Estate Planning 101: What Every CPA Should Know


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JUNE 2008 Michael and his co-author outline various caveats of estate planning and discuss helpful methods for applying federal estate tax rules.

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Estate Planning 101: What Every CPA Should Know

  1. 1. EstatePlanning by Williams M. Weintraub, Esq. and Michael B. Allmon, CPA EstatePlanning101 What Every CPA Should Know The following primer on federal estate tax annual gift tax exclusion for each gift is rules can help provide CPAs with the tools $24,000 since each spouse can gift $12,000. needed to conduct a meaningful conversation Even if all of the property comes from one with their clients about their estate planning. spouse, an election can be made on a gift tax return to treat it as if made by both, The Common Exceptions thereby allowing annual gifts by one spouse of Basic estate planning involves using one or $24,000. more techniques to reduce the tax cost of Each of these gifts reduces the value of transferring assets to family members and the estate’s remaining assets. If the estate is other beneficiaries. Which techniques to use going to be a taxable estate, then the savings M depends upon many factors, tax and non-tax from these gifts is measured by the highest related. Also, not every tax-free transfer estate tax rate (currently 45 percent) since Most clients assume their CPAs are should be made in all circumstances. Further, these transfers come off the top of the estate. experts in all things financial, especially as estate planning honors the client’s wishes as Further, the gifts carry any future appre- related to tax matters. They believe that if to the ultimate transfer of their property. For ciation on the property transferred. Thus, the there is anything important for them to plan example, charitable giving is often employed estate is reduced by the amount of the gift for, their CPAs will raise the matter. One because of the client’s love for the charity, not and by all earnings and growth attributable particular area that many clients neglect, always with intent to reduce costs. to the property transferred. however, is estate planning. Some do not From an income tax perspective, it may Most important, the annual exemption want to deal with mortality issues, others do not be advantageous to make any lifetime applies on a “use it or lose it basis.” Gifts not want to confront family issues and still transfers. Assets that pass to a beneficiary not made in one year cannot be made up by others think that the estate plan they made 20 upon death frequently receive an increase in increased gifts in other years when such gifts years ago is fine. tax basis for income tax purposes, which can were not made. For example, you can’t gift Moreover, clients are generally unaware of provide additional depreciation or amortiza- $24,000 in one year and claim $12,000 for the state of the estate tax laws. For example, tion deductions when applied to depreciable the previous year. despite repeated efforts by Congress to repeal or amortizable assets. It’s not just about gifts of cash, however. the “death tax,” no agreement has been Similarly, the increased income-tax basis Some gifts increase the value of the property reached. The current law is effective until the can reduce the subsequent gain on the sale of transferred. For example, a gift of an inter- end of 2010, then we revert to a prior estate such assets by the beneficiary. Therefore, if est in a limited partnership that is valued at tax law that, unless modified, will result in a the amount of the potential estate in question $12,000 will often have a value on liquidation big increase in both the amount of wealth is small enough that there will be no estate that is substantially greater. subject to tax and the rate of tax applied. tax, a tax-free transfer taken during the Gifts can be made outright or in trust. Clients often do not realize that the estate client’s lifetime may not be a tax benefit. However, most gifts made in trust will not tax, like the gift tax and generation-skipping Instead, the client may wish to transfer qualify for the annual exemption unless the transfer tax, impose a tax on the transfer of all assets upon death so the beneficiaries trust includes special language to create a wealth. While clients bemoan the amount of will receive an income-tax basis in the assets “present interest” in the beneficiary, often income tax they pay, they are often in denial equal to the fair market value as of the date referred to as “Crummey provisions.” These over the fact that they (or their estates) will of the client’s death. provisions are derived from Crummey v. be subject to a separate tax as their assets are With that caveat, here are some common Commissioner, in which the Ninth Circuit U.S. transferred. However, there are exceptions to estate planning techniques: Court of Appeals held that a right of with- the imposition of transfer taxes. Annual Gift Tax Exclusion. The law allows drawal granted to a beneficiary made a gift in Another factor to keep in mind is that an annual tax-free transfer of property or trust a present interest gift so that it qualified estate tax reduction planning should first cash up to $12,000. These transfers are for the annual exclusion. consider the long-term effects on the donor’s exempt from gift tax and are not counted to- Payments for Qualified Education and Health financial planning status. After all, you don’t ward the amount that can be transferred free Care Expenses. Another gift that is not a gift for want clients making gifts they can’t afford. of tax as part of the lifetime exemption. tax purposes is a payment made for qualified Enter the CPA to help clients with these Annual gifts can be made to an unlimited education (tuition for everything from pre- matters. CPAs are usually aware of the scope number of people every year and the same school to grad school) or health care. Here, of their client’s assets and often know some- people can receive the gift each year. Far bet- payments are made directly to the education thing about their client’s family relationships. ter, for married couples, the amount of the or medical services provider and are not a 20 C a l i f o r n i a C P a JUNE 2008
  2. 2. reimbursement to the person who incurred transferor’s estate. Thus, a lifetime transfer of mum, distribute all income to the spouse for the expenses. $1 million can result in estate tax savings on life. Thus, a trust that provides distributions of The treatment of these items as tax-free hundreds of thousands (or millions) of dollars income to a spouse until the spouse remarries, transfers reflects a policy consideration to of earnings, and appreciation on the $1 mil- or until a house is sold, will not qualify. encourage such personal charitable acts. lion that would be included in the transferor’s A transfer to a spouse who is not a U.S. Lifetime Exclusions. The estate and gift tax estate if no gift were made. citizen is not eligible for a marital deduc- systems are unified in the sense that the tax- As with all other transfers, there may be tion unless the transfer is made to a qualified free transfers available lifetime and upon death more important non-tax reasons to make or domestic trust, which is generally referred to work in tandem. IRC Sec. 2505 provides a not make the gift. It is important to recognize as a QDOT. credit for an “exclusion amount” for cumula- that tax savings alone should not motivate im- Why use a QTIP trust? First, like any tive lifetime transfers of taxable gifts of up to portant financial decisions, particularly those transfer of assets to a spouse, no estate tax $1 million. Thus, every transfer made during a infused with family relations. applies on the transfer. Ultimately, an estate lifetime that does not qualify for one of the ex- For example, gifts may result from the tax will apply upon the death of the spouse, as ceptions, such as annual exclusion or qualified transfers required to provide support for a the assets in the trust will be includible in the education and medical expenses, uses part of parent or an adult child. While transfers of spouse’s gross estate and potentially subject to the lifetime exclusion amount to avoid gift tax. property may be tax efficient, many potential estate tax. However, a QTIP trust can achieve All transfers constituting taxable gifts in parents won’t approve of how gifts, particu- a deferral of estate tax for an unlimited excess of $1 million are subject to the gift tax larly of cash, would be used by the donee. amount of property. of a rate of 45 percent. Any portion of the Transfers to a Spouse. There is no tax on Second, the use of a QTIP trust assures lifetime exemption that is not used is available transfers of property to a spouse—who is a that assets that remain upon the death of the for transfers made upon death. The cumula- U.S. citizen—whether made outright or in surviving spouse are owned by the deceased tive exclusion amount for transfers made trust, during lifetime or upon death. The estate spouse and will pass to the beneficiaries desig- during lifetime and upon death is $2 million, of a deceased spouse is generally entitled to nated by the deceased spouse. In contrast, if increases to $3.5 million in 2009 and increases a “marital deduction” for certain transfers to the deceased spouse’s assets are left outright to again to an unlimited amount in 2010, but a surviving spouse. Trusts that qualify for the the surviving spouse, there can be no assur- only for 2010. Thereafter, unless amended, the tax-free transfer between spouses are often ance that those assets will end up with those exclusion amount will reduce to $1 million. referred to as qualifying terminal interest beneficiaries selected by the deceased spouse. The main reason to use the lifetime exclu- property (QTIP) trusts. Finally, the QTIP trust can provide a sion is that all income and appreciation of the However, for transfers in trust for a spouse measure of asset protection for the surviving transferred property are removed from the to qualify as tax free, the trust must, at a mini- spouse. Assets in a QTIP trust can be used for
  3. 3. the benefit of the surviving spouse, but are As a result, the estate tax due upon her death example, H and W have the same children, so not generally recoverable by the surviving would be $900,000. there may be less concern that the surviving spouse’s creditors. H, by leaving everything outright to spouse, spouse would change his or her plan to alter did not take advantage of his own exemption what their children would receive. However, if Lifetime Exemption and QTIP Trust amount. He could have left up to $2 million in the children were all H’s from a prior marriage, Here is a case study that demonstrates how a trust for their children, (typically referred to he may want to make sure that his remaining the QTIP trust and lifetime exemption can be as a bypass trust) so that these assets would not assets, after W’s death, pass on to his children, used together in a typical estate plan. be includible in W’s estate upon her death. and not to W’s children or to W’s new spouse. Husband (“H”) and wife (“W”), both age A bypass trust can provide substantial Accordingly, by transferring all of his assets 60, have three children. They have a combined benefits for the surviving spouse, while still to the bypass trust and the QTIP trust, H can net worth of $6 million and live in a commu- excluding the assets in the trust from the provide for W during her lifetime and, at the nity property state. H and W want their de- surviving spouse’s estate. Thus, the surviv- same time, provide, irrevocably, that his chil- scendents to have full use of their assets upon ing spouse can receive all of the income of dren will receive the remaining assets upon W’s their deaths, to minimize the potential estate the bypass trust and may invade principal for death. Therefore, instead of leaving all of his tax liability. They also want to assure that their purposes defined as subject to an ascertainable assets in excess of what can pass tax-free in the children eventually will receive all of the assets standard, meaning the health, support, main- bypass trust outright to W, H may provide that remaining after they both die. H and W have tenance and education of the surviving spouse. the excess go to a QTIP trust for W’s benefit. made no taxable gifts during their lifetimes. Therefore, instead of leaving $3 million to Since many of the basic concepts of estate Assume that H dies in 2007 and that W W, H could leave $2 million to a bypass trust planning are tax driven, at least in part, many dies in 2009. Upon W’s death, the fair market for W’s benefit and the remaining $1 million to clients expect their CPAs to be well versed in value of their combined assets has declined to W. Both transfers would be exempt from estate the subject. CPA $5.5 million. tax. As a result, W’s gross estate would be only What are the options? In the simplest of $3.5 million, an amount equal to the exemp- William M. Weintraub is a partner at plans, H and W can each provide that all of tion amount available in 2009. Accordingly, no Jeffer, Mangels, Butler & Marmaro LLP the assets of the deceased spouse pass out- tax would result upon the death of both H and specializing in estate planning and right to the surviving spouse. Because of the W and their children would divide the $5.5 transactional tax matters. You can reach unlimited marital deduction, there would be million upon W’s death, assuming that W did him at Michael B. Allmon, no estate tax on the transfer of H’s asset to W. not alter her estate plan after H’s death. CPA, is a partner at Michael B. Allmon & However, upon W’s death in 2009, her gross But what if one or both spouses are con- Assoc. LLP CPAs and founding chair of the estate of $5.5 million would exceed her then cerned about the final disposition of the assets CalCPA Estate Planning Committee. You can available exemption amount of $3.5 million. that passed to the surviving spouse. In this reach him at