Estate Tax Provisions: Key Strategies Legacy Conference Dec. 2-3 in Kansas City, Mo. Paul Neiffer, CPA December 2 & 3, 2014 Speaker Introduction Paul Neiffer, Principal, CliftonLarsonAllen Frequent national speaker on taxation, agricultural, farm bill and estate tax topics Current chair of the AICPA National Agriculture Conference committee. Vice President of Farm Financial Standards Council Author of the FarmCPA Top Producer column Author of the FarmCPA blog on www.agweb.com 4 Estate Tax Seminar - Agenda Gift or Estate Which is Better Portability Versus Trust Wills Versus Revocable Living Trust Special Use Valuation How to Handle Life Insurance Small Size Estate Key Strategies Medium Size Estate Key Strategies Large Size Estate Key Strategies GIFT OR ESTATE WHICH IS BETTER 5 1
Specific Farm Estate Planning Objectives Family harmony Maintain continued financial security for senior family members, their spouses and family Maximize use of tax exemptions and exclusions available Minimize complexity Transfer substantial values to the next generation quickly Minimize IRS audit risk/challenge Avoid probate privacy Philanthropy? Gift & Estate Tax System Lifetime Gifts $14,000 annual exclusion per donee (was $13K, probably $15K in 2016 or 2017) Husband-wife gift splitting permitted Gifts exceeding annual exclusion: Use $5.43M unified gift-estate exemption (for 2015) Carryover income tax basis on lifetime gifts 7 8 Gift & Estate Tax System Estate Tax $5.43M unified exemption (2015 amounts) + Plus deceased spouse s unused exemption (post-2010 portability ) - Prior gifts in excess of annual exclusion Step-up in income tax basis to FMV for heirs State Estate Tax exposure considerations 15 States with estate tax currently 2 States with a gift tax Lifetime Gifts vs. Estate Transfers Carryover tax basis vs. step-up to FMV tax basis Is fresh depreciation important? Is reduced gain on eventual sale important? Current 40% estate tax versus 30%+ capital gains rate including state income taxes Timing of the transfer Lower value today vs. at estate? Income and cash flow reduction to donor if gift 9 10 Gift Versus Estate No Estate Tax Gift Estate Fair Market Value $1,000,000 $1,000,000 Basis $100,000 $1,000,000 Taxable Gain $900,000 Zero Federal Income Tax @23.8% $214,200 Zero State Income Tax @8% $72,000 Zero Total Income Tax $286,200 Zero Net to heirs $713,800 $1,000,000 Gift Versus Estate Estate Tax Gift Estate Fair Market Value $1,000,000 $1,000,000 Basis $100,000 $1,000,000 Taxable Gain $900,000 Zero Federal Income Tax @23.8% $214,200 Zero State Income Tax @8% $72,000 Zero Total Income Tax $286,200 Zero Sub-total $713,800 $1,000,000 Estate Tax @40% Zero $400,000 Net to heirs $713,800 $600,000 2
Portability PORTABILITY VERSUS TRUST The decedent spouse s unused exemption can be transferred Surviving spouse can use the unused estate tax exemption for: Lifetime gifts As part of their estate tax filing Election to transfer must be made timely; no election allowed on late-filed return (special extension for pre-2014 estates) Statute of limitations remains open on decedent spouse until surviving spouse s statute has run its course Portability Disadvantages Amount ported to surviving spouse not indexed to inflation If farmland appreciates greater than inflation, second spouse estate will owe estate taxes versus using a shelter or family trust Asset protection In case of multiple marriages, only most recent unused exemption can be used The Estate tax exemption is portable, but the GST is not Assets passing directly to an individual are subject to claims of creditors The executor must make an election on a timely filed estate tax return. Once made, the election is irrevocable. Example: Portability H dies in 2014 H has taxable transfers at death of $3.0 million Election is made in his filed estate return to permit W to use H s unused $2.34 million exemption W at death has $7.68 million exemption [$2.34 million from H and $5.34 million (+) of her own] W can have taxable estate of $7.68 million (+) and not owe any estate taxes Gifts are made out of ported amount first (gift tax arbitrage?) 16 The use of a Credit Shelter Trust Portability Versus Trust Example Credit Shelter Trust is still an important estate planning tool: Portability may be lost if the surviving spouse remarries and is later widowed again The trust can protect any appreciation of the assets from estate tax at the second spouse s death The trust can provide protection of assets from the reach of the surviving spouse s creditors Portability does not apply to GST, the trust may be needed to fully leverage GST exemptions for both spouses Portability Trust John s estate tax value $4,840,000 $4,840,000 Tax Owed on John s estate Zero Zero Amount ported to Mary $5,340,000 Zero Value of Mary s estate $14,328,765 6,424,260 Exemption amount $11,850,000 $6,510,000 Taxable Estate $2,478,765 Zero Estate Tax $991,506 Zero Net assets to heirs $13,337,259 $14,328,765 Inflation of 2%, Overall Assets Increase by 4%, John & Mary estate in 2014-$9,680,000, Mary dies 10 years later 3
Wills Versus Revocable Living Trusts WILLS VERSUS REVOCABLE LIVING TRUST Revocable Living Trust are used to: To ensure property continues to be properly managed To reduce costs and time delays by avoiding probate To lessen potential challenges to or elections against the will To maintain privacy To avoid ancillary administration of out-of-state assts Disadvantages of Revocable Living Trusts Does not save estate taxes (versus a will) Does not shelter assets from creditors Costs to setup Husband and Wife Revocable Trusts Trust A Survivor s Trust Remains Revocable First Spouse Dies Trust B Family Trust Remains Irrevocable Survivor Gets All Income All Principal Right to amend Unlimited Power to appoint to anyone Tax on Assets over $5,430,000 Second Spouse Dies Survivor Can Have All Income Principal for health, support and maintenance Some discretionary distributions with independent trustee No Tax Children s Trust Assets can be held in this trust while children are growing in maturity The trustee manages estate and distributes it to children at specified ages SPECIAL USE VALUATION 21 Special Use Valuation Estate Tax Special Use Valuation (Sec. 2032A) 50% of estate consists of farming assets Actively farmed prior to death or retirement An heir continues to actively farm 10 yrs. post-death Value land at lower 5-year. average capitalized rent value Valuation reduction limited to approx. $1.1M Special Use Valuation Example Fair market value of land (per acre) $8,500 Average cash rents for comparable land $200 Current real estate taxes $10 Net cash rents $190 Farm Credit System current interest rate 5.50% Special use value $3,455 Approximate maximum reduction in value $1.1 Million 23 4
Life Insurance and Estate Planning HOW TO HANDLE LIFE INSURANCE Proper amount of insurance (risk protection) Proper ownership of policy to avoid estate inclusion Who pays premiums? Keeping insurance out of estate 26 Life Insurance: Estate Tax on Death Benefit Total Estate Assume $ 11.0 million Life Insurance Husband has $2.0 million death benefit with wife as beneficiary Assume husband dies and wife collects death benefit Total Estate now $ 13.0 million $2.0 million exposed to Federal Estate Tax Estate tax cost estimated $700,000 Net death benefit after estate tax erosion is $1.3 million Irrevocable Life Insurance Trust (ILIT) Insured A $20,000/year Premiums paid by Trust to Insurance Co. Insurance Company Pays annual premiums by gift of cash to trust Insurance Trust Trustee buys and owns Policy A 27 28 Insurance Trust At Death Insurance Issues to Consider Pays death benefit to Trust Insurance Company Insurance Trust $1,000,000 Trustee Pays out benefit to beneficiaries Lends money to estate for expenses Buys assets from estate Pays income to surviving spouse 29 Transfer of existing policies to insurance trust Gift value Three year rule Payment of premiums Annual gift exclusion GST exemption allocation 30 5
Small Size Estate Strategies SMALL, MEDIUM AND LARGE SIZE ESTATE STRATEGIES Keep appreciating assets in estate (get full step-up in value) Use LLE for landholdings to ease transfer of ownership Consider RLT for privacy and other reasons Medium Size Estate Strategies Use Limited Liability Entity (LLE) to own farmland Use annual gifts to keep estate under Lifetime Exemption Amount Retain as much in estate to get full step-up in value Update wills or use RLT Large Size Estate Strategies Use appropriate trust structure to freeze estate values Utilize annual gifts on a maximum basis Utilize ILITs to structure life insurance Appropriate entities to own farmland and operating assets Consider GST gifts (eliminate tax on next generation) 2013 CliftonLarsonAllen LLP Thank you Questions? Paul Neiffer Paul.Neiffer@CLAconnect.com 509-823-2920 (direct) 509-961-9739 (cell) CLAconnect.com twitter.com/ CLAconnect facebook.com/ cliftonlarsonallen linkedin.com/company / cliftonlarsonallen 36 6