What Exactly Is the Estate Tax? – Annapolis and Towson Estate Planning

In the U.S., we treat the estate tax and gift tax as a single tax system with unified limits and tax rates—but it is not very well understood by many people. The Motley Fool’s recent article entitled “What Is the Estate Tax in the United States?” gives us an overview of the U.S. estate and gift tax, including what assets are included, tax rates and exemptions in 2020.

The U.S. estate tax only impacts the wealthiest households. Let us look at why that is the case. Americans can exempt a certain amount of assets from their taxable estate—the lifetime exemption. This amount is modified every year to keep pace with inflation and according to policy modifications. This year, the lifetime exemption is $11.58 million per person. Therefore, if you are married, you and your spouse can collectively exclude twice this amount from taxation ($23.16 million). To say it another way, if you are single and die in 2020 with assets worth a total of $13 million, just $1.42 million of your estate would be taxable.

However, most Americans don’t have more than $11.58 million worth of assets when they pass away. This is why the estate tax only impacts the wealthiest households in the country. It is estimated that less than 0.1% of all estates are taxable. Therefore, 99.9% of us do not owe any federal estate taxes whatsoever at death. You should also be aware that the lifetime exemption includes taxable gifts as well. If you give $1 million to your children, for example, that counts toward your lifetime exemption. As a result, the amount of assets that could be excluded from estate taxes would be then decreased by this amount at your death.

You do not have to pay any estate or gift tax until after your death, or until you have used up your entire lifetime exemption. However, if you give any major gifts throughout the year, you might have to file a gift tax return with the IRS to monitor your giving. There is also an annual gift exclusion that lets you give up to $15,000 in gifts each year without touching your lifetime exemption. There are two key points to remember:

  • The exclusion amount is per recipient. Therefore, you can give $15,000 to as many people as you want every year, and they do not even need to be a relative; and
  • The exclusion is per donor. This means that you and your spouse (if applicable) can give $15,000 apiece to as many people as you want. If you give $30,000 to your child to help her buy their first home and you’re married, you can consider half of the gift from each spouse.

The annual gift exclusion is an effective way for you to reduce or even eliminate estate tax liability. The estate tax rate is effectively 40% on all taxable estate assets.

Finally, the following kinds of assets aren’t considered part of your taxable estate:

  • Anything left to a surviving spouse, called “the unlimited marital deduction”;
  • Any amount of money or property you leave to a charity;
  • Gifts you have given that are less than the annual exclusion for the year in which they were given; and
  • Some types of trust assets.

Reference: The Motley Fool (Jan. 25, 2020) “What Is the Estate Tax in the United States?”

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A 2020 Checklist for an Estate Plan – Annapolis and Towson Estate Planning

The beginning of a new year is a perfect time for those who have not started the process of getting an estate plan started. For those who already have a plan in place, now is a great time to review these documents to make changes that will reflect the changes in one’s life or family dynamics, as well as changes to state and federal law.

Houston Business Journal’s recent article entitled “An estate planning checklist should be a top New Year’s resolution” says that by partnering with a trusted estate planning attorney, you can check off these four boxes on your list to be certain your current estate plan is optimized for the future.

  1. Compute your financial situation. No matter what your net worth is, nearly everyone has an estate that is worth protecting. An estate plan formalizes an individual’s wishes and decreases the chances of family fighting and stress.
  2. Get your affairs in order. A will is the heart of the estate plan, and the document that designates beneficiaries beyond the property and accounts that already name them, like life insurance. A will details who gets what and can help simplify the probate process, when the will is administered after your death. Medical questions, provisions for incapacity and end-of-life decisions can also be memorialized in a living will and a medical power of attorney. A financial power of attorney also gives a trusted person the legal authority to act on your behalf, if you become incapacitated.
  3. Know the 2020 estate and gift tax exemptions. The exemption for 2020 is $11.58 million, an increase from $11.4 million in 2019. The exemption eliminates federal estate taxes on amounts under that limit gifted to family members during a person’s lifetime or left to them upon a person’s passing.
  4. Understand when the exemption may decrease. The exemption amount will go up each year until 2025. There was a bit of uncertainty about what would happen to someone who uses the $11.58 million exemption in 2020 and then dies in 2026—when the exemption reverts to the $5 million range. However, the IRS has issued final regulations that will protect individuals who take advantage of the exemption limits through 2025. Gifts will be sheltered by the increased exemption limits, when the gifts are actually made.

It is a great idea to have a resolution every January to check in with your estate planning attorney to be certain that your plan is set for the year ahead.

Reference: Houston Business Journal (Jan. 1, 2020) “An estate planning checklist should be a top New Year’s resolution”

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Is There Estate Tax on the Property I Inherited? – Annapolis and Towson Estate Planning

The vast majority of those who inherit real estate don’t end up paying any taxes on the property. However, there are some instances where estate or inheritance taxes could be assessed on inherited real estate. Motley Fool’s recent article, “Do You Have to Pay Estate Tax on Real Estate You Inherit?” provides a rundown of how estate taxes work in the U.S. and what it means to you if you inherit or are gifted real estate assets.

An estate tax is a tax applied on property transfers at death. A gift tax is a tax levied on property transfers while both parties are alive. An inheritance tax is assessed on the individual who inherits the property. For real estate purposes, you should also know that this includes money and property, and real estate is valued based on the fair market value at the time of the decedent’s death.

Most Americans don’t have to worry about estate taxes because we’re allowed to exclude a certain amount of assets from our taxable estates, which is called the lifetime exemption. This amount is adjusted for inflation over time and is $11.58 million per person for 2020. Note that estate taxes aren’t paid by people who inherit the property but are paid directly by the estate before it is distributed to the heirs.

The estate and gift taxes in the U.S. are part of a unified system. The IRS allows an annual exclusion amount that exempts many gifts from any potential transfer tax taxation. In 2020, it’s $15,000 per donor, per recipient. Although money (or assets) exceeding this amount in a given year is reported as a taxable gift, doesn’t mean you’ll need to pay tax on them. However, taxable gifts do accumulate from year to year and count toward your lifetime exclusion. If you passed away in 2020, your lifetime exclusion will be $11.58 million for estate tax purposes.

If you’d given $3 million in taxable gifts during your lifetime, you’ll only be able to exclude $8.58 million of your assets from estate taxation. You’d only be required to pay any gift taxes while you’re alive, if you use up your entire lifetime exemption. If you have given away $11 million prior to 2020 and you give away another $1 million, it would trigger a taxable gift to the extent that your new gift exceeds the $11.58 million threshold.

There are a few special rules to understand, such as the fact that you can give any amount to your spouse in most cases, without any gift or estate tax. Any amount given to charity is also free of gift tax and doesn’t count toward your lifetime exemption. Higher education expenses are free of gift and estate tax consequences provided the payment is made directly to the school. Medical expense payments are free of gift and estate tax consequences, if the payment is made directly to the health care provider.

Remember that some states also have their own estate and/or inheritance taxes that you might need to consider.

States that have an estate tax include Connecticut, Illinois, Maine, Massachusetts, Minnesota, New York, Oregon, Rhode Island, Vermont and Washington. The states with an inheritance tax are Iowa, Kentucky, Nebraska, New Jersey and Pennsylvania. Maryland has both an estate and an inheritance tax. However, there are very few situations when you would personally have to pay tax on inherited real estate.

Estate tax can be a complex issue, so speak with a qualified estate planning attorney.

Reference: Motley Fool (December 11, 2019) “Do You Have to Pay Estate Tax on Real Estate You Inherit?”

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What Does an Estate Planning Attorney Really Do? – Annapolis and Towson Estate Planning

Vents Magazine’s recent article, “Understanding What an Estate Planning Attorney Does,” explains that estate planning is a legal set of instructions for your family about how to distribute your wealth and property after you die. Estate planning attorneys make sure the distribution of property happens according to the decedent’s will.

An estate planning attorney can provide legal advice on how to prepare your will after you pass away or in the event that you experience mental incapacity. She will have all the information and education on all the legal processes, beginning with your will and moving on to other important estate planning documents. She will also help you to understand estate taxes.

An estate planning attorney will also help to make certain that all of your savings and property are safe and distributed through the proper legal processes.

Estate planning attorneys can also assist with the power of attorney and health care directives. These documents allow you to designate an individual to decide issues on your behalf, in the event that you become mentally incapable of making decisions for yourself. They can also help you with a guardian who will look after your estate.

It’s important that you select the right estate planning attorney to execute the legal process, as you’ve instructed in your estate plan. You should only retain an attorney with experience in this field of law because other legal counsel won’t be able to help you with these issues—or at least, they may say they can, only to find out later that they’re not experienced in this area.

You also want to feel comfortable with your estate planning attorney because you must disclose all your life details, plans and estate issues, so she can create an estate plan that’s customized to your circumstances.

If you choose the right attorney, it will save you money in the long run. She will help you save from all the estate taxes and make all the processes smooth and easy for you and your loved ones.

Reference: Vents Magazine (December 12, 2019) “Understanding What an Estate Planning Attorney Does”

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How is My Retirement Income Taxed? – Annapolis and Towson Estate Planning

Based on the state in which you retire, state income taxes could vary by thousands of dollars. However, as a recent Kiplinger article, “State Taxes on Retirees Differ by Types of Retirement Income,” tells us, it’s not just a state’s tax rate that matters. The type of income you get in retirement frequently has a bigger impact on your state taxes than your tax rate, because each state has its own method of taxing specific types of retirement income.

Let’s look at the taxes on Social Security benefits. The federal government can tax up to 85% of Social Security benefits, but most states don’t tax Social Security benefits. There are seven states—Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming—that don’t tax Social Security benefits because they don’t have any income tax. New Hampshire and Tennessee only tax interest and dividends. Social Security benefits are exempt from tax in DC and 28 states: Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia, and Wisconsin.

That leaves 13 states where part of Social Security benefits may be taxable. New Mexico, Utah, and West Virginia currently tax Social Security benefits to the same extent they are taxed on federal returns, but West Virginia plans to phase out its tax on Social Security benefits in 2020. Taxation of Social Security benefits in the rest of the states—Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, North Dakota, Rhode Island, and Vermont—is based on your income and, in many instances, on your filing status. Some of these states may also exempt Social Security for taxpayers under certain income thresholds.

As far as retirement plan payouts, state taxation of payouts from retirement plans, such as pensions, IRAs, and 401(k)s, can be more complicated. States without an income tax or that just tax interest and dividends don’t tax retirement plan payouts. However, with the other states, it’s all over the board. Mississippi and Pennsylvania are the most generous—they typically don’t tax any retirement income. However, California, D.C., Nebraska, and Vermont offer few or no tax breaks for retirement plan payouts. In some cases, the type of retirement plan involved makes a difference.

Reference: Kiplinger (October 28, 2019) “State Taxes on Retirees Differ by Types of Retirement Income”

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How Can Life Insurance Help My Estate Plan? – Annapolis and Towson Estate Planning

In the 1990s, it wasn’t unusual for people to buy second-to-die life insurance policies to help pay federal estate taxes. However, in 2019, with estate tax exclusions up to $11,400,000 (and rising with the cost-of-living adjustments), fewer people would owe much for estate taxes.

However, IRAs, 401(k)s, and other accounts are still 100% taxable to the individuals, spouses and their children. The stretch IRA options still exist, but they may go away, as Congress may limit stretch IRAs to a maximum of 10 years.

Forbes’ recent article, “3 Ways Life Insurance Can Help Your Estate Plan,” explains that as the IRA is giving income from the RMDs, it may also be added, after tax, to the life insurance policy. If this occurs, it’s even possible that the death benefits could grow in the future, giving a cost-of-living benefit to children. This is one way how life insurance can be used creatively to help your estate plan.

For married couples, one strategy is to consider how life insurance on one individual could be used to pay “conversion tax” at death, using tax-free benefits. When the retiree dies, the spouse beneficiary can then convert all the IRA (taxable money) to a Roth IRA, which is tax-exempt with new, lower income tax rates (37% in 2018-2025 versus 39.6% in 2017 or earlier).

This tax-free death benefit money can be used to pay the taxes on the conversion, letting the surviving beneficiary have a lifetime of tax-exempt income without RMD issues from the Roth IRA. The Social Security income could also be tax-exempt, because Roth withdrawals don’t count as “income” in the calculation to see how much of your Social Security is taxed. However, you’d have to be within the threshold for any other combined income.

Life insurance for both individuals (if married) may also be a good idea. If the spouse of the IRA owner dies, the money from the life insurance can be used once again. If this is done in the tax year of the death for married individuals, the tax conversion could be done under “married filing status” before the next year, when the individual must use single tax filing status.

Another benefit of the IRA-to-Roth conversion is the passing of Roth IRAs to heirs, which could create a lasting legacy, if planned well. New life insurance policies that add long-term care features with chronic care and critical care benefits can also provide an extra degree of benefits, if one of the insureds has health issues prior to death.

Be sure to watch the tax rates and possible changes. With today’s lower tax rates, this could be very beneficial. Remember that there are usually individual state taxes as well. However, considering all the tax-optimized benefits to spouses and beneficiaries, the long-term tax benefits outweigh the lifetime tax liabilities, especially when you also consider SSI tax benefits for the surviving spouse and no RMD issues.

Life insurance in retirement can help protect, build and transfer wealth in one of the easiest ways possible. If you’re not certain about where to start with your life insurance needs, speak with an experienced estate planning attorney.

Reference: Forbes (November 15, 2019) “3 Ways Life Insurance Can Help Your Estate Plan”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys

What’s the Best Way to Take My Required Minimum Distribution? – Annapolis and Towson Estate Planning

CNBC’s recent article, “These tips can help retirees make required minimum distributions easy and tax penalty free,” gives the steps to follow, so we don’t leave money on the table.

RMDs or required minimum distributions, are the minimum amount people age 70½ and older must withdraw from their retirement funds. If you’ve inherited a retirement account, you may also have to make a withdrawal. The amount you need to withdraw varies from year to year and is based on specific calculations, including what your account values were as of December 31 the prior year and your age.

The time to get started on your RMD for this year is right now, because the paperwork may take some time. You have until April 1, if you just turned 70½ this year. Let’s look at a few tips:

Get your paperwork organized. In order to know how much you have to withdraw, you have to have an accurate picture of what you own. Create a list of accounts and take an inventory first, so you know where all your retirement accounts are located.

Know what you can take from what account. If you have multiple IRAs, you can take your total RMD from any one of those accounts because of the aggregation rule. However, with multiple IRAs, you still must calculate the amount you take out based on the value of all of them. It’s that same with multiple 403(b) retirement accounts. The rule doesn’t apply to 401(k) plans. If you have multiple 401(k) accounts, you must take money from each one, and you can’t take an RMD from an IRA to satisfy a 401(k), or vice versa.

Understand the rules, if you’re still working. If you’re 70½ and still employed, you could get a break from taking your RMD in certain circumstances. Generally, 401(k) plans have a still-working rule, which stipulates that you don’t have to take the RMD until you retire. However, you can only delay the RMDs, if the plan is attached to the company where you’re currently employed. Other accounts from a previous employer are excluded, so you must still take distributions from those.

Keep an eye on any inherited accounts. If you’ve inherited a retirement account, you may have to take an RMD by the end of this year. That generally doesn’t apply if you inherited the money from your spouse, because spouses can do a rollover and keep postponing the distributions. However, if you’re a non-spouse beneficiary, you probably must take a distribution by the end of 2019. If you inherited the account in 2018, you’ll need to take your first RMD in 2019.

RMDs from a Roth IRA will likely be tax-free. However, if you’ve inherited one of these accounts and you didn’t take that money out, you’ll have to pay a 50% penalty on the funds you should’ve withdrawn.

Consider giving to charity. A good way to avoid paying taxes on your RMD, is to give the money to charity. A qualified charitable distribution lets you make donations to a charity directly from your IRA, instead of taking the RMD yourself. Therefore, if your RMD is $5,000, and you typically give $5,000 to charity each year, you can donate that money directly and not pay tax on it.

Reference: CNBC (November 29, 2019) “These tips can help retirees make required minimum distributions easy and tax penalty free”

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Why Even “Regular Folks” Can Benefit from Trust Funds – Annapolis and Towson Estate Planning

A trust is a useful tool, even if you’re not a wealthy person. There are many different types of trusts, but the most basic types are revocable and irrevocable. A recent article from Business Insider “A trust fund gives you control over your money after you’re gone, and it’s not just for the super rich” clarifies when and how to use a trust fund.

Trust funds are often used to avoid having assets pass through the probate process. They allow for a tax-efficient means of transferring wealth, avoid or defer estate taxes and help with charitable giving. An experienced estate planning attorney can help clarify what type of trust is needed, and how it can work with an overall estate plan.

Trust funds have a bad reputation for creating badly-behaved young adults, but they are a good planning tool for anyone. Some trusts are more expensive to maintain than others, which is why they are often associated with wealthy people. However, they have the same purpose: to ensure that a person’s money goes where they want it to go. The directions can be as specific as you wish.

There are three people involved in any trust: the grantor, who puts their assets in the trust fund; the beneficiary or beneficiaries, who receive those assets according to the terms of the trust; and the trustee, the person or group of advisors or the organization that is responsible for managing the trust when the trust is created and after the grantor has died. A grantor can put almost any kind of asset into a trust, but most people use them for real estate, bank accounts, investment accounts, business interests and life insurance policies.

If a trust is revocable, it means the grantor may make changes at any time and can generate income through the assets in the trust. The assets are included in the grantor’s estate and the grantor may pay taxes on the assets now and upon their death. Creditors can access the assets for any unpaid debts. Once the grantor of a revocable trust dies, the trust becomes irrevocable.

An irrevocable trust cannot be changed, once it is created. It can only be accessed after the death of the grantor. The assets are not included in the grantor’s estate and they do not have to pay taxes during their lifetime or at death. The taxes are the responsibility of the trust and beneficiaries. Depending on how the trust is designed, creditors may not access the trust.

If you are considering setting up a trust, meet with an estate planning lawyer to discuss your unique situation and determine which type of trust works best for you and your family.

Reference: Business Insider (December 2, 2019) “A trust fund gives you control over your money after you’re gone, and it’s not just for the super rich”

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What 2020 Tax Changes May Bring for Wealthy Families – Annapolis and Towson Estate Planning

What happens in the political landscape in 2020 could have an impact on wealthy individuals, in a positive and a negative way. The biggest impact may be changes in estate and income taxes. With income taxes, the tax brackets are indexed, so they will go higher in 2020. There are also new IRS thresholds, so people will need to be aware of these changes.

The article “What Wealthy Clients Need to Know About 2020 Tax Changes” from Financial Advisor offers a look at what’s coming next year.

The tax rates were generally lowered, and thresholds increased. The top bracket for married couples in 2017 was 39.6% for couples whose taxable income was higher than $470,700. In 2020, that same bracket is 37%, with a new income threshold of $622,051.

There are more holiday gifts from the IRS. The estate exemption increases to $11.58 million in 2020, although the annual exclusion for gifts stays at $15,000. The maximums for retirement account contributions have also been increased.

The mandated penalty for not having health insurance is gone. Therefore, anyone who has the income to self-insure without having a policy that is ACA-qualified won’t have to pay a penalty. However, that varies by state: California enforces a tax penalty for people who do not have health insurance.

A major consideration for 2020 is the higher standard deduction. This may mean more strategic planning for which years people should itemize. Some experts are advising that taxpayers bunch their deductions, so they can itemize. One strategy is to do this every other year.

Many nonprofits are advising their donors to plan their charitable giving to take place every other year for the same reason.

With the stock market continuing to hit record highs, it may also make sense for people to transfer highly appreciated securities to donor advised funds.

Another potentially big series of changes that is still pending is the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019. The legislation is still pending, but it is likely that some form of the bill will become law, and there will be further changes regarding retirement accounts and taxes. The bill passed the House in the spring, but it still pending in the Senate.

Reference: Financial Advisor (December 2, 2019) “What Wealthy Clients Need to Know About 2020 Tax Changes”

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Can You Explain the Concept of Step-Up Basis? – Annapolis and Towson Estate Planning

If you inherit assets—especially real property—you need to understand the step-up in basis rules. These rules can save you a lot of money on capital gains and depreciation recapture taxes.

Motley Fool’s recent article on this subject asks “What is a Step-Up in Basis?” The article explains that step-up in basis has significant implications for inherited property. When an asset is inherited because the original owner has passed away, in many cases, it’s worth more than when it was first purchased. To avoid a huge capital gains tax bill when the inherited property is sold, the cost basis of the asset is modified to its value at the time of its owner’s death. This is called a step-up in basis. Note that this only applies to property transferred after death. If a property was gifted or transferred before the original owner dies, the original cost basis would transfer to the recipient.

This is a gigantic tax benefit for estate planning, regardless of whether you go ahead and sell the inherited asset immediately or hold on to it for a time. While a step-up in basis can let heirs avoid capital gains taxes, it doesn’t allow heirs to avoid estate taxes that apply to big inheritances.

The estate tax this year is imposed on property in excess of $11.4 million per individual and $22.8 million per married couple. Therefore, if you and your spouse leave a $25 million estate to your heirs, $2.2 million of this will still be taxable, even though your heirs’ cost basis in assets they inherited will be stepped up for capital gains tax purposes.

There are many strategies that a qualified estate planning attorney can advise you on to avoid estate taxes, but step-up in basis doesn’t exclude the value of inherited property from a taxable estate all by itself.

There are two significant ramifications of stepped-up cost basis regarding inherited real estate assets. First, like with other assets, you don’t have to pay capital gains on any appreciation that occurred before you inherited the property. Selling an investment property after years of holding it, can mean a massive capital gains tax bill. Therefore, a stepped-up cost basis can be a very valuable benefit. A step-up in basis can also give you a larger depreciation tax benefit. The cost basis of residential real estate can be depreciated (deducted) over 27½ years: a higher number divided by 27½ years is a greater annual depreciation deduction than a smaller number would produce.

Estate transfers are pretty complicated, so work with a qualified estate planning attorney.

Reference: Motley Fool (November 21, 2019) “What is a Step-Up in Basis?”

Sims & Campbell, LLC – Annapolis and Towson Estate Planning Attorneys