if distrb d or in yr of termtn) - Expenses Allocable to Tax-exempt Income = DNI

28 Who pays the tax? (Form 1041) Trust has $10,000 dividends, $10,000 LTCGs & $1,200 fiduciary fees Trust is a simple trust required to distribute all income incl. CGs NOTE: Distrbtns from complex trust are discretionary ($100 xmptn) Trust Inc. 10,ooo + 10,000 1,200 = 18,800 Taxable Inc. 18,800 $300 xmptn = 18,500 DNI 18,800 Trust s taxable inc after distribution = 18,800 18,800 = 0 Beneficiary s taxable income = 18,800 If trust is not required to distribute capital gains Trust Inc. 10,ooo + 10,000 1,200 = 18,800 Taxable Inc. 18,800 $300 xmptn = 18,500 DNI 18,800 10,000 = 8,800 Trust s taxable income after distribution = 18,800 8,800 = 10,000 Beneficiary s taxable income = 8,800

29 Whose income is it? (Form 1041) Trust s Inc. DNI Taxable Inc. Ordinary Income Tax-exempt Inc. Dividends Cap. Gains Fiduciary Fees Exemptions Inc. Dist. Ded. DNI TE Inc.

30 Deductions (Form 1041) Trusts & estates entitled to many of same deductions as individual taxpayers on either 1041 or 706 (not both) Expenses in connection with administration of trust/estate deductible without 2% AGI limitation (e.g. accounting fees, 1041 tax preparation, trust/will contest, bonding fees) Miscellaneous itemized deductions that would have been subject to 2% AGI limitation if deducted by decedent, subject to same limitation if deducted by fiduciary (e.g. investment advice, property mngt., defense against creditors claims) Pro-rate deductible expenses if trust/estate has tax-exempt income Non-ded Xpns = (Gross TE Inc / Gross Acctg Inc ) * Indirect Xpns Excess deductions in final year of estate/trust may be passed through to beneficiaries ( Schedule as Misc. Item. Ded. Subject to 2% AGI)

31 Depreciation (Form 1041) Depreciation/depletion must be allocated between trust & income beneficiaries on same basis as accounting income is allocated Trust instrument requires the following distributions: 30% to Beneficiary #1, 20% to Beneficiary #2, 50% accumulated by fiduciary. Depreciation of $4,000 1,200 Depreciation to Bene Depreciation to Bene 2 2,000 Depreciation to Trust

32 Charitable Contributions (Form 1041) Individuals Trusts & Estates Ceiling 50% AGI Unlimited Recipient Qualified Org. Any charitable purpose Locale US only Worldwide Deductible Amount Amount Paid Amount set aside When deductible? In year paid In year paid or prior (if elected) Source of funds Any income Taxable income only* Authorization n/a Controlling Instrument NOTE: Charitable contribution deductible only if donation made from taxable gross income under terms of trust/will

33 The Estate Tax Return (Form 706) No filing requirement if estate plus taxable gifts < $5M (2011 & 2012; will revert to $1M exemption in 2013) NOTE: May elect to file if only to establish valuation & prevent potential disputes Tax rate in 2011 and 2012 is 35% (will revert to 55% in 2013) Due 9 months after DOD; extend 6 months (Form 4768) SOL can be shortened to 18 months (Form 4810)

34 Gross Estate (Form 706) Decedent s property wherever situated Examples Cash, investments, tax-exempt assets, business assets, real & personal property Jointly-held assets ½ of decedent s community property Retirement assets, life insurance & annuities (all non-probate) Special interests & powers, incl. retained & reversionary interests, life estates, revocable transfers Income in Respect of Decedent (IRD) Deductions: if reasonable & necessary under state/federal laws EXAMPLE: Interest expense incurred to maintain, rather than sell asset for 7 years disallowed because incurred for benefit of heirs, not estate

35 Valuation Rules (Form 706) Vehicles based on retail, not trade-in value Inventory household items on room-by-room basis Reduce checking account balance by as-yet uncleared checks Uncashed gift checks to individuals are incomplete gifts Stocks/bonds valued on average of high & low selling prices Mutual funds valued at NAV For business interests consider net worth, earning power, dividend-paying capacity, goodwill, comparable securities May apply special use valuation (based on current use) to certain real property

36 IRD (Form 706) Income earned by decedent before death but paid to estate after death Deferred compensation & bonuses Retirement plan distributions & annuity payments Dividends Pre-death leasehold income Proceeds from sale of jointly-owned residence Retains same character when reported by estate as it would have if reported by decedent May be reduced by Deductions in Respect of Decedent (DRD) similar to allowable Schedule A Deductions Estate tax attributable to IRD is deductible as expense on Form 1041

37 Heir s Basis & Holding Period (Form 706) Inherited assets receive steppedup (down) basis to value on DOD or AVD Jointly-held assets receive ½ step-up Community property assets receive full step-up No step-up for IRD property Capital gains from sale of inherited property are always long-term

38 Election for 2010 (Form 706) Although estate tax was repealed for 2010, last-minute legislation retroactively applies 2011 rules to decedent s dying 1/1/10 12/16/10: $5 million exemption & stepped-up basis unless executor opts out Executor may affirmatively elect to be exempt from estate tax & instead subject to carry-over basis rules under IRC 301(c) If elected, some assets may receive step-up: First $1.3 million Plus additional $3 million if assets transferred to surviving spouse File Form 8939 to report property acquired from decedent & allocate basis increase Originally intended to be submitted with decedent s final 1040 by April 15 th but form not yet available IRS website promises to post form at least 90 days before it is required to be filed

39 Estate Tax Formula (Form 706) Gross Estate (GE) = Value of worldwide property Taxable Estate (TE) = GE Deductions Tax Base = TE + Adjustable Taxable Gifts

40 Example of Estate Tax Calculation (Form 706) Decedent died in 2011, leaving a gross estate of $6M with no allowable deductions. He made $1.5M taxable gifts between 2002 & 2005 $555,800 Gift tax liability on previously-made gifts 345,800 Lifetime credit allowed on $1M gifts $210,000 Gift tax previously paid during lifetime $6M Gross estate (GE) $0 No deductions $6M Taxable estate (TE) + 1.5M Previously made taxable gifts (ATG) $7.5M Tax base $2,605,800 Tentative estate tax liability 1,730,800 Applicable credit based on $5M in 2011 $875,000 Tax $210,000 Gift tax previously paid $665,000 Estate tax due now

41 The Gift Tax Return (Form 709) Due April 15th in year following transfer or file with 706 No return due if gift is excludable (e.g. if < $13K) $5 million lifetime exclusion per donor Tax-exclusive since assets used to pay tax are not part of gift

42 Donee s Basis & Holding Periods (Form 709) = Donor s Carryover Basis + Allocable Gift Tax Paid Donee received gift from Donor, whose basis was $100K; FMV at time of gift was $120K. Donor paid $5K gift tax Allocable Gift Tax = (FMV Basis) / Basis * Gift Tax = ( ) / 100 * 5 = 1 Donee s Basis = Basis + AGT = = 101 Unless selling at a loss: New basis will be lesser of Donor s Basis or FMV on date of gift

43 Selling Gifted Property (Form 709) Example # 1 Loss Example # 2 Sell between FMV & Donor s Basis Example # 3 Gain Donor s Basis FMV at time of gift Donee s Sales Price Donee s Basis 90* * lower of FMV or Donor s Basis since property was sold at loss for less than FMV at time of gift Donee s Capital Gain (Loss) 90 or 100** **Basis for gain is 100, but there is no gain Basis for loss is 90, but there is no loss 100*** ***since Donee sold property at gain for more than FMV at time of gift, Donee s basis is equal to Donor s (10) = =

44 Gift Tax Calculation (Form 709) (Taxable Gifts during lifetime * Applicable Tax Rate) (Taxable Gifts in current year * Applicable Tax Rate) = Tentative Tax (calculated at cumulative graduated rate) Credits (i.e. Applicable Credit Amount) = Tax Due

45 Gift & Estate Tax Example (Form 709) Assume $500K gifted in 2003 & $600K gifted in 2006 $500,000 tax = $155,800 (not paid since < $345,800 lifetime credit) 600,000 gifted in 2006 $1,100,00 total gifts $ 386,800 tentative tax on total gifts made in both years 155,800 tax on 2003 gift $ 231,000 tax attributable to 2006 gift $345,800 lifetime credit -155,800 credit used in 2003 $190,000 unused credit available $231,000 tax attributable to 2006 gift [see above] 190,000 unused credit [see above] $41,000 tax due in 2006

46 Gift & Estate Tax Example (cont d) (Form 709) Assume taxable estate of $4.9 million on DOD in 2011 $ 4.90M estate in M prior taxable gifts [see above] $ 6.00M tax base $ 2,080,800 tentative tax on $6M tax base 41,000 tax previously paid on gifts [see above] $ 2,039,800 estate tax liability 1,730,800 unified credit (based on $5M in 2011) $ 309,000 tax 2011

47

48 Call or Monica Haven, E.A., J.D. (310) PHONE (310) FAX The information contained herein is for educational use only and should not be construed as tax, financial, or legal advice. Each individual s situation is unique and may require specialized treatment. It is, therefore, imperative that you consult with tax and legal professionals prior to implementation of any strategies discussed.