How Do I Protect an Inheritance from the Tax Man? – Annapolis and Towson Estate Planning Attorneys

Inheritances are not income for federal tax purposes, whether you inherit cash, investments or property. However, any subsequent earnings on the inherited assets are taxable, unless it comes from a tax-free source. Therefore, you must include the interest income in your reported income.

The Street’s recent article entitled “4 Ways to Protect Your Inheritance from Taxes” explains that any gains when you sell inherited investments or property are usually taxable. However, you can also claim losses on these sales. State taxes on inheritances vary, so ask a qualified estate planning attorney about how it works in your state.

The basis of property in a decedent’s estate is usually the fair market value (FMV) of the property on the date of death. In some cases, however, the executor might choose the alternate valuation date, which is six months after the date of death—this is only available if it will decrease both the gross amount of the estate and the estate tax liability. It may mean a larger inheritance to the beneficiaries.

Any property disposed of or sold within that six-month period is valued on the date of the sale. If the estate is not subject to estate tax, the valuation date is the date of death.

If you are getting an inheritance, you might ask that they create a trust to deal with their assets. A trust lets them pass assets to beneficiaries after death without probate. With a revocable trust, the grantor can remove the assets from the trust, if necessary. However, in an irrevocable trust, the assets are commonly tied up until the grantor dies.

Let us look at some other ideas on the subject of inheritance:

You should also try to minimize retirement account distributions. Inherited retirement assets are not taxable, until they are distributed. Some rules may apply to when the distributions must occur, if the beneficiary is not the surviving spouse. Therefore, if one spouse dies, the surviving spouse usually can take over the IRA as their own. RMDs would start at age 72, just as they would for the surviving spouse’s own IRA. However, if you inherit a retirement account from a person other than your spouse, you can transfer the funds to an inherited IRA in your name. You then have to start taking RMDs the year of or the year after the inheritance, even if you’re not age 72.

You can also give away some of the money. Sometimes it is wise to give some of your inheritance to others. It can assist those in need, and you may offset the taxable gains on your inheritance with the tax deduction you get for donating to a charitable organization. You can also give annual gifts to your beneficiaries, while you are still living. The limit is $15,000 without being subject to gift taxes. This will provide an immediate benefit to your recipients and also reduce the size of your estate. Speak with an estate planning attorney to be sure that you are up to date with the frequent changes to estate tax laws.

Reference: The Street (May 11, 2020) “4 Ways to Protect Your Inheritance from Taxes”

 

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Should I Create an LLC for Estate Planning? – Annapolis and Towson Estate Planning

If you want to transfer assets to your children, grandchildren or other family members but are worried about gift taxes or the weight of estate taxes your beneficiaries will owe upon your death, a LLC can help you control and protect assets during your lifetime, keep assets in the family and lessen taxes owed by you or your family members.

Investopedia’s article entitled “Using an LLC for Estate Planning” explains that a LLC is a legal entity in which its owners (called members) are protected from personal liability in case of debt, lawsuit, or other claims. This shields a member’s personal assets, like a home, automobile, personal bank account or investments.

Creating a family LLC with your children lets you effectively reduce the estate taxes your children would be required to pay on their inheritance. A LLC also lets you distribute that inheritance to your children during your lifetime, without as much in gift taxes. You can also have the ability to maintain control over your assets.

In a family LLC, the parents maintain management of the LLC, and the children or grandchildren hold shares in the LLC’s assets. However, they do not have management or voting rights. This lets the parents purchase, sell, trade, or distribute the LLC’s assets, while the other members are restricted in their ability to sell their LLC shares, withdraw from the company, or transfer their membership in the company. Therefore, the parents keep control over the assets and can protect them from financial decisions made by younger members. Gifts of shares to younger members do come with gift taxes. However, there are significant tax benefits that let you give more, and lower the value of your estate.

As far as tax benefits, if you are the manager of the LLC, and your children are non-managing members, the value of units transferred to them can be discounted quite steeply—frequently up to 40% of their market value—based on the fact that without management rights, LLC units become less marketable.

Your children can now get an advance on their inheritance, but at a lower tax burden than they otherwise would have had to pay on their personal income taxes. The overall value of your estate is reduced, which means that there is an eventual lower estate tax when you die. The ability to discount the value of units transferred to your children, also permits you to give them gifts of discounted LLC units. That lets you to gift beyond the current $15,000 gift limit, without having to pay a gift tax.

You can give significant gifts without gift taxes, and at the same time reduce the value of your estate and lower the eventual estate tax your heirs will face.

Speak to an experienced estate planning attorney about a family LLC, since estate planning is already complex. LLC planning can be even more complex and subject you to heightened IRS scrutiny. The regulations governing LLCs vary from state to state and evolve over time. In short, a family LLC is certainly not for everyone and it appropriately should be vetted thoroughly before creating one.

Reference: Investopedia (Oct. 25, 2019) “Using an LLC for Estate Planning”

 

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How Is the Inheritance Tax on My Estate Paid? – Annapolis and Towson Estate Planning

If your state has an inheritance tax, you should have an idea how it will be paid when you pass away.

Financial institutions may not withhold the tax before the inheritances are paid, and if there will not be enough in the residue of your estate to pay the tax, you need some options.

Nj.com’s recent article entitled, “How can I be sure the inheritance tax is paid when I die?” says that, while it is admirable to try to avoid trouble for your executors, there is a simple solution.

The article suggests that you can remove all beneficiary designations from your financial accounts. When you add beneficiary designations to your financial accounts, you create non-probate assets, or assets that are not distributed pursuant to your will.

If you do this, those assets will become probate assets, or assets that pass through your will. As a result, you can then state in your will how these assets should be distributed.

For instance, it can be based on percentages of your estate or based on which financial institution holds the assets, or another method.

With these assets now being probate assets, the executor of your will is now able to withhold the inheritance tax on each of the distributions, before distributing the rest.

The amount of inheritance tax paid by the beneficiary is the same whether the distribution is made as a probate asset or a non-probate asset, except for life insurance.

However, if the financial account is a retirement account, by having it paid to the estate instead of directly to a beneficiary, the payout period may be lessened. Therefore, you should speak with an experienced estate planning attorney.

Reference: nj.com (May 5, 2020) “How can I be sure the inheritance tax is paid when I die?”

 

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How Do the Children Divide Up Mom’s Tangible Property? – Annapolis and Towson Estate Planning

What should you do if you have been given the task to be in charge of divvying up a parent’s estate that includes assorted tangible items?

Minneapolis Tribune’s article entitled “A clever way to divvy up items after a parent’s death” says that some families do it by taking turns selecting which items each will keep.

The article discusses how a family decided to divide things up their mom’s grand estate and how the method the family used to divvy up the tangible items could be one that other families with much smaller estates could use.

After their mom’s death at 93, the brother and sister co-executors created an inventory of 724 items in her estate that had monetary or sentimental value. These included things like furniture, artwork, oriental rugs, cutlery, china, a piano and a car. They did not include their mom’s jewelry, books or linens, or her silver, gold and collectible coins. The four siblings all agreed to sell the coins and to deal with the many books, linens, and jewelry more informally, after the more significant items had been distributed.

The family did not use the common way of disbursing tangible items of an estate, in which family members take turns choosing items. With over 700 items, that could take a while. They felt that system would not maximize the value received by the four children and seven grandchildren. Instead, their process for dividing the intangible items used the following steps:

  1. The inventory was given to all four siblings and asked each one to state the items that they were interested in. This divided the 724 items into three groups: (a) items in which no one had an interest; (b) items in which only one person had an interest; and (c) those in which two or more were interested. Things in which no one had an interest were set aside to be sold or given away, and those who were the only siblings to want certain items got them.
  2. They then made lists of items in which more than one sibling expressed an interest. Each received a list of those items. They were not given information on ones in which they were not interested—one of two ways the system was not transparent.
  3. Each person was then “given” 500 virtual poker chips that he or she could use to bid for contested items. However, prior to the bidding deadline, they could talk with one another about their intentions. The result was that many had bid for several similar items, like family pictures, bookcases and oriental rugs — when they really only wanted one from each category. Thus, they agreed among themselves who would receive each one, without wasting too many chips. This also avoided two siblings using a lot of tokens to bid for a particular item, and no one bidding on another similar one.
  4. After the bids were in, the co-executors announced the results without revealing the bids, to avoid a silent auction where bidders can see what others are bidding and readjust their bids up to the deadline. This was the second part of the system that was not transparent.
  5. Finally, when all the allocations were determined, the co-executors tabulated the monetary value of all the items and readjusted the estate monetary distributions to ensure that everyone came out at the same place financially. The most valuable items were a 1919 Steinway drawing room grand piano valued at $25,000; a 2005 Toyota Camry valued at $4,500; and some oriental rugs with a total value of $13,975. Those who got the big-ticket items had to pay their siblings something for them, with a total of $17,500 trading hands.

It was time-consuming and took several months, but the siblings thought that their system was very fair and the process, unlike what is done in some other family estates, relieved tensions and brought the siblings closer together.

Reference: Minneapolis Tribune (Feb. 25, 2020) “A clever way to divvy up items after a parent’s death”

 

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What Can a Strong Estate Planning Attorney Help Me Accomplish? – Annapolis and Towson Estate Planning

The Legal Reader’s recent article entitled “When Should I Start My Estate Planning?” explains that, as we settle down, we should start considering how we will provide for and protect those you love.

Talk to an experienced estate planning attorney—one with the knowledge and skill to help you design a workable, legally binding estate plan that will keep your assets safe as they accumulate, protect your spouse and children and consider the possibility that you may become incapacitated when you least expect it.

No matter what your age, the estate planning attorney you hire should have outstanding credentials and testimonials to his/her efficiency and personal concern.

This legal professional must be able to:

  • Listen, understand, and address your individual needs
  • Clarify your options
  • Draft, review, and file all necessary estate planning documents
  • Make certain your estate plan covers all contingencies; and
  • Is prepared to modify your documents as your life circumstances change.

When you see that the future is unpredictable, you realize that estate planning can help you make that future as secure as possible.

Estate planning can be as complicated as it is essential. Accordingly, regardless of our age, speak with a highly competent estate planning attorney as soon as possible.

As the COVID-19 pandemic has dramatically shown us, planning for the unexpected can never be addressed too soon.

Reference: Legal Reader (June 23, 2020) “When Should I Start My Estate Planning?”

 

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Does a Beneficiary of a Trust Have to Pay a Tax? – Annapolis and Towson Estate Planning

When a trust makes a distribution, it deducts the income distributed on its own tax return and issues the beneficiary a tax form called a K-1. That form shows what part of the beneficiary’s distribution is interest income and principal. This tells beneficiaries what they must claim as taxable income, when filing taxes.

A recent Investopedia article asks “Do Trust Beneficiaries Pay Taxes?” The article explains that a trust is a fiduciary relationship, whereby the trustor or grantor gives another party–the trustee–the right to hold assets for the benefit of a beneficiary. Trusts are established to provide legal protection and to safeguard assets as part of estate planning.

When trust beneficiaries get distributions from the trust’s principal balance, they do not have to pay taxes on the distribution. The IRS assumes this money was already taxed before it was placed into the trust. Once money is placed into the trust, the interest it accumulates is taxable as income—either to the beneficiary or the trust itself. The trust is required to pay taxes on any interest income it holds and doesn’t distribute past year-end. Interest income the trust distributes is taxable to the beneficiary.

The amount distributed to the beneficiary is thought to be from the current-year income first, then from the accumulated principal. This is usually the original contribution plus subsequent ones. It is income in excess of the amount distributed.

Capital gains from this amount may be taxable to either the trust or the beneficiary. The entire amount distributed to and for the benefit of the beneficiary is taxable to that person to the extent of the distribution deduction of the trust.

The two most significant tax forms for trusts are the 1041 and the K-1. Form 1041 is similar to Form 1040. The trust deducts from its own taxable income any interest it distributes to beneficiaries in Form 1041. At the same time, the trust issues a K-1. That form details the distribution, or how much of the distributed money came from principal versus interest.

The K-1 schedule for taxing distributed amounts is generated by the trust and given to the IRS.

The IRS will then send the document to the beneficiary to pay the tax.

The trust then fills out a Form 1041 to determine the income distribution deduction that is accorded to the distributed amount.

Reference: Investopedia (Feb. 8, 2020). “Do Trust Beneficiaries Pay Taxes?”

 

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Five Top Reasons to Add Beneficiaries to Investment Accounts – Annapolis and Towson Estate Planning

One way to show loved ones that you care, is by having an estate plan and communicating your wishes to them clearly, notes the article “Why You Should Add Beneficiaries to Your Investment Accounts Now” from The Street. That includes adding beneficiaries to your retirement and investment accounts. This simple step will help save heirs time, money and emotional stress at a time when they are likely to be overwhelmed with grief and paperwork.

They will retain more of your estate and get it faster too. When beneficiaries are assigned to investment and retirement accounts, the assets pass directly to them. If there are no beneficiaries, the asset may have to go through probate, the legal process of settling an estate when someone dies.

Probating an estate usually involves going to court, which is something your beneficiaries would probably prefer not to deal with during a challenging time. A typical probate case could last a year, sometimes longer, depending on where you live. During this time, your beneficiaries are not able to access their inheritance. Going to court also means court fees, attorney fees, lost time, and additional stress.

Let us not leave out how much of a bite probate can take out of your estate. Depending on its complexity, probate can consume anywhere from 0.5% to 5% of the estate.

Removes one stress for loved ones. Having assets transfer directly to beneficiaries lessens what can be an intense burden for heirs, while they are grieving. Once the account provider is notified of the death of the account holder, the provider typically notifies beneficiaries. The beneficiaries have to provide the correct documentation, like a death certificate, but that is a whole lot easier than going through probate. Obtaining death certificates is usually part of the executor’s responsibility and does not cost very much.

Beneficiary designations override your last will and testament. By law, a beneficiary designation determines who receives assets, regardless of what is in your will. That is why it is so important to make sure your beneficiary designations are up to date. What happens if you neglect to update your beneficiaries on a life insurance policy purchased when your children were young? For instance, what if you are divorced from their father, but you forget to replace him as the policy beneficiary? In that case, your ex-spouse will receive the policy proceeds, no matter how many years you have been divorced.

It is easy and relatively painless. Updating or establishing beneficiaries is one of the easiest parts of estate planning. Start by making a list of your accounts, which you should have anyway and contact the account custodian to find out who is listed as a beneficiary. If no one has been named, get directions on how to establish the beneficiary designation and if possible, name a secondary beneficiary.

If you have an IRA or a 401(k), your account will typically offer a beneficiary form within the account. If you have investment accounts, you will need to request a form from the custodian.

Special rules for retirement account beneficiaries. There are rules about leaving retirement plan assets to a spouse, so if you want to leave those assets to children or grandchildren, your spouse will have to sign off on that, with a waiver. Depending upon where you live, a spouse may be entitled to half of the assets in an IRA, even if other beneficiaries are listed, unless there is written consent.

Reference: The Street (June 12, 2020) “Why You Should Add Beneficiaries to Your Investment Accounts Now”

 

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How Do I Avoid the Three Biggest Estate Planning Mistakes? – Annapolis and Towson Estate Planning

After you die, your last will and testament must be approved by the local probate court. The judge will determine if the document is the last will of the deceased, review the inventory of the estate and confirm who will administer the estate proceeds. It is known as “executing” a will.

Wealth Advisor’s recent article entitled “Avoid these 3 estate-planning mistakes and make probate cheaper and easier for your loved ones” discusses some mistakes that people make and how to avoid them.

  1. You do not have a will, or you have a will that was written in another state. You also should have a current will. Life changes, and you need a will for where you live in now. Residency is defined differently in each state, and an out-of-state will delays the probate process, because it fails to satisfy state requirements. Worse yet, it may even be declared invalid.

If there is no will, the deceased is said to have died “intestate,” and his estate must go through probate. However, an administrator will be named by the judge to distribute assets, according to state law. It can be a lengthy and often costly process.

Some people do not want to hire an attorney to create their estate plan or write a will, because they believe it is too expense or they never get around to doing it. However, if you die without a will, the legal costs will be even more and that will be paid by your estate—that decreases what’s left to give to your heirs.

  1. Mixing up estate taxes with probate. Your estate may be too small to be subject to federal tax, if it is less than the $11.58 million exemption. However, you still will be subject to probate and possibly a state estate tax. Therefore, you still need an estate plan.
  2. Disregarding easy things to keep some assets from probate. Most states have a “mini-probate” that is expedited for small estates. With this process, heirs may have fewer fees, less paperwork and shorter waiting.

You can also create a living trust (revocable trust) to avoid probate altogether, if done correctly. This is a legal vehicle to which all of your assets pass upon your death. Ask an estate planning lawyer to help you create a trust, because they can be complicated. Whether you need a trust, a will, or both, an experienced estate planning attorney has worked through a variety of situations and will have sound and creative ideas. Investing time and money with an attorney makes life easier for you now and for your family later.

Reference: Wealth Advisor (Feb. 18, 2020) “Avoid these 3 estate-planning mistakes and make probate cheaper and easier for your loved ones”

 

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What You Need to Know about Drafting Your Will – Annapolis and Towson Estate Planning

A last will and testament is just one of the legal documents that you should have in place to help your loved ones know what your wishes are, if you cannot say so yourself, advises CNBC’s recent article entitled, “Here’s what you need to know about creating a will.” In this pandemic, the coronavirus may have you thinking more about your mortality.

Despite COVID-19, it is important to ponder what would happen to your bank accounts, your home, your belongings or even your minor children, if you are no longer here. You should prepare a will, if you do not already have one. It is also important to update your will, if it is been written.

If you do not have a valid will, your property will pass on to your heirs by law. These individuals may or may not be who you would have provided for in a will. If you pass away with no will —dying intestate — a state court decides who gets your assets and, if you have children, a judge says who will care for them. As a result, if you have an unmarried partner or a favorite charity but have no legal no will, your assets may not go to them.

The courts will typically pass on assets to your closest blood relatives, despite the fact that it would not have been your first choice.

Your will is just one part of a complete estate plan. Putting a plan in place for your assets helps ensure that at your death, your wishes will be carried out and that family fights and hurt feelings do not make for destroyed relationships.

There are some assets that pass outside of the will, such as retirement accounts, 401(k) plans, pensions, IRAs and life insurance policies.

Therefore, the individual designated as beneficiary on those accounts will receive the money, despite any directions to the contrary in your will. If there is no beneficiary listed on those accounts, or the beneficiary has already passed away, the assets automatically go into probate—the process by which all of your debt is paid off and then the remaining assets are distributed to heirs.

If you own a home, be certain that you know the way in which it should be titled. This will help it end up with those you intend, since laws vary from state to state.

Ask an estate planning attorney in your area — to ensure familiarity with state laws—for help with your will and the rest of your estate plan.

Reference: CNBC (June 1, 2020) “Here’s what you need to know about creating a will”

 

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Update Will at These 12 Times in Your Life – Annapolis and Towson Estate Planning

Estate planning lawyers hear it all the time—people meaning to update their will, but somehow never getting around to actually getting it done. The only group larger than the ones who mean to “someday,” are the ones who do not think they ever need to update their documents, says the article “12 Different Times When You Should Update Your Will” from Kiplinger. The problems become abundantly clear when people die, and survivors learn that their will is so out-of-date that it creates a world of problems for a grieving family.

There are some wills that do stand the test of time, but they are far and few between. Families undergo all kinds of changes, and those changes should be reflected in the will. Here are one dozen times in life when wills need to be reviewed:

Welcoming a child to the family. The focus is on naming a guardian and a trustee to oversee their finances. The will should be flexible to accommodate additional children in the future.

Divorce is a possibility. Do not wait until the divorce is underway to make changes. Do it beforehand. If you die before the divorce is finalized, your spouse will have marital rights to your property. Once you file for divorce, in many states you are not permitted to change your will, until the divorce is finalized. Make no moves here, however, without the advice of your attorney.

Your divorce has been finalized. If you did not do it before, update your will now. Do not neglect updating beneficiaries on life insurance and any other accounts that may have named your ex as a beneficiary.

When your child(ren) marry. You may be able to mitigate the lack of a prenuptial agreement, by creating trusts in your will, so anything you leave your child will not be considered a marital asset, if his or her marriage goes south.

Your beneficiary has problems with drugs or money. Money left directly to a beneficiary is at risk of being attached by creditors or dissolving into a drug habit. Updating your will to includes trusts that allow a trustee to only distribute funds under optimal circumstances protects your beneficiary and their inheritance.

Named executor or beneficiary dies. Your old will may have a contingency plan for what should happen if a beneficiary or executor dies, but you should probably revisit the plan. If a named executor dies and you do not update the will, then what happens if the second executor dies?

A young family member grows up. Most people name a parent as their executor, then a spouse or trusted sibling. Two or three decades go by. An adult child may now be ready to take on the task of handling your estate.

New laws go into effect. In recent months, there have been many big changes to the law that impact estate planning, from the SECURE Act to the CARES act. Ask your estate planning attorney every few years, if there have been new laws that are relevant to your estate plan.

An inheritance or a windfall. If you come into a significant amount of money, your tax liability changes. You will want to update your will, so you can do efficient tax planning as part of your estate plan.

Can’t find your will? If you cannot find the original will, then you need a new will. Your estate planning attorney will make sure that your new will has language that states revokes all prior wills.

Buying property in another country or moving to another country. Some countries have reciprocity with America. However, transferring property to an heir in one country may be delayed, if the will needs to be probated in another country. Ask your estate planning attorney, if you need wills for each country in which you own property.

Family and friends are enemies. Friends have no rights when it comes to your estate plan. Therefore, if families and friends are fighting, the family member will win. If you suspect that your family may push back to any bequests to friends, consider adding a “No Contest” clause to disinherit family members who try to elbow your friends out of the estate.

Reference: Kiplinger (May 26, 2020) “12 Different Times When You Should Update Your Will”

 

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