Asset Valuations and Your Estate Plan Go Hand in Hand

If your estate plan calls for making noncash gifts in trust or outright to beneficiaries, you need to know the values of those gifts and disclose them to the IRS on a gift tax return. For substantial gifts of noncash assets other than marketable securities, it’s a good idea to have a qualified appraiser value the gifts at the time of the transfer.

Adequately disclosing a gift
A three-year statute of limitations applies during which the IRS can challenge the value you report on your gift tax return. The three-year term doesn’t begin until your gift is “adequately disclosed.” This means you need to not just file a gift tax return, but also:

  • Give a detailed description of the nature of the gift,
  • Explain the relationship of the parties to the transaction, and
  • Detail the basis for the valuation.

The IRS also may require certain financial statements or other financial data and records.

Generally, the most effective way to ensure you’ve disclosed gifts adequately and triggered the statute of limitations is to have a qualified, independent appraiser submit a valuation report that includes information about the property, the transaction and the appraisal process.

IRS-imposed penalties
Using a qualified appraiser is important because, if the IRS deems your valuation to be “insufficient,” it can revalue the property and assess additional taxes and interest. If the IRS finds that the property’s value was “substantially” or “grossly” misstated, it will also assess additional penalties.

A “substantial” misstatement occurs if you report a value that’s 65% or less of the actual value — the penalty is 20% of the amount by which your taxes are underpaid. A “gross” misstatement occurs if your reported value is 40% or less of the actual value — the penalty is 40% of the amount by which your taxes are underpaid.

Before taking any action, consult with us regarding the tax and legal consequences of any estate planning strategies. In addition, we can help you work with a qualified appraiser to ensure your gifts are adequately disclosed.

Are you leaving your IRA to someone other than your spouse?

An IRA can be a powerful wealth-building tool, offering tax-deferred growth (tax-free in the case of a Roth IRA), asset protection and other benefits. But if you leave an IRA to your children — or to someone else other than your spouse — these benefits can be lost without careful planning.

“Inherited IRA” stretches tax benefits
A surviving spouse who inherits an IRA is permitted to roll that IRA into his or her own IRA, allowing the funds to continue growing tax-deferred or tax-free until the funds are withdrawn in retirement or after age 70½. Beneficiaries who are not your spouse are treated differently.

To take advantage of an IRA’s tax benefits, nonspouse beneficiaries must transfer the funds directly into an “inherited IRA.” Even then the beneficiaries will have to begin taking distributions by the end of the following year, but they’ll be able to stretch those distributions over their life expectancies.

This option is only available to your children or other non-spouse beneficiaries if you name them as beneficiaries (or secondary beneficiaries) of your IRA. If you leave an IRA to your estate, your children or other heirs will still receive a share of the IRA as beneficiaries of your estate, but they’ll have to withdraw the funds within five years (or, if you die after age 70½, over what would otherwise be your actuarial life expectancy).

If you name multiple nonspousal beneficiaries (several children, for example), each beneficiary will have to establish a separate inherited IRA account by the end of the year after the year of your death in order to take distributions over their respective life expectancies. If any beneficiary misses the deadline, he or she can still roll the distribution into an inherited IRA but he or she will have to use the oldest beneficiary’s life expectancy as the time over which they must remove the monies.

Be aware that, unlike other IRAs, inherited IRAs aren’t protected from creditors in bankruptcy.

Inherited IRA rules
The following special rules apply to an inherited IRA:

  • The IRA must be a new IRA set up for the specific purpose of receiving the inherited account.
  • The IRA must be specially titled in the deceased account owner’s name.
  • No other contributions may be made to the IRA.
  • No other amounts may generally be rolled into or out of the IRA.
  • Required minimum distributions will need to be made over the beneficiary’s life expectancy starting the year after the IRA owner’s death.

Please contact us if you have questions about how to address your IRA in your estate plan.

The Wall Street Journal: Divorced Couples, Put Aside Your Differences…for the Tax Break

Tax issues can surface every year, but former spouses who continue to feud lose the opportunity to save themselves taxes. The Wall Street Journal shares six tax issues that could affect you if you are divorced.

Divorce has many miseries. Taxes are one of the most persistent.

Issues can resurface annually during filing season and continue to affect couples years after they split. If former spouses don’t set aside their differences, one or both partners often end up overpaying.

Scott Kaplowitch, a managing partner with Edelstein & Co. in Boston, recently prepared a divorced couple’s returns. Although the ex-wife had the right to take deductions and credits for the couple’s children, there was no benefit for her because she has no employment income. She allowed her former husband to use the tax breaks and saved him about $2,500, Mr. Kaplowitch says.

The couple didn’t split the savings, he adds, but “it produced good will for the future.”

That’s the best case.

Tensions between ex-spouses are evident in Internal Revenue Service data. For the five years that ended in 2015, people paying alimony deducted some $57 billion, while people receiving alimony claimed only about $47 billion—a $10 billion discrepancy.

After a Treasury watchdog chided the IRS about the alimony gap in 2014, the agency became more vigilant. Now returns are automatically rejected if the alimony payer doesn’t supply a Social Security number for the recipient, an IRS spokesman says.

If you’re divorced, here are tax issues to watch.

Alimony. These payments, often called “maintenance,” are deductible by the payer and taxable to the recipient. To be deductible, payments must be made in cash and must be provided for in the divorce or separation agreement.

Voluntary payments for other items, such as a new computer for a child, typically can’t be deducted. The IRS has a history of challenging alimony deductions it thinks are nondeductible property settlements, child support or gifts.

Alimony can fund an individual retirement account. Alimony deductions end when the recipient dies, if payments haven’t already ended. For more on the definition of alimony, see IRS Publication 504.

Child support. These payments aren’t deductible by the payer or taxable to the recipient.

Dependent exemption. This benefit is a deduction, currently $4,050 for each child who qualifies as a dependent. There are several tests for this benefit, and they are detailed in IRS Publication 501.

Ex-spouses can often use IRS Form 8332 to toggle this exemption back and forth from year to year. This can be a good strategy if one ex is sometimes a high earner, because in 2016 the exemption began to phase out at $259,400 of adjusted gross income for single filers.

For feuding ex-spouses, there is an important caveat: The parent claiming the dependent exemption must include each child’s Social Security number, and the IRS’s system will reject a later-filed return claiming the same number. Even if the second-filing spouse deserves to take the exemption, the IRS seldom has the resources to sort out this issue, experts say.

Tax credits. These valuable breaks offset taxes instead of merely reducing income, and in some cases they can result in a refund check for a taxpayer who owes no tax. Tax credits involving children typically go to the spouse claiming the personal exemptions for them.

The Child Tax Credit of up to $1,000 per child began to phase out at $75,000 for single filers in 2016. The Earned Income Credit, which benefits the working poor, was up to $6,269 for single filers with three or more children and income up to about $48,000. The Dependent Care Credit, which is up to $2,100 for two or more children and $6,000 of total eligible expenses, has no income limit.

Education benefits. For most people, the best tax break for college is the American Opportunity Credit, which can reduce taxes by as much as $2,500 on up to $4,000 of college expenses per child.

Single filers get a lesser break or none if their income exceeds $80,000, but in some cases the child can benefit by claiming the credit if neither parent can—even if the child doesn’t pay the tuition.  

Taxes on a residence. To take typical homeowner deductions for mortgage interest or property taxes, a person must have full or partial ownership of the home and actually pay the expenses.
What if a home is sold and the proceeds divided? Each ex-spouse can get an exemption of up to $250,000 of gain, as long as that person both owned the home for two years and used it as a main residence for two years. For more details, see IRS Publication 523.

Jason Smolen Shares Ways to Keep Inheritances from Unnecessary Taxation on MainStreet.com

SmolenPlevy_Jason_Smolen_Mainstreet_Capital_Gains_Tax

When estate planning, consider whether taxes will turn an inheritance into a burden for your beneficiaries. In a just-published article on MainStreet.comSmolenPlevy Co-founding Principal Jason Smolen discusses various tools used to transfer wealth while limiting the impact of estate taxes.

The federal estate tax exempts $5.43 million for individuals and $10.86 million for couples. However, 16 states and the District of Columbia impose state estate taxes of up to 20% on estates valued at more than a specified amount. For example, in Maryland, heirs may face an additional tax of 10% to 26% upon receiving their inheritance.

While Roth IRAs (which are exempt from income taxes) and trusts are ways to safeguard inheritance from taxes, Smolen suggests three other tools to consider:

  1. Gifting: Gifts to heirs before death reduce the size of an estate and can help it avoid additional estate or inheritance taxes. A person can gift up to $14,000 to an individual (or $28,000 with a spouse) each year without incurring a gift tax.
  2. Real Estate Transfers: Because real estate often represents a significant portion of the estate, a limited partnership to transfer property may be effective. Beneficiaries can be given shares in the limited partnership directly or in a trust.
  3. Life Insurance in a trust: If a policy is held by a trust that is set up outside of an estate, insurance proceeds are generally tax free.

Read the full article on MainStreet here.

In The Media: Jason Smolen Takes a Close Look at Proposed Changes to the Capital Gains Tax

Jason D. Smolen

The proposal to end the “step up” provision in the capital gains tax could mean substantive changes in how inheritances are taxed. Just published, SmolenPlevy Co-Founding Principal Jason Smolen takes a closer look at the proposal in Wealth Management and MainStreet.

President Obama’s plan to close the “trust fund loophole” could affect more than just the rich. Any beneficiary would have to look up the original cost of just about any asset they inherit—causing them to spend time and money sorting out the financial details.

Without the “step up” provision, beneficiaries may need to set up additional trusts to protect their assets from increased taxation. Some people can transfer assets to trusts, which would take them out of the tax picture, or sell the assets entirely instead of passing on potentially huge tax bills to their heirs.

The proposal is a long way from reality, but its adoption will make estate planning more complicated, according to Smolen. Families may need additional professional advice from estate attorneys and accountants to devise a strategy to maximize assets and minimize taxes.

Read Smolen’s exploration of the proposed changes on WealthManagement.com and MainStreet.

In the Media: Bank of America Spotlights SmolenPlevy’s Jason Smolen on the Need for Businesses to Have Counsel

A business can only be successful if it capably handles its legal issues. This is especially true for small businesses, according to Jason Smolen, co-founding Principal of SmolenPlevy, in a just published interview with Bank of America’s Small Business Community.

Smolen stresses the importance of having a legal advisor for your small business. You may know your business, but an attorney knows the law as it applies to your business.

“Having a good attorney advising a business can help avoid those pitfalls that could crush one before it gets started,” reflects Smolen on his 30 + years of experience in business and commercial law. “Depending on the business, there are compliance issues, employment issues, and business issues.”

Smolen says the most common legal mistakes small businesses make fall into the categories of tax planning, human resources and regulatory compliance. Addressing these issues proactively and properly is the difference between being focused on the growth and success of your business, and spending time and money fixing problems.

With limited resources and personnel, small business owners may be hesitant to retain a lawyer for their business, but Smolen notes that the cost of counsel is well worth it. Most commonly, small businesses pay for the time expended by the attorney. Sometimes it makes sense for a small business to build into their budget a monthly fee for the attorney that covers most routine activities and counsel (but specifically excludes litigation).

Smolen recommends hiring a lawyer with knowledge and experience in your business area and above all, you and your counsel should have a shared vision of the future of your business and the means to achieve that future.

To read more about Jason Smolen’s Q & A, click here. To learn about Smolen’s experience in business and commercial law, read his full biography, here.