|The legislation formerly known as the “Tax Cuts and Jobs Act” (the “Act”) has passed the House and Senate and is headed to the President for signature. Here are some of the ways the Act will impact estate planning.
Annual Exclusion from Gift Tax
529 Plans May be Used for Elementary and Secondary Education
Planning opportunity: Some clients hold back on funding 529 accounts to the maximum amount permitted under state law because of the prior limitations on what was considered a qualified educational expense. Now that the use of 529 accounts has been broadened by the Act, clients should consider making increased gifts to 529 accounts. If you make the election to use 5 years’ worth of annual exclusions, you can fund a 529 account in January 2018 with $75,000 per recipient (or $150,000 per recipient if you are married). This 5-year election must be made on a timely-filed gift tax return.
Pay Estimated State Income Taxes for 2017 before Year End and Pre-Pay Property Taxes
Congress anticipated that some of us may try to prepay our 2018 state and local taxes, and it closed that loophole by disallowing deductions on your 2017 income tax returns for prepaid 2018 state and local taxes; however, property taxes are not mentioned and should be able to be pre-paid if the local jurisdiction allows it.
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 The official name of the new law will be: “To Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018”.
Parable of the Rich Fool
In the Bible, Jesus tells the parable of the “rich fool” after one of his followers requests help convincing his brother to share an inheritance. The rich fool was a man who had such an abundant farm, he decided to tear down his existing barns and build bigger ones to store all the grain he had harvested. The rich fool went to bed happy with this decision, thinking he had ample goods built up to allow him to eat, drink and be merry for many years. But, alas, that was the man’s last night on earth. He was a fool for treasuring his things, and not his blessings.
In the Jewish tradition, the “Zava’ah” is a document used by Rabbis and laypersons to pass ethical values from one generation to the next. President Barack Obama famously wrote this legacy letter to his daughters on the eve of his first inauguration, January 18, 2009. These are examples of Ethical Wills – the dissemination of knowledge, rather than money and things.
As estate planners, we focus our attention almost exclusively on our client’s material possessions, rather than their values. But we are uniquely positioned to set our clients on a path to creating their true family legacy – a set of core, shared beliefs that are passed along the generations. We can and should introduce our clients to the concept of an Ethical Will.
An Ethical Will is not a legal document. In fact, it should be written by the you, the client, not your attorney. An Ethical Will can take many shapes – a spiral-bound notebook, a Word document, a scrapbook, a voice recording or a professionally-produced video. The purpose of an Ethical Will is to communicate with your children, grandchildren and other loved ones your beliefs, lessons learned, family history, expressions of love and gratitude. An Ethical Will can even end a long-held grudge by expressing forgiveness.
Without a doubt, the most difficult thing about an Ethical Will is starting. The second hardest thing may be knowing when to stop. If you allow yourself a quiet space and time to think about an Ethical Will, your thoughts are likely to spin off in a thousand different directions. In your lifetime, hundreds upon hundreds of events have shaped you. The tapestry of your family history is complex and not easily unraveled. A blank canvas is daunting.
My former colleague, David Rutstein, has written and spoken extensively on the topic of Ethical Wills. When clients are interested in embarking on this noble mission, I give them Dave’s materials as a starting point. Here are the potential subjects he suggests for an Ethical Will:
- Introduction. Briefly state why you are creating the Ethical Will. What is your objective?
- Statements of Value. What ideals are most important to you?
- Lessons Learned. What significant experiences or relationships have shaped you and how?
- Major Influences. What people and events have been meaningful to you and why?
- Thoughts about Religion.
- Family Lore. What family stories need to be memorialized for posterity?
- Advice. What do you wish you had been told when you were young?
- Personal. Specific expressions of love, gratitude, appreciation and forgiveness.
- Blessings and Hopes. Your hopes and wishes for the future.
Expanding on any one of these topics is better than nothing. So is an unfinished draft. Many people who have successfully written Ethical Wills have done so bit by bit rather than in one sitting. They might carry around a notebook and jot down ideas or stories as they think of them. After some time, they might have enough recorded thoughts to identify common themes that can help them write a beginning, middle and end. Others may block off a whole day and force themselves to start and finish by the end of the day because that is how they work best. Know yourself, and set a goal that is realistic for you.
Use Examples and Stories
As with performance evaluations at work, the use of examples is more impactful than making broad generalizations. If you are trying to impart the values that have best served you during life, you might tell stories revealing the traits you admire most in others – the time your friend stuck by you, the day your spouse used humor to diffuse a tense situation, the nanny who went out of her way to treat your siblings and you fairly. Just like religious parables, stories will help make the lessons memorable.
Don’t use an Ethical Will to try to remake your image into the saint you always wanted to be. If you are known to have a flaw, admit it and explain how that flaw has impacted you. Use humor if that comes naturally to you. The Ethical Will is also an opportunity to explain yourself. If you are famous for always wearing pearls or a bowtie, explain why you have done so all these years. If you have a family motto (ours is “Southern hospitality meets Western adventure”) explain it – even if you think everyone already knows why it is the family motto. Like the game of telephone, things get lost in translation.
While you may use an Ethical Will to discuss your own flaws, take care not to point out those of others. If you hurt someone’s feelings, there is no opportunity to reconcile after you are gone. Generally, it is best not to single out any one family member in the Ethical Will, unless they are part of a family story (see above). If you talk about how proud you are of grandson Johnny for his artistic talents, your granddaughter who secretly believes she is a better artist than Johnny may never forgive you. If you think you might devote a paragraph to each child or grandchild, you invite scrutiny over things you could never imagine – “she used more words in my paragraph” or, “he was funny in Jane’s paragraph but serious in mine, so he must like Jane/me better”. An Ethical Will should serve up inspiration, not criticism.
Now or Later?
Once you have finished your Ethical Will, do you read it or discuss it with your family, or do you give it to your lawyer to be revealed after you’ve passed away? That is a personal choice, but most experts agree that the closest families are those that communicate. By sharing the Ethical Will while you are living, you will start a family dialogue, perhaps be asked for more details about your stories, and hopefully receive hugs and thanks. If your family or friends plan a “roast” or retirement party for you, that is a good time to share your Ethical Will, when everyone is gathered and focused on you. This can be the gift you give them in return. The process of making an Ethical Will can also be a gift to yourself – inspiring you to live in a manner that matches your own expectations for others, and providing an opportunity to focus on your blessings instead of material things.
Déjà vu– As was the case sixteen years ago in January 2001, we ring in the new year with a Republican president and a Republican-controlled Congress threatening to repeal the federal estate tax. What’s a taxpayer to do? President Trump has proposed a repeal of the federal estate tax and a $10 million exemption for capital gains at death (without any additional specificity). The House Republicans have proposed a repeal of both the estate and generation-skipping transfer (“GST”) tax. Ultimately, we don’t really know what legislation will pass, or when. Will the gift tax remain? Will there be a capital gain tax on inherited assets (which effectively reduces death taxes but does not eliminate them)? Will the Republicans be able to pass a true repeal of the federal estate tax or will a repeal be temporary, with a sunset back to today’s rates after ten years? In such uncertain times, estate planning is more important than ever!
Planning with no estate tax.
- Review of current plan. If Congress were to pass a permanent estate tax repeal (which we believe would be very difficult), it will be important for clients to review their current estate plan with their estate planner to determine if modifications are needed. Flexibility will continue to be important so that your estate plan covers the different potential scenarios with or without an estate tax.
- Federal estate tax provisions. Many times planning is tied to the available federal estate or GST tax exemption. In 2017, the federal estate tax exemption is $5,490,000 per person, and $10,980,000 for a married couple. If the federal estate tax were repealed, many clients’ estate plans would need to be updated. In the event of a repeal, there are some plans that would cause the entire estate to pass to a client’s descendants, while the spouse would be disinherited.
- State estate tax provisions. Despite a repeal of the federal estate tax, state estate tax planning may still be necessary. As of January 1, 2017, Maryland has an exemption from its estate tax of $3,000,000 per taxpayer, which will increase to $4,000,000 in 2018 and will match the federal exemption in 2019. Beginning in 2017, the District of Columbia estate tax exemption is $2,000,000 per person. If the District hits certain revenue targets, its exemption could rise to match the federal exemption in future years. If the federal estate tax law changes, it is uncertain whether Maryland and/or D.C. will revise their estate tax laws to ensure the continued existence of a state-level estate tax.
- Charitable bequests. Clients may have large charitable bequests under their plans that were included to reduce federal estate taxes. Such clients may want to reduce or remove these charitable bequests if assets can be transferred to family members free of Federal estate taxes.
- Review of life insurance. Often clients purchase individual or joint and survivor life insurance policies for the purpose of providing an illiquid estate with cash to pay estate taxes. If the federal estate tax is repealed, clients will need to weigh the costs and benefits of maintaining such insurance policies. Do you hedge and keep some insurance in case the estate tax is reintroduced? Do you still have a state estate tax or a new capital gains tax for inherited assets to mitigate with insurance?
- Gift planning. If the federal estate tax is repealed, it will be more advantageous than ever to move assets into an irrevocable trust for family members to protect such assets from estate taxes should the tax be reinstated in the future. To avoid giving too much to descendants too soon, a spouse could be included as a potential trust beneficiary.
- Trust protection. Although trusts have been included in estate plans for estate tax planning for many years, there are numerous nontax reasons to incorporate trusts in your estate plan, irrespective of an estate tax repeal:
- Creditor protection (including a former spouse in a divorce);
- Planning for spouses with children from prior marriages;
- Spendthrift or minor beneficiaries;
- Special needs beneficiaries; and
- Creation of a common family investment fund.
Planning with an estate tax. Because of the uncertainty of the estate tax laws in the near future and the distant future, we will continue to plan for our clients as usual (other than to avoid making taxable gifts where possible). Certain decisions may be postponed until we have a better idea of the future tax landscape. We will continue to provide flexibility in our documents and recommend that our clients do the following:
- Review of current estate plan. Again, if your plan incorporates distributions that are linked to the federal estate or GST exemption, you should update your plan to ensure that your assets will pass to your heirs as intended, regardless of changes to federal tax law.
- Continue with certain gifting. Although it may make sense to defer any gifts that would require the payment of a gift tax, if your goal is to benefit family members currently, there is no reason to defer certain tax-free gifting.
- Annual exclusion and excluded gifts. In 2017, the gift tax annual exclusion amount remains at $14,000. This is the amount you can gift to any number of persons and it is not considered a taxable, reportable gift. If no additional reportable gifts are made in 2017, a gift tax return does not need to be filed. Subject to certain restrictions, you can also pay a person’s tuition and medical expenses without it being counted as a gift, so long as the payment is made directly to the educational institution or medical provider. There is no cap on the amount of tuition or medical expenses that can be paid on a person’s behalf in any given year.
- 2017 Gift Tax Exclusions/Exemptions: As of January 1, 2017, the federal GST and gift tax exemptions are $5,459,000 per person, allowing you to gift up to this amount during your lifetime to any one or more persons without having to pay gift or GST taxes. Please note, however, that, even though no gift or GST tax would be owed, gifts in excess of $14,000 per recipient must be reported on a timely-filed gift tax return.
Income tax planning for irrevocable trusts.
Trust income is taxed at the highest personal income tax level (39.6%) for income exceeding $12,500. There is an additional surcharge of 3.8% for certain types of income. This surcharge was enacted as part of the “Obamacare” legislation. Republicans have indicated that repealing President Obama’s Patient Protection and Affordable Care Act is a top priority, but for now, the surcharge remains a concern for trustees. Clients should discuss with their advisors whether or not it would be more advantageous to distribute trust income to the trust beneficiaries in order to have such income taxed at the beneficiary’s income tax rate, especially if the beneficiary’s rate is lower than the trust’s rate. Such distributions can be made for the first 65 days of the tax year (or by March 5, 2017) and still qualify as a 2016 income distribution.
Tips & Tricks for National Estate Planning Awareness Week!
October 20-26 is National Estate Planning Awareness Week. With this in mind, Birchstone Moore has partnered with the YMCA of Metropolitan DC to promote the following tips for a healthy estate plan:
- Could my life insurance proceeds be subject to estate tax at my death?
Yes! If you are the owner of a life insurance policy at the time of your death, the value of the insurance proceeds will be included in your estate for estate tax purposes. If you live in Maryland or DC and have a life insurance policy with a death benefit of $1M or more, you currently have a taxable estate simply because of your life insurance policy.
- True or False: My Will controls the distribution of my entire estate at my death.
False! The portion of your estate that passes under your Will is called your “probate estate.” Retirement benefits, life insurance proceeds and property owned jointly with your spouse, as a general rule, are not part of your probate estate and will not pass under your Will. Retirement benefits and life insurance proceeds pass in accordance with beneficiary designations that you complete for those items. Property that you own as tenants by the entirety or as joint tenants with rights of survivorship will pass to the surviving joint owner by operation of law.
- True or False: If I pass away without a Will, my spouse will inherit my entire estate under all circumstances.
False! If you are a Maryland or DC resident and you pass away without a Will, your spouse will receive only part of your probate estate if one or more of your descendants or your parents survives you. Your parents and/or children will also be beneficiaries of your probate estate. For Virginia residents dying without a Will, your spouse will receive your entire probate estate unless you are survived by one or more children from a prior marriage who are not also children of your surviving spouse.
- I want to leave a portion of my estate to charity. Is it best to make a bequest under my Will or designate the charity as a beneficiary of my retirement account?
It is generally preferred to leave your retirement assets to charity, and let your other assets pass to your family. If you leave a tax-deferred retirement account to an individual beneficiary, the individual must pay ordinary income tax on any withdrawal from the account, just as you would have if you had taken withdrawals from the account in retirement. Charities pay no income tax on a bequest of tax-deferred retirement assets because charities are tax-exempt. By sending the taxable retirement account to charity, and other assets to your family, you free up the more income tax-advantaged assets for your family, at no cost to the charity.
- Do I need to address my digital assets (my email account, my Facebook page, etc.) as part of my estate plan?
Absolutely! As part of your estate plan, you will want to ensure that your fiduciaries are able to access your digital assets. You should create a list of such assets and their corresponding usernames and passwords. You should then store such list in a secure place (e.g., with an online storage service, on a home computer with a password that you provide to your fiduciaries, etc.). You should also include in your estate planning documents language authorizing your fiduciaries to access your digital assets. This will give your fiduciaries not only the means, but also the right, to manage your online accounts.