How incomplete nongrantor trusts can help avoid state income taxes

By Cleve Hill December 6, 2018

How incomplete nongrantor trusts can help avoid state income taxes

With the federal gift and estate tax exemption at $11.40 million for 2019, people whose estates are below the exemption amount are shifting their focus to income tax reduction. High-income taxpayers — particularly those who live in high-income-tax states — may want to consider incomplete nongrantor trusts, which make it possible to eliminate state taxes on trust income.

Defining an incomplete nongrantor trust

Generally, trusts are classified as either grantor trusts or nongrantor trusts. In a grantor trust, you, as “grantor,” establish the trust and retain certain powers over it. You’re treated as the trust’s owner for income tax purposes and pay taxes on income generated by the trust assets.

In a nongrantor trust, you relinquish certain controls over the trust so that you aren’t considered the owner for income tax purposes. Instead, the trust becomes a separate legal entity, with income tax responsibility shifting to the trust itself. By setting up the trust in a no-income-tax state (typically by having it administered by a trust company located in that state), it’s possible to avoid state income taxes.

Ordinarily, when you contribute assets to a nongrantor trust you make a taxable gift to the trust beneficiaries. By structuring the trust as an incomplete nongrantor trust, you can avoid triggering gift taxes, or tapping your gift and estate tax exemption. This requires relinquishing just enough control to ensure nongrantor status, while retaining enough control so that transfers to the trust aren’t considered completed gifts for gift-tax purposes.

Analyzing the benefits

Although the trust will allow you to receive distributions, assets you place in the trust should produce income that you don’t need. If you take money out, trust taxable income could follow to you and be taxed in your state of residence.

Incomplete nongrantor trusts aren’t right for everyone. It depends on your particular circumstances and the tax laws in your home state.

While this strategy can produce significant state income tax savings, it may increase federal income taxes, depending on your individual tax bracket. Nongrantor trusts pay federal income taxes at the highest marginal rate (currently, 37%) once income reaches $12,700 for 2019, while the 37% rate threshold is $612,350 for married couples filing jointly and $510,300 for singles and heads of households. If you’re not in the 37% bracket, the increased federal income taxes the incomplete nongrantor trust would pay might outweigh the state income tax savings.

Also, if federal estate taxes aren’t a concern now but could be in the future — such as if your estate could exceed the estate tax exemption when it drops to an inflation-adjusted $5 million in 2026, as currently scheduled — be sure to consider the potential estate tax consequences. Incomplete gifts remain in your estate for estate tax purposes.

Is it right for you?

To determine whether an incomplete nongrantor trust is right foryou, weigh the potential state income tax savings against the potential federalestate and income tax costs. Contact us with any questions.

Of Counsel attorney, Judge Phill Bettis, Saves Forsyth County Toddler

By Cleve Hill July 19, 2018

Of Counsel attorney, Judge Phill Bettis, Saves Forsyth County Toddler

Our friend, mentor, and colleague, Judge Phill Bettis, jumped into action on Sunday, July 15, 2018 after receiving a reverse 911 call about a missing toddler in his neighborhood. As stated by the Forsyth County Sheriff’s Office in their official press release”

“Judge Bettis knew of an unoccupied home in the area and traveled there on a hunch to help look for the child. As Judge Bettis arrived he located the child floating in a swimming pool. Miraculously the child was floating on his back, being kept afloat by a diaper’s buoyancy. Without hesitation, Judge Bettis immediately dove into the pool to rescue the child. A Sheriff’s Lieutenant heard the noises and arrived during the rescue and witnessed Judge Bettis’s heroic actions. Medical assistance was immediately rendered to the child by local EMS and the child was found to be in good condition.”

We are honored to work with Phill and are continually inspired by his dedication to his faith, family, profession and community. Here is a link to a television interview with Phill: https://www.wsbtv.com/…/judge-credits-divine-inte…/793017558.

Power of attorney abuse: What you can do about it

By Cleve Hill March 15, 2018

Power of attorney abuse: What you can do about it

A financial power of attorney — sometimes called a “power of attorney for property” or a “general power of attorney” — can be a valuable estate planning tool. Such a document can help prevent the need for a court-appointed financial guardian (called a conservator in Georgia), which can be an expensive and intrusive procedure. Therefore, many attorneys will recommend that their clients execute a power of attorney in order to avoid the court process.

The main disadvantage to a power of attorney, however, is that it’s susceptible to abuse by scam artists, dishonest caretakers or greedy relatives. Financial abuse and exploitation is a growing area of concern–one which requires the vigilance of family, friends, and counsel.

Help or harm

The most common type is the durable power of attorney, which allows someone (the agent) to act on behalf of another person (the principal) even if the person becomes mentally incompetent or otherwise incapacitated. It authorizes the agent to manage the principal’s investments, pay bills, file tax returns and handle other financial matters if the principal is unable to do so as a result of illness, advancing age or other circumstances.

A broadly written power of attorney gives an agent unfettered access to the principal’s bank and brokerage accounts, real estate and other assets. In the right hands, this can be a huge help in managing a person’s financial affairs when the person isn’t able to do so himself or herself. But in the wrong hands, it provides an ample opportunity for financial harm.

Take steps to prevent abuse

If you or a family member plans to execute a power of attorney, there are steps you can take to minimize the risk of abuse:

Make sure the agent is someone you know and trust.
Consider using a “springing” power of attorney, which doesn’t take effect until certain conditions are met. There are, however, pros and cons to the use of a “springing” document, which should be discussed with counsel.
Use a “special” or “limited” power of attorney that details the agent’s specific powers.
Appoint a “monitor” or other third party to review transactions executed by the agent, and require the monitor’s approval of transactions over a certain dollar amount.
Provide that the appointment of a guardian automatically revokes the power of attorney.

Some state laws contain special requirements, such as a separate rider, to authorize an agent to make large gifts or conduct other major transactions.

Act now

If you have elderly parents who’ve signed powers of attorney, keep an eye on their agents’ activities. When dealing with powers of attorney, the sooner you act if when you sense something suspicious, the better. If you’re pursuing legal remedies against an agent, the sooner you proceed, the greater your chances of recovery. And if you wish to execute or revoke a power of attorney for yourself, you need to do so while you’re mentally competent. Contact us for additional details.

Follow IRS rules to ensure you receive your charitable tax deductions

By Cleve Hill February 15, 2018

Follow IRS rules to ensure you receive your charitable tax deductions

If reducing your taxable estate is an important estate planning goal, making lifetime charitable donations can help achieve that goal and benefit your favorite organizations. In addition, by making donations during your lifetime, rather than at death, you can claim income tax deductions. But some of your charitable deductions could be denied if you don’t follow IRS rules.

3 things to be aware of

First, the recipient charity must be a qualified charitable organization: it must have a tax-exempt status. The IRS has developed a tool on its website — the Exempt Organizations Select Check — that allows users to search for a specific tax-exempt organization, check its federal tax status and learn about tax forms the charity may file that are up for public review.

Second, the timing of pledging vs. payment of your charitable contributions can affect your deduction. Why? For most taxpayers, contributions are deductible only in the tax year they’re made. So if you pledged $5,000 in October of 2017, but paid only $1,500 of your pledge to the charity by December 31, 2017, you’re allowed to deduct only the $1,500 amount on your 2017 tax return.

Third, if you donate property and receive something in return, it’s important to know the fair market value of each item. For example, if you donate a flat screen TV to your child’s school and receive two tickets to a sporting event in return for your donation, you must first determine the value of your donation. Then you may deduct only the amount exceeding the fair market value of the two tickets.

Substantiate your donations

Be aware that substantiation rules also apply when giving cash or property to charity, and they vary based on the type and amount of the donation. For example, cash gifts of $250 or more require a “contemporaneous” written acknowledgment from the charity that includes information such as the gift’s amount and date and the estimated value of any goods or services received. For smaller gifts, a canceled check or credit card receipt may be sufficient.

If you’ve made substantial charitable donations, their deductibility depends on compliance with IRS rules, which go far beyond what we’ve discussed here. When in doubt, contact us to be sure you’ve dotted all the i’s and crossed all the t’s.

Who should own your life insurance policy?

By Cleve Hill October 12, 2017

Who should own your life insurance policy?

If you own life insurance policies at your death, the proceeds will be included in your taxable estate. Ownership is usually determined by several factors, including who has the right to name the beneficiaries of the proceeds. The way around this problem is to not own the policies when you die. However, don’t automatically rule out your ownership either.

And it’s important to keep in mind the current uncertain future of the estate tax. If the estate tax is repealed (or if someone doesn’t have a large enough estate that estate taxes are a concern), then the inclusion of your policy in your estate is a nonissue. However, there may be nontax reasons for not owning the policy yourself.

Plus and minuses of different owners

To choose the best owner, consider why you want the insurance. Do you want to replace income? Provide liquidity? Or transfer wealth to your heirs? And how important are tax implications, flexibility, control, and cost and ease of administration? Let’s take a closer look at four types of owners:

You or your spouse. There are several nontax benefits to your ownership, primarily relating to flexibility and control. The biggest drawback is estate tax risk. Ownership by you or your spouse generally works best when your combined assets, including insurance, won’t place either of your estates into a taxable situation.
Your children. Ownership by your children works best when your primary goal is to pass wealth to them. On the plus side, proceeds aren’t subject to estate tax on your or your spouse’s death, and your children receive all of the proceeds tax-free. On the minus side, policy proceeds are paid to your children outright. This may not be in accordance with your estate plan objectives and may be especially problematic if a child has creditor problems.
Your business. Company ownership or sponsorship of insurance on your life can work well when you have cash flow concerns related to paying premiums. Company sponsorship can allow premiums to be paid in part or in whole by the business under a split-dollar arrangement. But if you’re the controlling shareholder of the company and the proceeds are payable to a beneficiary other than the business, the proceeds could be included in your estate for estate tax purposes.
An ILIT. A properly structured irrevocable life insurance trust (ILIT) could save you estate taxes on any insurance proceeds. The trust owns the policy and pays the premiums. When you die, the proceeds pass into the trust and aren’t included in your estate. The trust can be structured to provide benefits to your surviving spouse and/or other beneficiaries.

Have you properly funded your revocable trust?

By Cleve Hill August 24, 2017

Have you properly funded your revocable trust?

If your estate plan includes a revocable trust — also known as a “living” trust or a “revocable living trust”— it’s critical to ensure that the trust is properly funded. Revocable trusts offer significant benefits, including asset management (in the event you become incapacitated) and probate avoidance. But these benefits aren’t available if you don’t fund the trust.

We consistently see clients who come to our practice with nice, shiny, thick binders containing their revocable living trusts and other estate plannings, and our usual first question is “what do you have titled in the trust?” The blank stares coming from the clients can be disconcerting. They have spent considerable time and money developing the documents, yet nothing has been moved into the trusts. By failing to move assets into the trust, the administration of the estate will be more costly and less time efficient–this is because probate would generally be necessary to transfer title to your assets.

The basics

A revocable trust acts as a will substitute, although you’ll still need to have a short will, often referred to as a “pour over” will. The trust holds assets for your benefit during your lifetime.

You can serve as trustee or select someone else. If you choose to be the trustee, you must name a successor trustee to take over as trustee upon your death, serving in a role similar to that of an executor. The successor trustee will manage the administration of your estate after your death ensuring that your bills would be paid and your assets are distributed according to the terms of your trust.

Essentially, you retain the same control you had before you established the trust. Whether or not you serve as trustee, you retain the right to revoke the trust and appoint and remove trustees. If you name a professional trustee to manage trust assets, you can require the trustee to consult with you before buying or selling assets.

The trust doesn’t need to file an income tax return until after you die. Instead, you pay the tax on any income the trust earns as if you had never created the trust. The trust will use your Social Security Number to set up accounts while you are alive instead of obtaining a separate tax identification number.

Asset ownership transfer

Funding your trust is simply a matter of transferring ownership of assets to the trust. Assets you should transfer include real estate, bank accounts, certificates of deposit, stocks and other investments, partnership and business interests, vehicles, and personal property (such as furniture and collectibles).

Certain assets shouldn’t, however, be transferred to a revocable trust. For example, moving an IRA or qualified retirement plan, such as a 401(k) plan, to a revocable trust can trigger undesirable tax consequences. And it may be advisable to hold a life insurance policy in an irrevocable life insurance trust to shield the proceeds from estate taxes. This does not mean, however, that sub-trusts under the revocable trust cannot be named as beneficiary of your qualified retirement plans or life insurance proceeds. To the contrary, such trusts can be named as the beneficiary; note, however, that special language is required in the trust to ensure the most favorable tax treatment when it comes to qualified retirement plans. A qualified estate planning attorney should generally be engaged to make sure that proper drafting is achieved–most “self help” websites and software will not properly cover this issue.

Don’t forget to transfer new assets to the trust

Most people are diligent about funding a trust at the time they sign the trust documents. But trouble can arise when they acquire new assets after the trust is established. Unless you transfer new assets to your trust, they won’t enjoy the trust’s benefits.

To make the most of a revocable trust, be sure that, each time you acquire a significant asset, you take steps to transfer it to the trust. If you have additional questions regarding your revocable trust, we’d be happy to answer them.

Powers of attorney: Springing vs. nonspringing

By Cleve Hill August 17, 2017

Powers of attorney: Springing vs. nonspringing

Estate planning typically focuses on what happens to your assets when you die. But it’s equally important (some might say more important) to have a plan for making critical financial and medical decisions if you’re unable to make those decisions yourself.

That’s where the power of attorney (POA) comes in. A POA appoints a trusted representative (the “agent”) who can make medical or financial decisions on your behalf in the event an accident or illness renders you unconscious or mentally incapacitated. Typically, separate POAs are executed for health care and property–this is the case in Georgia. Without them, your loved ones would have to petition a court for guardianship or conservatorship, a costly process that can delay urgent decisions. (Depending on the state you live in, the health care POA document may also be known as a “medical power of attorney” or “health care proxy.” In Georgia, these documents are called the “Advance Directive for Health Care”.)

A question that people often struggle with is whether a POA should be springing or nonspringing.

To spring or not to spring

A springing POA is effective on the occurrence of specified conditions; a nonspringing, or “durable,” POA is effective immediately. Typically, springing powers would take effect if you were to become mentally incapacitated, comatose or otherwise unable to act for yourself.

A nonspringing POA offers two advantages:

It allows your agent to act on your behalf for your convenience, not just when you’re incapacitated. For example, if you’re traveling out of the country for an extended period of time, your POA for property agent could pay bills and handle other financial matters for you in your absence.

It avoids the need for a determination that you’ve become incapacitated, which can result in delays, disputes or even litigation. This allows your agent to act quickly in an emergency, making critical medical decisions or handling urgent financial matters without having to wait, for example, for one or more treating physicians to examine you and certify that you’re incapacitated.

A potential disadvantage to a nonspringing POA — and a common reason people opt for a springing POA — is the concern that the agent may be tempted to commit fraud or otherwise abuse his or her authority. But consider this: If you don’t trust your agent enough to give him or her a POA that takes effect immediately, how does delaying its effect until you’re incapacitated solve the problem? Arguably, the risk of fraud or abuse would be even greater at that time because you’d be unable to monitor what the agent is doing.

What to do?

Given the advantages of a nonspringing POA, and the potential delays associated with a springing POA, a nonspringing POA is generally preferable–however, this should be carefully analyzed with your estate planning attorney on a case by case basis. Just make sure the person you name as agent is someone you trust unconditionally.

Beware the GST tax when transferring assets to grandchildren

By Cleve Hill August 10, 2017

Beware the GST tax when transferring assets to grandchildren

As you plan your estate, don’t overlook the generation-skipping transfer (GST) tax. Despite a generous $5.49 million GST tax exemption, complexities surrounding its allocation can create several tax traps for the unwary.

GST basics

The GST tax is a flat, 40% tax on transfers to “skip persons,” including grandchildren, other family members more than a generation below you, nonfamily members more than 37½ years younger than you and certain trusts (if all of their beneficiaries are skip persons). If your child predeceases his or her children, however, they’re no longer considered skip persons.

GST tax applies to gifts or bequests directly to a skip person and to certain transfers by trusts to skip persons. Gifts that fall within the annual gift tax exclusion (currently, $14,000 per recipient; $28,000 for gifts split by married couples) are also shielded from GST tax.

Allocation traps

To take full advantage of the GST tax exemption, you (or your estate’s representative) must properly allocate it to specific gifts and bequests (on a timely filed gift or estate tax return). Allocating the exemption wisely can provide substantial tax benefits.

Suppose, for example, that you contribute $2 million to a trust for the benefit of your grandchildren. If you allocate $2 million of your GST exemption to the trust, it will be shielded from GST taxes, even if it grows to $10 million. If you don’t allocate the exemption, you could trigger a seven-figure GST tax bill.

To help prevent costly mistakes like this from happening, the tax code and regulations provide for automatic allocation under certain circumstances. Your exemption is automatically allocated to direct skips as well as to contributions to “GST trusts.” These are trusts that could produce a generation-skipping transfer, subject to several exceptions.

Often, the automatic allocation rules work well, ensuring that GST exemptions are allocated in the most tax-advantageous manner. But in some cases, automatic allocation can lead to undesirable results.

Suppose you establish a trust for your children, with the remainder passing to your grandchildren. You assume the automatic allocation rules will shield the trust from GST tax. But the trust gives one of your children a general power of appointment over 50% of the trust assets, disqualifying it from GST trust status. Unless you affirmatively allocate your exemption to the trust, distributions or other transfers to your grandchildren will be subject to GST taxes.

Handle with care

If you plan to make gifts to skip persons, or to trusts that may benefit skip persons, consider your potential GST tax exposure. Also, keep in mind that repeal of the GST tax, along with the gift and estate tax, has been proposed. We’ll keep you abreast of any tax law changes that affect estate planning, and we can answer your questions regarding the GST tax.

ABLE accounts can benefit loved ones with special needs

By Cleve Hill July 14, 2017

ABLE accounts can benefit loved ones with special needs

For families with disabled loved ones who are potentially eligible for means-tested government benefits such as Medicaid or Supplemental Security Income (SSI), estate planning can be a challenge. On the one hand, you want to provide the most comfortable life possible for your family member. On the other hand, you don’t want to jeopardize his or her eligibility for needed government benefits.

For many years, the most effective solution to this problem has been to set up a special needs trust (SNT). But beginning in 2014, the Achieving a Better Life Experience (ABLE) Act created Internal Revenue Code Section 529A, which authorizes the states to offer tax-advantaged savings accounts for the blind and severely disabled, similar to Sec. 529 college savings plans.

Effective June 14, 2017, Georgia has launched its own ABLE account program, which will be called the Georgia STABLE accounts.

How ABLE accounts work

The ABLE Act allows family members and others to make nondeductible cash contributions to a qualified beneficiary’s ABLE account, with total annual contributions limited to the federal gift tax annual exclusion amount (currently, $14,000). To qualify, a beneficiary must have become blind or disabled before age 26.

The account grows tax-free, and earnings may be withdrawn tax-free provided they’re used to pay “qualified disability expenses.” These include health care, education, housing, transportation, employment training, assistive technology, personal support services, financial management and legal expenses.

An ABLE account generally won’t affect the beneficiary’s eligibility for Medicaid and SSI — which limits a recipient’s “countable assets” to $2,000 — with a couple of exceptions. First, distributions from an ABLE account used to pay housing expenses are countable assets. Second, if an ABLE account’s balance grows beyond $100,000, the beneficiary’s eligibility for SSI is suspended until the balance is brought below that threshold.

Comparison with SNTs

Here’s a quick review of a few of the relative advantages and disadvantages of ABLE accounts and SNTs:

Availability. Anyone can establish an SNT, but ABLE accounts are available only if your home state offers them, or contracts with another state to make them available. Also, as previously noted, ABLE account beneficiaries must have become blind or disabled before age 26. There’s no age restriction for SNTs.

Qualified expenses. ABLE accounts may be used to pay only specified types of expenses. SNTs may be used for any expenses the government doesn’t pay for, including “quality-of-life” expenses, such as travel, recreation, hobbies and entertainment.

Tax treatment. An ABLE account’s earnings and qualified distributions are tax-free. An SNT’s earnings are taxable.

DIY Elder Law Planning: Just Don’t Do It

By 3alawmanagement September 9, 2015

I love everything DIY (or Do-It-Yourself, for the uninitiated). Give me can of spray paint and a Pinterest DIY Board or blog post, and I’ll be entertained for hours. However, some tasks just don’t lend themselves to DIY. In terms of home repairs, electrical work comes to mind: as accomplished as I feel fixing up our home, it’s probably not worth violating building codes or burning down the house. Needless to say, my husband would not be pleased.

Unfortunately, I have a number of clients come see me when DIY long-term care planning goes awry. Even estate planning attorneys, who prepare wills, trusts, powers of attorney, etc., feel appropriately nervous ‘dabbling’ in areas such as Medicaid and VA Pension planning. It is so important to work with someone who has a solid understanding of the effect any care planning will have on a person’s eligibility for Veterans or Medicaid benefits, as well as the tax, legal, insurance, and practical implications.

Families rarely realize that their plans for an aging relative – which make perfect practical sense – could have a negative impact on the relative’s eligibility for government benefits down the road. Often, the problems are not highlighted until the person’s assets are running low and these benefits become increasingly important.

The bottom line? If you are doing any planning for the care of an elderly or disabled relative, especially, if such care involves the management and/or transfer of assets, consult a knowledgeable elder law attorney first. But if you want to spray paint some vintage furniture? Grab your can of spray paint and DIY-away!

Hill & Watchko, LLC

How incomplete nongrantor trusts can help avoid state income taxes