News from Samuel, Sayward & Baler LLC for January 2019 includes the articles: Five Answers to Your Questions about Using Trusts to Save Estate Taxes, GETTING ORGANIZED in 2019, Ask SSB, Retirement Account Caution: Change in Firm or Provider Requires Confirmation of Beneficiaries, and What’s New at Samuel, Sayward & Baler LLC.
Taxes
Five Answers to Your Questions about Using Trusts to Save Estate Taxes
Although all citizens or residents of the United States are subject to the federal estate tax at death, the current federal estate tax exemption of $11.2 million per person means that most of us will not pay a federal estate tax at death. However, Massachusetts has the distinction of being one of only 18 states to impose a separate state estate or inheritance tax on the estates of its residents at death. Massachusetts and Oregon are tied for the lowest amount ($1 million) you can leave tax-free at death. This means that if you live in Massachusetts and own assets valued at more than $1 million, your estate, or your spouse’s estate, will likely pay Massachusetts estate tax at death without proper trust and estate planning.
As anyone who lives in Massachusetts knows, it is not difficult to amass an estate valued at more than $1 million – add up the value of your home, retirement accounts, life insurance, bank and investment accounts and you have calculated the value of your “estate” for estate tax purposes. With tax rates ranging from 6.4% (for estates just over $1 million) to 16% for estates in excess of $10 million, the tax bill can be significant.
What can be done about this? One way married couples in Massachusetts can reduce or eliminate estate tax at death is to use credit shelter trusts. Here are five things to know about these types of trusts:
- What is a Credit Shelter Trust?
A so-called “credit shelter trust” is a type of revocable living trust created by married couples. One of these trusts is created by each spouse. The purpose of these credit shelter trusts is to reduce the value of the assets that are owned by the second member of a married couple to die, thereby reducing or eliminating the estate tax payable at the second spouse’s death.
- How do Credit Shelter Trusts Work to Save Estate Tax?
A married individual may leave an unlimited amount of assets to his or her surviving spouse at death without paying any estate tax. Similarly, an unlimited amount of assets may be left to charity estate tax free at death. Finally, in Massachusetts, up to $1 million of assets may be left to any person or entity (other than your spouse or charity) without paying any estate tax. Assets in excess of $1 million left to anyone other than your spouse or charity will be subject to estate tax. Because of this, at the death of the second member of a married couple, when assets are passing to children or other heirs, significant estate tax may be due. Credit shelter trusts work by holding or “sheltering” up to $1 million of assets in the trust of the first spouse to die following the first spouse’s death. The surviving spouse may serve as the Trustee of the deceased spouse’s trust, and may use the trust assets as needed. However, because those assets are not “owned” by the surviving spouse they are not “taxable” in the surviving spouse’s estate.
- What type of Assets Can be Used to Fund a Credit Shelter Trust?
In order for credit shelter trusts to work as intended, each spouse must own assets in his or her own trust, or structure assets so that assets automatically flow into the trust of the first spouse to die at his or her death. Any amount of assets can be held in each spouse’s trust, however the maximum amount that can be sheltered from estate tax for Massachusetts purposes is $1 million. Trust assets in excess of $1 million will typically be held in a sub-trust that will qualify for the marital deduction (so that estate tax on those assets is deferred until the surviving spouse’s death). Assets such as cash, investments, residential or commercial real estate and life insurance are all great assets to use to fund a credit shelter trust. Retirement accounts (such as IRAs, 401(k)s, 403(b)s, etc.) are typically not used to fund a credit shelter trust as the income tax advantages of paying these assets directly to the surviving spouse may be lost.
- What is Involved in Creating a Credit Shelter Trust?
Meet with an experienced trust and estate planning attorney to discuss whether your estate will be subject to estate tax at death, how much estate tax will be payable by your heirs, whether you have assets appropriate to fund a credit shelter trust, and how much estate tax can be saved by creating an estate plan that includes credit shelter trusts for you and your spouse. If you decide to proceed, the estate planning attorney will prepare credit shelter trusts for both spouses, along with so-called “pour-over” Wills that direct any probate assets into the trusts at death. Your trust and estate planning attorney should provide you with detailed instructions about how to “fund” your trusts – which means changing the ownership or beneficiary designation on your assets so that the appropriate assets are either owned by or payable to your respective trusts at death. A final and most important step is for you to follow those instructions and fund your trusts appropriately. It is not unusual for credit shelter trusts to be created but not funded. Unfortunately, if credit shelter trusts are not funded the anticipated estate tax savings will not be achieved.
- How much Estate Tax can be Saved by Using Credit Shelter Trusts?
Depending on the value of your assets, creating and properly funding credit shelter trusts can reduce or eliminate the Massachusetts estate tax payable at the death of both spouses. A couple of examples will illustrate the tax savings credit shelter trusts can accomplish. Example #1: Jim and Sue have assets of approximately $1.5 million. If all assets are owned jointly or left to the surviving spouse at the first spouse’s death, the surviving spouse will have $1.5 million of assets at her death and will pay Massachusetts estate tax of approximately $70,000. If instead the first spouse to die leaves $700,000 of assets in a credit shelter trust for the benefit of the surviving spouse, the surviving spouse will have a taxable estate of only $800,000 ($1.5 million minus $700,000), and no estate tax would be payable at the surviving spouse’s death. In this example, creating and funding credit shelter trusts will save Jim and Sue’s family $70,000 in Massachusetts estate tax. Example #2: Bob and Jean have assets of approximately $5 million. If all assets are owned jointly or left to the surviving spouse at the first spouse’s death, the surviving spouse will have $5 million of assets at her death and her estate will pay Massachusetts estate tax of approximately $400,000. If instead the first spouse to die leaves $1 million in a credit shelter trust for the benefit of the surviving spouse, the surviving spouse will have a taxable estate of only $4 million ($5 million minus $1 million), and $290,000 of estate tax would be payable at the surviving spouse’s death, a savings of $110,000.
Credit shelter trusts are an important trust and estate planning option and a staple of the estate planning attorney’s toolkit for clients who have a taxable estate. However, the proper preparation and funding of these trusts is crucial to ensure they will work as intended to achieve the desired estate tax savings. If your assets are in excess of $1 million and you live in Massachusetts, you may be able to realize significant estate tax savings by using credit shelter trusts as part of your estate plan. The best place to start is a consultation about your particular situation with an experienced trust and estate planning attorney.
Maria Baler, Esq. is an estate planning and elder law attorney and partner at Samuel, Sayward & Baler LLC, a law firm based in Dedham. She is also a former director of the Massachusetts Chapter of the National Academy of Elder Law Attorneys (MassNAELA). For more information, visit www.ssbllc.com or call (781) 461-1020. This article is not intended to provide legal advice or create or imply an attorney-client relationship. No information contained herein is a substitute for a personal consultation with an attorney.
November, 2018
© 2018 Samuel, Sayward & Baler LLC
Tis the Season for Gifting- but what about the taxes?
Presents! Fun to give, fun to get, but what about taxes? Since we are smack-dab in the middle of gift-giving season it seems like a good time for a primer on the tax consequences of making and receiving gifts. Here are a few things to keep in mind.
A Gift is not taxable income to the recipient. Gifts are essentially free money to the recipient. If my dad gives me $10,000 this is not income to me – I do not have to report it on my income tax return.
A Gift to an individual is not income tax deductible by the gift giver but a gift to a qualified charity is. When my dad gives me that $10,000 he cannot deduct that on his income tax return. However, if he gave that money to the American Cancer Society instead of to me, it would be deductible on his income tax return. Gifts to so-called qualified charities are deductible up to 50% percent of a taxpayer’s adjusted gross income. A 30% limitation applies to contributions to private foundation. The IRS publishes a booklet which explains the rules for deductibility of charitable gifts in detail.
Most people don’t need to worry about gift tax. The gift tax seems to be the most misunderstood tax in the tax code. First of all, the gift tax is a federal tax only (except if you live in Connecticut). The key aspects of the federal gift tax are:
- In 2016 each person may give $5,450,000 during their lifetime before there is any gift tax payable ($5,490,000 in 2017). This amount is sometimes called the “lifetime credit” or “lifetime exemption”. So if you do not make gifts in excess of $5,450,000 (twice that amount if you are married), you need not worry about the gift tax.
- In addition to the lifetime exemption amount, each person may make annual gifts of up to $14,000 to as many people as they wish. This is called the annual exclusion amount. For example, if Mr. Trump gives his daughter Ivanka a business worth $5,450,000 this year, he may also give all of his children, including Ivanka, an additional $14,000 in 2016 and there would not be any gift tax due.
- If a person does give more than the allowable exemption amount, then the gift giver (not the recipient) will owe federal gift tax on the amount in excess of the lifetime credit amount at the rate of 40% (ouch!). So if the value of the business given to Ivanka is $6,450,000 then Mr. Trump will owe gift tax of $400,000 (40% of $1 million).
- A person may make unlimited gifts to a U.S. citizen spouse and there is no gift tax payable. For example, if one spouse gives the other a big office building worth $100 million, there is no gift tax payable. But, if the spouse receiving the gift is not a U.S. citizen then the amount of the gift is limited to $148,000 in 2016 (increasing to $149,000 in 2017), and there would be gift tax due on the amount of the gift in excess of the allowable amount.
- The federal gift tax is linked to the federal estate tax. Current federal estate tax laws allow each person to pass on $5,450,000 (2016) at death without any federal estate tax. However, to the extent a person ‘uses up’ some or all of that lifetime credit by making taxable gifts during his or her lifetime, the gift giver reduces the amount of the credit available at his or her death. In the above example where Mr. Trump used his entire lifetime credit by giving his daughter his business, then the full value of the assets Mr. Trump owns at his death will be subject to federal estate tax at the rate of 40% (unless of course he has repealed the federal estate tax, but that’s a topic for another day).
Capital gain tax can be an unwelcome surprise for gift recipients. Most people are familiar with capital gain tax which works like this: Dad buys 100 shares of Microsoft stock for $1,000 in 2000. In 2016, that stock is now worth $10,000. If he sells the stock, he will have a gain of $9,000 ($10,000 – $1,000) on which he will have to pay capital gain tax. If Dad gives the stock to Daughter, he will have made a gift of $10,000 – the current value of the gift. As we know from above, there are no gift tax implications to either Dad or Daughter. Even though Daughter received a gift worth $10,000, her tax basis in the stock is the same as Dad’s – $1,000. That means that when Daughter sells the stock, she will have to pay capital gain tax just like Dad would have had to pay.
If instead of giving the stock to Daughter as a gift, Dad kept the stock and then Daughter inherited it when Dad passed away, Daughter’s tax basis in the stock would be the market value of the stock on the day Dad died. That means that if the stock was worth $10,000 when Dad passed away and Daughter sells it for $10,000 she will not have any capital gain ($10,000 – $10,000 = $0) and will not have to pay any tax – a sweet result.
There are no freebies when it comes to Medicaid eligibility. Medicaid is that state and federally funded program that provides funds to pay for long-term care nursing home care (and other care costs) for individuals who meet the financial eligibility requirements of the Medicaid program. In order to be eligible, a person cannot have more than $2,000 in countable assets. There is a 5-year ineligibility period if an applicant, or his/her spouse, gives away assets. Although there are exceptions to this rule, such as gifts made to a spouse or to a disabled child, there are no exceptions for the amount of a gift. The annual gift tax exclusion amount described above has no bearing on, or relation to, the Medicaid rules.
The bottom line is that while gift tax may not be an issue for most people who are considering making a large gift, there are other issues to be concerned about. Consult with your estate planning attorney so that you understand the implications and can make an informed decision before making gifts. Have a happy holiday and may you be on the receiving end of some of those gifts!
December 2016