Making Use of a Deceased Spouse’s Unused Estate Tax Exemption Simplified

The election for married couples to elect portability of the Federal Estate Tax Exemption was introduced in late 2010 when the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act (“TRUIRJCA”) was signed into law. Portability allows a surviving spouse to possibly make use of their deceased spouse’s unused federal estate tax exemption by adding it to their own exemption. The estate tax is a tax on the amount of a decedent’s taxable estate (pus adjusted taxable gifts). Under federal law, a certain amount of each estate is exempted from taxation. The exemption amount for 2017 is $5.49 million.[1] This means that estates valued above this amount are subject to a 40% estate tax for the amount exceeding the exemption. A little over two years following the signing of the TRUIRJCA, the American Taxpayer Relief Act (“ATRA”) was signed into law, making portability a permanent election for married couples.

However, the unused applicable exemption amount does not automatically transfer to the surviving spouse upon the death of the predeceased spouse. In order to elect portability, the executor must, on or before nine months following the death of the predeceased spouse, file a United States Estate (and Generation-Skipping Transfer) Tax Return (IRS Form 706). On or before that due date, an Application of Extension of Time to File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes (IRS Form 4768), can be filed to request an automatic six-month extension.

In the event that the estate missed the nine-month deadline, there were two separate processes in place to elect portability at a later date, depending on the decedent’s date of death. Where the decedent died after December 31, 2010, and on or before December 31, 2013, the IRS, in Rev. Proc. 2014-18, provided for a simplified method of filing so long as the estate met certain qualifications. The decedent must have been a citizen or resident of the United States at the time of death, and the estate must have been one not required to file an estate tax return under Sec. 6018(a) because the value of the gross estate (plus adjusted taxable gifts) did not exceed the basic exemption amount in effect for the year of death. If these qualifications were met, and the estate tax return was filed before the December 31, 2014 deadline, stating that the form was being filed pursuant to Rev. Proc. 2014-18, the estate tax return would be considered timely filed and a valid portability election. No filing fee was required.

However, if the decedent died on January 1, 2014 or later, the process was more difficult and more expensive. Estates that did not qualify for Rev. Proc. 2014-18 relief were required to seek an extension to file the estate tax return to elect portability under Regs. Secs. 301.9100-1 and 301.9100-3 for an estate not required to file an estate tax return under Sec. 6018.[2] Accordingly, the executor looking to elect portability was required to submit a private letter ruling request providing evidence to the IRS’s satisfaction that the executor acted reasonably and in good faith and that granting relief would not prejudice the interests of the government. Regs. Sec. 301.9100-3(c)(1)(i) lists the ways in which an executor can be deemed to have acted reasonably and in good faith. The private letter ruling request had to be submitted in accordance with applicable procedures, contain affidavits and declarations from the parties, and be accompanied by a filing fee ($10,000 for requests received after February 1, 2017).

But recently the IRS, in Rev. Proc. 2017-34, 2017-26 (effective June 9, 2017) eliminated the requirement that an executor seek a private letter ruling to file a late estate tax return electing portability. So long as the decedent was a citizen or resident of the U.S., the estate was not required to file an estate tax return under Sec. 6018, and the estate tax return is filed before the second anniversary of the decedent’s death, or (if later) January 2, 2018, stating that the return is being “FILED PURSUANT TO REV. PROC. 2017-34 TO ELECT PORTABILITY UNDER §2010(c)(5)(A),” the executor may elect late portability without seeking a private letter ruling. No fee is required. However, the private letter ruling request procedure is still available to an executor who fails to file under Rev. Proc. 2017-34 within the applicable time constraints.

The IRS has made it easier and less expensive for executors to file late estate tax returns electing portability. For letter rulings pending on the effective date of Rev. Proc. 2017-34, 2017-26, the file will be closed and the user fee refunded. The estate may then obtain relief granted by Rev. Proc. 2017-34, 2017-26, by complying with the above procedure. However, it should be noted that this relief is only available for estates where the gross estate (plus adjusted taxable gifts) do not exceed the exemption amount applicable as of the decedent’s year of death and that the late return must be filed no later than two years after the decedent’s date of death or, if later, January 2, 2018.

[1] Some states have their own estate tax, some of which exempt estates at the federal level, and others which have lower exemption levels. In New Jersey, the current exemption is $2 million.

[2] No relief is available for estates large enough to be required to file an estate tax return under Sec. 6018 that failed to timely file.

For more information or if you have any questions about estate planning and taxation, please contact Judson M. Stein, Chair of the Trusts & Estates Practice Group, at 973-230-2080 or jstein@genovaburns.com or Lauren M. Ahern, Associate in the Trusts & Estates Practice Group.

IRS Clarifies “Grantor Trust” Definition in Bankruptcy and Insolvency Settings

       The IRS has issued final regulations clarifying the definition of grantor trusts within the context of the bankruptcy and insolvency exclusions for cancellation of debt (COD) income.   COD income is includable in gross income; however, the Code provides for a number of pertinent exclusions. For example, gross income does not include any amount which would otherwise be includible in gross income by reason of the discharge of indebtedness of the taxpayer if the discharge occurs during bankruptcy or to the extent the taxpayer is insolvent. The terms “indebtedness of the taxpayer,” “Title 11 case,” and “insolvent” are all defined using the term “taxpayer.” The Code broadly defines a “taxpayer” as any person subject to any internal revenue tax.

       Notably, a grantor trust is any part of a trust that is treated as being owned by the grantor or another person. All items of income, deductions, and credits attributable to the trust are includable in computing the owner’s taxable income and credits. For example, a parent may create a grantor trust for estate and succession planning. Where the parent is the grantor, the parent reports the grantor trust’s income on their own Form 1040. Stated another way, the grantor and their own trust are considered the same economic unit.

       Nevertheless, some taxpayers have taken the position that the bankruptcy exception is available if a grantor trust or disregarded entity is under the jurisdiction of a bankruptcy court, even if its owner is not. Similarly, some taxpayers maintain that the insolvency exception is available to the extent a grantor trust or disregarded entity is insolvent, even if its owner is not. The taxpayers argue that because, for Federal income tax purposes, the disregarded entity is disregarded and the “taxpayer” is the owner of the disregarded entity’s assets and liabilities, the owner is properly seen as being subject to the bankruptcy court’s jurisdiction, or being insolvent, even though, technically, they are not.

       The IRS has rejected this position and now clarifies in the final regulations that when applying the bankruptcy or insolvency exceptions to the discharge of indebtedness income of a grantor trust or a disregarded entity, the term “taxpayer,” refers to the owner(s) of the grantor trust or disregarded entity. The regulations provide that the insolvency exception is available only to the extent the owner is insolvent, and the bankruptcy exception is available only if the owner of the grantor trust or disregarded entity is subject to the bankruptcy court’s jurisdiction. Thus, the regulations provide that grantor trusts and disregarded entities themselves will not be considered owners for this purpose.

       With respect to partnerships, the regulations state that the owner rules apply at the partner level to the partners of the partnership to whom the discharge of indebtedness income is allocable. For example, if a partnership holds an interest in a grantor trust or disregarded entity, the applicability of the bankruptcy and insolvency exceptions to COD income of the grantor trust or disregarded entity is tested by looking to the partners to whom the income is allocable.

        For more information or if you have any questions about estate planning, please contact Judson M. Stein, Esq., Director of the Trusts & Estates Practice Group, at 973-230-2080 or jstein@genovaburns.com or John A. Grey, Esq., member of the Trusts & Estates Practice Group, at 973-230-2088 or jgrey@genovaburns.com.

 

How to Reduce Gift Taxes Transferring Wealth Parent to Child

Parents can transfer substantial amounts of wealth, free of gift taxes, to their children every year through the use of “annual exclusion gifting.”

For 2015, the annual exclusion amount is $14,000. It follows that an individual can gift free of tax, up to $14,000 per donee, per year. To illustrate, a parent with three children can transfer a total of $42,000 to them, free of federal gift taxes. However, if the annual gifts exceed $14,000, the excess amount over the exclusion is taxable.

Gift-Splitting by Married Taxpayers

Married couples can transfer even more money, tax-free. Gifts to children made during the year can be treated as “split” between the husband and wife, even if the gift is only given by one of them.

Accordingly, and by “gift-splitting,” a married couple can presently transfer to each child up to $28,000 a year ($14,000 per spouse). Indeed, the more beneficiaries that qualify for the annual exclusion, the more opportunity to consistently remove wealth from the taxable estate. To illustrate, a married couple with two married children can currently transfer tax-free a total of $112,000 to their children and the children’s spouses.

Gifting to a Trust: The “Present Interest” Requirement
As an alternative to making gifts directly to a child, parents may gift to a Trust designed for the benefit of their children. In general, Trusts provide a myriad of tax and asset protection benefits; moreover, they protect against inexperience.

To qualify a gift for the annual exclusion, it must constitute a transfer of a “present interest.” This means that the donee’s enjoyment of the gift must be immediate (as in the present) and not delayed until a date in the future. When gifting to a Trust, the Trust must allow each beneficiary a limited right of withdrawal for a reasonable period of time. Typically, 30 days is sufficient in this setting.

Lifetime Credit for Taxable Gifts
Finally, it is noteworthy that gifts which exceed the annual exclusion amount of $14,000 may not ultimately result in any tax liability. This is because, in addition to the annual exclusion, each individual has a lifetime credit from the federal gift tax of presently $5,430,000 which mirrors that of the federal estate tax exemption. The federal exemption amount is adjusted annually for inflation.

In conclusion, parents can transfer significant amounts of wealth to their children by the use of regular annual exclusion gifting. Such gifting, while relatively easy to set up and administer, requires periodic attention to the tax rules as taxation pervades much of estate planning.

For more information about annual exclusion gifting, or if you have any questions about estate planning, please contact Judson M. Stein, Esq., Director of the Trusts & Estates Practice Group, at 973-230-2080 or jstein@genovaburns.com or John A. Grey, Esq., member of the Trusts & Estates Practice Group, at 973-230-2088 or jgrey@genovaburns.com.

IRS Issues Final Portability Regulations

On June 12, 2015, the Treasury issued Final Portability Regulations (TD 9593, IRB 2012-28) which clarifies previous regulations, as well as responds to comments made to the Treasury by the American Bar Association’s Real Property, Trust, and Probate Law Section.  The final regulations substantively address a few of the inquiries made.  The regulations remove the earlier temporary regulations and provide guidance on portability rules for estates of married decedents dying on or after January 1, 2011 and the surviving spouses of those decedents.

The guidance under the final regulations applies only to estates of decedents dying after the date that the regulations were issued.  The temporary regulations will continue to apply to estates of decedents dying between January 1, 2011 and June 12, 2015.  Treas. Reg. §§ 20.2010-1(e), 2(e), and 3(f).  Therefore, guidance has not changed for those decedents dying prior to the issuance of the final regulations.

The concept of “portability” refers to an election that may be made on a decedent’s estate tax return, which permits a decedent’s surviving spouse to inherit the unused Federal estate tax exemption of their predeceased spouse (this inherited amount is referred to as the Deceased Spousal Unused Exemption Amount or “DSUEA”).  Portability was initially a temporarily relief for married persons dying after 2010 and was made permanent by the American Taxpayer Relief Act of 2012 (“ATRA”).

The fundamental portability qualification requirements remain unchanged including: (1) the decedent must be a U.S. citizen or resident alien; (2) the election must be made on a timely estate tax return (filed within 9 months of date of death or within 15 months with an automatic extension); and (3) the estate tax return must be complete (unless simplified reporting applies, in which substantiation of valuation is not necessary when the estate passes under an estate tax marital or charitable deduction and the value is not needed to compute any non-deductible transfer).  Only the DSUEA from the last deceased spouse may be used by the surviving spouse against otherwise taxable gifts or on death.

In the final regulations, the IRS provided some guidance on what is considered a “complete and properly prepared” estate tax return sufficient to make the portability election.  Advisors sought clarification on this topic, as a variety of simple technical deficiencies on a return that could otherwise be easily rectified caused concern that the election would be lost. Advisers were also concerned that a return mistakenly prepared using the simplified requirements could later materialize into situation in which a complete return was required.  Declining to elaborate on specific circumstances that would render a return deficient and incomplete, the IRS stated that it “consider[s] the issue of whether an estate tax return is complete and properly prepared to be determined most appropriately on a case-by-case basis.”  The IRS offered a glancing reassurance that a taxpayer can cure any defects by acknowledging that some “errors or omissions [on] an estate tax return will be considered minor and correctible.”

The Treasury also addressed the tax consequences under circumstances in which a non-citizen spousal beneficiary of a Qualified Domestic Trust (“QDOT”) later becomes a United States citizen.  Prior to the issuance of the final regulations, it was clear that a United States citizen decedent may pass his or her DSUEA amount to his or her surviving spouse who is not a United States citizen, assuming that the estate is left to the surviving spouse in a QDOT.  The DSUEA amount of the deceased spouse would not be “ported” over to the surviving spouse at death, but rather, the transfer would be delayed until the assets of the QDOT are fully subject to estate tax, i.e. at the surviving spouse’s death.  The predeceased spouse’s DSUEA amount would thereafter be reported on the surviving spouse’s estate tax return.  The final regulations clarify that the deceased spouse’s available DSUEA amount will be automatically transferred to the surviving spouse in the event he or she becomes a United States citizen during the QDOT term.  See Treas. Reg. § 20.2010-3(c)(2) and Treas. Reg. § 25.2505-2(d)(3)(ii).

The final regulations also confirm that discretionary extensions of time may be available for estates that only had to file a Federal estate tax return in order to elect portability and that no protective portability election is required when the amount or even existence of a DSUEA amount is uncertain.  The Treasury declined to include any provisions indicating the release of an abridged estate tax return to be utilized solely for making a portability election.

These final regulations on the portability election provide some guidance and clarification for concerns taxpayers had under the temporary regulations.  For more information about the portability election, or if you have any questions about estate planning, please contact Judson M. Stein, Esq., Director of the Trusts & Estates Practice Group, at 973-230-2080 or jstein@genovaburns.com. This blog post was written with the assistance of Ryann M. Aaron.

Year-end Tax Planning Update

Year-end tax planning is especially challenging this year because Congress has yet to act on a host of tax breaks that expired at the end of 2013. Some of these tax breaks may be retroactively reinstated and extended, but Congress may not decide the fate of these tax breaks until the very end of this year (and, possibly, not until next year).

These breaks include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line-deduction for qualified higher education expenses; tax-free IRA distributions for charitable purposes by those age 70- 1/2 or older; and the exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence.  For businesses, tax breaks that expired at the end of last year and may be retroactively reinstated and extended include: 50% bonus first year depreciation for most new machinery, equipment and software; the $500,000 annual expensing limitation; the research tax credit; and the 15-year writeoff for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.

Higher-income-earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income and the additional 0.9% Medicare (hospital insurance, or HI) tax that applies to individuals receiving wages with respect to employment in excess of $200,000 ($250,000 for married couples filing jointly and $125,000 for married couples filing separately).

The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his or her estimated MAGI and net investment income (NII) for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year, others should try to see if they can reduce MAGI other than NII, and other individuals will need to consider ways to minimize both NII and other types of MAGI.

The additional Medicare tax may require year-end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward year end to cover the tax. For example, an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year. He would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000. Also, in determining whether a taxpayer may need to make adjustments to avoid a penalty for underpayment of estimated tax, one also should be mindful that the additional Medicare tax may be overwithheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple’s income won’t be high enough to actually cause the tax to be owed.

We have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you (or a family member) will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:

 Year-End Tax Planning Moves for Individuals

•           Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes.  You can give present interest $14,000.00 gifts in 2014 to each of an unlimited number of individuals, but you cannot carry over unused exclusions from one year to the next.  The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.  Also, be mindful of the basis rules when giving appreciated property or property that has declined in value.  Consider selling loss property and gifting the proceeds.  Keep in mind that unused annual exclusions cannot be carried over and are forever lost.  If you are making a gift by check near the end of 2014 and you would like to take advantage of this year’s exclusion, you should urge the recipient to deposit the check before year-end so that there is no doubt as to when the gift was made.

•           Make gifts sheltered by the lifetime gift tax exemption before the end of the year and thereby save gift and estate taxes.  You can give up to $5,340,000.00 of taxable gifts in 2014 (reduced by prior taxable gifts) without incurring gift taxes (or generation skipping transfer taxes).  Although such gifts will subsequently reduce your federal estate tax exemption, the post gift appreciation and cash flow from the property gifted will escape estate taxation, and there are gifting strategies that can significantly leverage the value of the gifts.  Note that the $5,340,000.00 exemption is up from 2013’s $5,250,000.00 exemption.  As such, if you have maxed out your gifting based on the 2013 exemption amount, consider making additional taxable gifts of up to $90,000.00.  In 2015, the lifetime gift tax exemption will increase to $5,430,000.00, as adjusted for inflation; although, the $14,000.00 annual gift tax exclusion will remain unchanged.

•       Gifts to non-citizen spouses qualify for an increased annual gift tax exclusion of $145,000.00 for 2014.  Therefore, consider making lifetime gifts to a non-citizen spouse before the end of the year.  A couple can avoid U.S. estate tax on the gifted property if the non-citizen spouse possessing the property has established a residence outside of the United States before the date of his or her death and the gifted property is not otherwise sitused in the United States. In 2015, the annual exclusion on gifts to non-citizen spouses will increase to $147,000.00.

  • Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later.
  • Postpone income until 2015 and accelerate deductions into 2014 to lower your 2014 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2014 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2014. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year or where lower income in 2015 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit.
  • The “Pease limitations” limit the amount of various itemized deductions that one can use in any given tax year.  More specifically, the limitation reduces the use of itemized deductions by 3% of amounts in excess of an individual’s threshold amount (up to a max of 80% of those reduced deductions), for 2014, the threshold for single individuals was an adjusted gross income (AGI) of $254,200 (or $305,050 for married couples filing jointly).  One can reduce the effect of the Pease limitations by reducing their AGI or by spreading out their charitable deductions (one type of itemized deduction) over several years.  There are many other planning techniques that can be used to effectuate this time of deduction planning, such as making gifts of income-producing property to non-grantor trusts. For 2015 the threshold amount for individuals is increases to $255,250.00 (or $309,900 for married couples filing jointly).
  • If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. While you will benefit from tax-free appreciation into the future, keep in mind, however, that such a conversion will increase your adjusted gross income for 2014.
  • If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by recharacterizing the conversion; that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA, if doing so proves advantageous.
  • It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2015.
  • Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2014 deductions even if you don’t pay your credit card bill until after the end of the year.
  • If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2014 if doing so won’t create an alternative minimum tax (AMT) problem.
  • Take an eligible rollover distribution from a qualified retirement plan before the end of 2014 if you are facing a penalty for underpayment of estimated tax and having your employer increase your withholding isn’t viable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2014. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2014, but the withheld tax will be applied pro rata over the full 2014 tax year to reduce previous underpayments of estimated tax.
  • Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2014, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes, miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes in the case of a taxpayer who is over age 65 or whose spouse is over age 65 as of the close of the tax year. As a result, in some cases, deductions should not be accelerated.
  • You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions (i.e., certain deductions that are allowed only to the extent they exceed 2% of adjusted gross income), medical expenses and other itemized deductions.
  • You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.
  • You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
  • Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70- 1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70- 1/2 in 2014, you can delay the first required distribution to 2015, but if you do, you will have to take a double distribution in 2015-the amount required for 2014 plus the amount required for 2015. Think twice before delaying 2014 distributions to 2015-bunching income into 2015 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2015 if you will be in a substantially lower bracket that year.
  • Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
  • If you are eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2014. This is so even if you first became eligible on Dec. 1, 2014.
  • Be cognizant of reporting requirements for foreign income and holdings; including Form 8938 – Statement of Specified Foreign Financial Assets.
  • If you have moved your residence, update your address with the IRS by filing a Form 8822.

Year-End Tax-Planning Moves for Businesses & Business Owners

  • Businesses should buy machinery and equipment before year end and, under the generally applicable “half-year convention,” thereby secure a half-year’s worth of depreciation deductions for the first ownership year.
  • Although the business property expensing option is greatly reduced in 2014 (unless legislation changes this option for 2014), do not neglect to make expenditures that qualify for this option. For tax years beginning in 2014, the expensing limit is $25,000, and the investment-based reduction in the dollar limitation starts to take effect when property placed in service in the tax year exceeds $200,000.
  • Businesses may be able to take advantage of the “de minimis safe harbor election” (also known as the book-tax conformity election) to expense the costs of inexpensive assets and materials and supplies, assuming the costs don’t have to be capitalized under the Code Section 263Auniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit-of-property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $500. Where the UNICAP rules aren’t an issue, purchase such qualifying items before the end of 2014.
  • A corporation should consider accelerating income from 2015 to 2014 where doing so will prevent the corporation from moving into a higher bracket next year. Conversely, it should consider deferring income until 2015 where doing so will prevent the corporation from moving into a higher bracket this year.
  • A corporation should consider deferring income until next year if doing so will preserve the corporation’s qualification for the small corporation alternative minimum tax (AMT) exemption for 2014. Note that there is never a reason to accelerate income for purposes of the small corporation AMT exemption because if a corporation doesn’t qualify for the exemption for any given tax year, it will not qualify for the exemption for any later tax year.
  • A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2014 (and substantial net income in 2015) may find it worthwhile to accelerate just enough of its 2015 income (or to defer just enough of its 2014 deductions) to create a small amount of net income for 2014. This will permit the corporation to base its 2015 estimated tax installments on the relatively small amount of income shown on its 2014 return, rather than having to pay estimated taxes based on 100% of its much larger 2015 taxable income.
  • If your business qualifies for the domestic production activities deduction for its 2014 tax year, consider whether the 50%-of-W-2 wages limitation on that deduction applies. If it does, consider ways to increase 2014 W-2 income, e.g., by bonuses to owner-shareholders whose compensation is allocable to domestic production gross receipts. Note that the limitation applies to amounts paid with respect to employment in calendar year 2014, even if the business has a fiscal year.
  • To reduce 2014 taxable income, consider deferring a debt-cancellation event until 2015.
  • To reduce 2014 taxable income, consider disposing of a passive activity in 2014 if doing so will allow you to deduct suspended passive activity losses.
  • If you own an interest in a partnership or S corporation consider whether you need to increase your basis in the entity so you can deduct a loss from it for this year.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you. We also will need to stay in close touch in the event Congress revives expired tax breaks, to assure that you do not miss out on any resuscitated tax saving opportunities.

Delaware Tax Trap Or Treasure?

With the passage of the ATRA providing certainty as to the future “permanency” of the federal $5MM estate tax exemption amount, many high net worth individuals will be less concerned with estate tax planning and will be more concerned with income tax planning. Whether traditional credit shelter trust planning is still proper for individual or married taxpayers will depend on various factors including asset protection, trust income tax rates, desire to shelter appreciation from estate tax, willingness to pay practitioners for trust planning, etc.  However, for those clients that decide to utilize irrevocable trust planning during their lifetimes and not rely entirely on portability, practitioners should consider drafting trusts to provide flexibility to account for potential changes to the estate tax laws and to allow for an income tax step-up in basis, if advisable.

An option known as the “Delaware Tax Trap,” (DTT) which, prior under the historically lower estate tax exemptions typically was to be avoided, now can provide flexibility in bypass trust planning.  Using this potential tool, it is possible for property subject to a limited power of appointment to be included in the power holder’s gross estate at death, resulting in an income tax step-up in basis, if preservation of the estate tax exemption is not necessary.  The DTT allows the surviving spouse to wait until soon before their death to decide whether to trigger estate tax inclusion or not by providing for the exercise of the power of appointment in a Will or codicil.

The rule states that a limited power of appointment will cause the subjected property to be included in the power holder’s gross estate at death (by converting the power to a general power of appointment) if the power is exercised to create another power of appointment which, under the applicable local law, can be validly exercised so as to postpone the vesting of any estate or interest in such property, or suspend the absolute ownership or power of alienation of such property, for a period ascertainable without regard to the date of the creation of the first power. (§§2041(a)(3), 2514(d)).

These provisions, enacted under the local law of most states, were designed to prevent the holders of limited powers in trusts to avoid the limited time frame that a trust may be in existence under the rule against perpetuities. Now many states have either greatly extended the rule against perpetuities period or have abolished it entirely.

One can also draft a formula contingent general power of appointment to cause estate tax inclusion to the extent that such inclusion would not cause any estate tax to be imposed on survivor’s estate. A court could argue, however, that the creation of the power is within the control of the surviving spouse, who has the power to generate it by spending down his or her estate.  A court will analyze the issue of act of independent significance to decide upon whether the power of appointment is in the control of the beneficiary to determine whether or not he or she will ultimately receive the power.  If the surviving spouse beneficiary ultimately loses on this argument, then the surviving spouse will be treated as having a general power over the entire non-marital trust, regardless of the size of his or her estate.  There is no bright line test as to what constitutes an act of truly independent significance that can be used to generate a power of appointment.

As an alternative, one may have an independent trustee or trust protector with authority to grant the surviving spouse a general power of appointment.  The release of this power may have adverse tax consequences, however, because the release of a power is a taxable transfer itself.

Tax Thoughts On Trust Protectors

Despite the frequent assurances practitioners very often hear from their clients that they have a perfect choice of a wholesome, trustworthy, and financially savvy Trustee, it is not uncommon to hear stories about these “ideal” individuals misappropriating or mismanaging funds in some way.

As is such, it may often be advisable to suggest the idea of a “trust protector” provision. The degree of a trust protector’s authority can vary greatly. The overarching purpose of the protector, however, is to place an additional set of checks and balances on an existing or successor trustee and to provide for additional flexibility over uncertain future events.

Although the concept of a trust protector is fairly novel and has not yet been fully hashed out either in common law or by statute, the definition of a protector is evolving, especially as additional jurisdictions pass new domestic or foreign asset protection trust legislation.

Some typical powers given to trust protectors include the ability to veto trust distributions or investment decisions, change the trust situs, consent to the exercise of a power of appointment, or remove, add, and replace trustees. However, as is the case with choosing whom to appoint as a normal trustee, there are important tax concerns that must be addressed when choosing a trust protector and selecting their permissible powers.

If a power is granted to a trust protector (who is acting in a fiduciary capacity) that can be exercised in favor of the protector, his creditors, or the creditors of his estate, or to discharge a legal obligation of support, then the protector will have retained a general power of appointment, unless it is limited by an ascertainable standard, such as “health, education, maintenance, and support.” However, it is of the opinion of some practitioners that, depending upon who is chosen to act as a trust protector, ascertainable standard language may be omitted without causing adverse general power of appointment tax consequences. For example, it may be argued that if a professional, such as an attorney, has been appointed as trust protector with the power to add beneficiaries, that it would not be inferred that the settlor’s intent was to include members of the attorney’s own family within the permitted class of appointees.

A Settlor can be given even greater flexibility and control over the originally appointed parties, including the power to remove and replace a trustee or even a trust protector without estate inclusion.  The scope of this permitted control will depend, however, upon the authority the trustee/protector is given and whether or not the trustee/protector is acting in a fiduciary capacity.

If the protector is acting in a fiduciary capacity and if the powers granted to the protector would cause estate inclusion if held by the grantor, then the grantor can hold a power to remove and replace the protector, if the replacement protector is not related or subordinate (independent person). If the protector is not a fiduciary and the powers granted the protector would cause estate inclusion if held by the grantor, then the grantor should not hold a power to remove and replace, even with a related or subordinate (independent) person. However, if the protector only holds powers that a grantor could also safely hold, then the grantor can have a power to remove and replace the protector, even with a related or subordinate person (non-independent trustee).