September 27, 2023
QTIP trust: Strange name, powerful trust
Granted, a QTIP trust is an odd sounding name for an estate planning technique. Nevertheless, it can be a valuable strategy, especially if you’re currently in a second marriage. The QTIP moniker is an acronym for the technical term of “qualified terminable interest property.” Essentially, the trust provides future security for both a surviving spouse and children from a prior marriage, while retaining estate planning flexibility.
Notably, any federal estate tax due on QTIP trust assets is postponed until the death of the surviving spouse. At that time, his or her gift and estate tax exemption may shelter the remaining trust assets from tax.
A QTIP trust in action
Generally, a QTIP trust is created by the wealthier spouse. When the grantor dies, the surviving spouse assumes a “life estate” in the trust’s assets. This provides the surviving spouse with the right to receive income from the trust, but he or she doesn’t have ownership rights — thus, he or she can’t sell or transfer the assets. Upon the death of the surviving spouse, the assets are passed to the final beneficiaries, who may be the children from the grantor’s prior marriage.
Accordingly, you must designate the beneficiaries of the QTIP trust, as well as the trustee to manage the assets. This could be your spouse, adult child, close friend, or, as is often the case, a third-party professional.
Estate tax ramifications
A QTIP trust is designed to combine the estate tax benefits of the unlimited marital deduction and the gift and estate tax exemption. When you create the trust and provide a life estate to your spouse, the assets are sheltered from tax by the unlimited marital deduction after your death.
After your spouse passes, assets in the QTIP trust are subject to federal estate tax. However, the $12.92 million (for 2023) gift and estate tax exemption will likely shelter most estates from estate tax liability.
Planning flexibility
A QTIP trust can provide added flexibility to your estate plan. For example, at the time of your death, your family’s situation or the estate tax laws may have changed. The executor of your will can choose to not implement a QTIP trust if that makes the most sense. Otherwise, the executor makes a QTIP trust election on a federal estate tax return. (It’s also possible to make a partial QTIP election.)
Once the election is made and the estate tax return is filed within nine months after the death (plus an additional six months if the executor obtains an extension), it’s irrevocable. There’s no going back.
Right for your plan?
If you wish to provide for your spouse after your death, but at the same time ensure that your children ultimately receive the inheritance you want to provide for them, a QTIP trust might be the preferred option. Contact us to learn if a QTIP trust is right for you.
© 2023
September 27, 2023
Update on depreciating business assets
The Tax Cuts and Jobs Act liberalized the rules for depreciating business assets. However, the amounts change every year due to inflation adjustments. And due to high inflation, the adjustments for 2023 were big. Here are the numbers that small business owners need to know.
Section 179 deductions
For qualifying assets placed in service in tax years beginning in 2023, the maximum Sec. 179 deduction is $1.16 million. But if your business puts in service more than $2.89 million of qualified assets, the maximum Sec. 179 deduction begins to be phased out.
Eligible assets include depreciable personal property such as equipment, computer hardware and peripherals, vehicles and commercially available software.
Sec. 179 deductions can also be claimed for real estate qualified improvement property (QIP), up to the maximum allowance of $1.16 million. QIP is defined as an improvement to an interior portion of a nonresidential building placed in service after the date the building was placed in service. However, expenditures attributable to the enlargement of a building, elevators or escalators, or the internal structural framework of a building don’t count as QIP and usually must be depreciated over 39 years. There’s no separate Sec. 179 deduction limit for QIP, so deductions reduce your maximum allowance dollar for dollar.
For nonresidential real property, Sec. 179 deductions are also allowed for qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems.
Finally, eligible assets include depreciable personal property used predominantly in connection with furnishing lodging, such as furniture and appliances in a property rented to transients.
Deduction for heavy SUVs
There’s a special limitation on Sec. 179 deductions for heavy SUVs, meaning those with gross vehicle weight ratings (GVWR) between 6,001 and 14,000 pounds. For tax years beginning in 2023, the maximum Sec. 179 deduction for heavy SUVs is $28,900.
First-year bonus depreciation has been cut
For qualified new and used assets that were placed in service in calendar year 2022, 100% first-year bonus depreciation percentage could be claimed.
However, for qualified assets placed in service in 2023, the first-year bonus depreciation percentage dropped to 80%. In 2024, it’s scheduled to drop to 60% (40% in 2025, 20% in 2026 and 0% in 2027 and beyond).
Eligible assets include depreciable personal property such as equipment, computer hardware and peripherals, vehicles and commercially available software. First-year bonus depreciation can also be claimed for real estate QIP.
Exception: For certain assets with longer production periods, these percentage cutbacks are delayed by one year. For example, the 80% depreciation rate will apply to long-production-period property placed in service in 2024.
Passenger auto limitations
For federal income tax depreciation purposes, passenger autos are defined as cars, light trucks and light vans. These vehicles are subject to special depreciation limits under the so-called luxury auto depreciation rules. For new and used passenger autos placed in service in 2023, the maximum luxury auto deductions are as follows:
- $12,200 for Year 1 ($20,200 if bonus depreciation is claimed),
- $19,500 for Year 2,
- $11,700 for Year 3, and
- $6,960 for Year 4 and thereafter until fully depreciated.
These allowances assume 100% business use. They’ll be further adjusted for inflation in future years.
Advantage for heavy vehicles
Heavy SUVs, pickups, and vans (those with GVWRs above 6,000 pounds) are exempt from the luxury auto depreciation limitations because they’re considered transportation equipment. As such, heavy vehicles are eligible for Sec. 179 deductions (subject to the special deduction limit explained earlier) and first-year bonus depreciation.
Here’s the catch: Heavy vehicles must be used over 50% for business. Otherwise, the business-use percentage of the vehicle’s cost must be depreciated using the straight-line method and it’ll take six tax years to fully depreciate the cost.
Consult with us for the maximum depreciation tax breaks in your situation.
© 2023
September 27, 2023
September 27, 2023
Did your spouse’s estate make a portability election? If not, there may still be time
Portability helps minimize federal gift and estate tax by allowing a surviving spouse to use a deceased spouse’s unused gift and estate tax exemption amount. Currently, the exemption is $12.92 million, but it’s scheduled to return to an inflation-adjusted $5 million on January 1, 2026.
Unfortunately, portability isn’t automatically available; it requires the deceased spouse’s executor to make a portability election on a timely filed estate tax return (Form 706). And many executors fail to make the election because the estate isn’t liable for estate tax and, therefore, isn’t required to file a return.
The numbers don’t lie
When there’s a surviving spouse, estates that aren’t required to file an estate tax return should consider filing one for the sole purpose of electing portability. The benefits can be significant, as the following example illustrates:
Bob and Carol are married. Bob dies in 2023, with an estate valued at $3.92 million, so his unused exemption is $9 million. His estate doesn’t owe estate tax, so it doesn’t file an estate tax return.
Carol dies in 2026, with an estate valued at $15 million. For this example, let’s say the exemption amount in 2026 is $6 million. Because the exemption has dropped to $6 million, her federal estate tax liability is $3.6 million [40% x ($15 million – $6 million)].
Had Bob’s estate elected portability, Carol could have added his $9 million unused exemption to her own for a total exemption of $15 million, reducing the estate tax liability on her estate to zero. Note that, by electing portability, Bob’s estate would have locked in the unused exemption amount in the year of his death, which wouldn’t be affected by the reduction in the exemption amount in 2026.
Take action before time expires
If your spouse died within the last several years and you anticipate that your estate will owe estate tax, consider having your spouse’s estate file an estate tax return to elect portability. Ordinarily, an estate tax return is due within nine months after death (15 months with an extension), but a return solely for purposes of making a portability election can usually be filed up to five years after death. Contact us with any questions regarding portability.
© 2023
September 27, 2023
Divorcing business owners should pay attention to the tax consequences
If you’re getting a divorce, you know the process is generally filled with stress. But if you’re a business owner, tax issues can complicate matters even more. Your business ownership interest is one of your biggest personal assets and in many cases, your marital property will include all or part of it.
Transferring property tax-free
In general, you can divide most assets, including cash and business ownership interests, between you and your soon-to-be ex-spouse without any federal income or gift tax consequences. When an asset falls under this tax-free transfer rule, the spouse who receives the asset takes over its existing tax basis (for tax gain or loss purposes) and its existing holding period (for short-term or long-term holding period purposes).
For example, let’s say that under the terms of your divorce agreement, you give your house to your spouse in exchange for keeping 100% of the stock in your business. That asset swap would be tax-free. And the existing basis and holding period for the home and the stock would carry over to the person who receives them.
Tax-free transfers can occur before a divorce or at the time it becomes final. Tax-free treatment also applies to post-divorce transfers as long as they’re made “incident to divorce.” This means transfers that occur within:
- A year after the date the marriage ends, or
- Six years after the date the marriage ends if the transfers are made pursuant to your divorce agreement.
Additional future tax issues
Eventually, there will be tax implications for assets received tax-free in a divorce settlement. The ex-spouse who winds up owning an appreciated asset — when the fair market value exceeds the tax basis — generally must recognize taxable gain when it’s sold (unless an exception applies).
What if your ex-spouse receives 49% of your highly appreciated small business stock? Thanks to the tax-free transfer rule, there’s no tax impact when the shares are transferred. Your ex will continue to apply the same tax rules as if you had continued to own the shares, including carryover basis and carryover holding period. When your ex-spouse ultimately sells the shares, he or she will owe any capital gains taxes. You will owe nothing.
Note: The person who winds up owning appreciated assets must pay the built-in tax liability that comes with them. From a net-of-tax perspective, appreciated assets are worth less than an equal amount of cash or other assets that haven’t appreciated. That’s why you should always take taxes into account when negotiating your divorce agreement.
In addition, the beneficial tax-free transfer rule is now extended to ordinary-income assets, not just to capital-gains assets. For example, if you transfer business receivables or inventory to your ex-spouse in a divorce, these types of ordinary-income assets can also be transferred tax-free. When the asset is later sold, converted to cash or exercised (in the case of nonqualified stock options), the person who owns the asset at that time must recognize the income and pay the tax liability.
Avoid surprises by planning ahead
Like many major life events, divorce can have significant tax implications. For example, you may receive an unexpected tax bill if you don’t carefully handle the splitting up of qualified retirement plan accounts (such as a 401(k) plan) and IRAs. And if you own a business, the stakes are higher. Contact us. We can help you minimize the adverse tax consequences of settling your divorce.
© 2023
September 27, 2023
Life insurance can be a powerful estate planning tool for nontaxable estates
For years, life insurance has played a critical role in estate planning, providing a source of liquidity to pay estate taxes and other expenses. It’s been particularly valuable for business owners, whose families might not have the liquid assets they need to pay estate taxes without selling the business.
Because the federal gift and estate tax exemption has climbed to $12.92 million (for 2023), estate tax liability generally is no longer a concern for the vast majority of families. But even for nontaxable estates, life insurance continues to offer significant estate planning benefits.
Replacing income and wealth
If you die unexpectedly, life insurance can protect your family by replacing your lost income. It can also be used to replace wealth in a variety of contexts. For example, suppose you own highly appreciated real estate or other assets and wish to dispose of them without generating current capital gains tax liability. One option is to contribute the assets to a charitable remainder trust (CRT).
CRTs are irrevocable trusts that work like this: You contribute property to a CRT during your life or upon your death and the trust makes annual distributions to you or your beneficiary (typically, your spouse) for a specified period of time. When that period ends, the remainder goes to a charity of your choice.
These instruments are particularly useful when you contribute highly appreciated assets and want to reduce capital gains tax exposure. Because the CRT is tax-exempt, it can sell the assets and reinvest the proceeds without currently triggering the entire capital gain.
Here’s where life insurance comes in. Because CRT assets eventually go to charity — usually after both you and your spouse have died — you won’t have as much to leave to your children or other heirs. A life insurance policy can replace that “lost” wealth in a tax advantaged way.
Treating your children equally
If much of your wealth is tied up in a family business, treating your children fairly can be a challenge. It makes sense to leave the business to those children who work in it, but what if your remaining assets are insufficient to provide an equal inheritance to children who don’t? For many families, the answer is to purchase a life insurance policy to make up the difference.
Protecting your assets
Depending on applicable state law, a life insurance policy’s cash surrender value and death benefit may be shielded from creditors’ claims. For additional protection, consider setting up an irrevocable life insurance trust to hold your policy.
Finding the right policy
These are just a few examples of the many benefits provided by life insurance. We can help determine which type of life insurance policy is right for your situation.
© 2023
September 27, 2023
Guaranteeing a loan to your corporation? There may be tax implications
Let’s say you decide to, or are asked to, guarantee a loan to your corporation. Before agreeing to act as a guarantor, endorser or indemnitor of a debt obligation of your closely held corporation, be aware of the possible tax implications. If your corporation defaults on the loan and you’re required to pay principal or interest under the guarantee agreement, you don’t want to be caught unaware.
A business bad debt
If you’re compelled to make good on the obligation, the payment of principal or interest in discharge of the obligation generally results in a bad debt deduction. This may be either a business or a nonbusiness bad debt deduction. If it’s a business bad debt, it’s deductible against ordinary income. A business bad debt can be either totally or partly worthless. If it’s a nonbusiness bad debt, it’s deductible as a short-term capital loss, which is subject to certain limitations on deductions of capital losses. A nonbusiness bad debt is deductible only if it’s totally worthless.
In order to be treated as a business bad debt, the guarantee must be closely related to your trade or business. If the reason for guaranteeing the corporation loan is to protect your job, the guarantee is considered closely related to your trade or business as an employee. But employment must be the dominant motive. If your annual salary exceeds your investment in the corporation, this generally shows that the dominant motive for the guarantee was to protect your job. On the other hand, if your investment in the corporation substantially exceeds your annual salary, that’s evidence that the guarantee was primarily to protect your investment rather than your job.
Except in the case of job guarantees, it may be difficult to show the guarantee was closely related to your trade or business. You’d have to show that the guarantee was related to your business as a promoter, or that the guarantee was related to some other trade or business separately carried on by you.
If the reason for guaranteeing your corporation’s loan isn’t closely related to your trade or business and you’re required to pay off the loan, you can take a nonbusiness bad debt deduction if you show that your reason for the guarantee was to protect your investment, or you entered the guarantee transaction with a profit motive.
More rules
In addition to satisfying the above requirements, a business or nonbusiness bad debt is deductible only if you meet these three requirements:
- You have a legal duty to make the guaranty payment (although there’s no requirement that a legal action be brought against you).
- The guaranty agreement was entered into before the debt became worthless.
- You received reasonable consideration (not necessarily cash or property) for entering into the guaranty agreement.
Any payment you make on a loan you guaranteed is deductible as a bad debt in the year you make it, unless the agreement (or local law) provides for a right of subrogation against the corporation. If you have this right, or some other right to demand payment from the corporation, you can’t take a bad debt deduction until the rights become partly or totally worthless.
These are only some of the possible tax consequences of guaranteeing a loan to your closely held corporation. To learn all the implications in your situation, consult with us.
© 2023
September 20, 2023
Avoiding probate: How to do it (and why)
Few estate planning subjects are as misunderstood as probate. But circumventing the probate process is usually a good idea, and several tools are available to help you do just that.
Why should you avoid it?
Probate is a legal procedure in which a court establishes the validity of your will, determines the value of your estate, resolves creditors’ claims, provides for the payment of taxes and other debts, and transfers assets to your heirs.
Depending on applicable state law, probate can be expensive and time consuming. Not only can probate reduce the amount of your estate due to executor and attorney fees, it can also force your family to wait through weeks or months of court hearings. In addition, probate is a public process, so you can forget about keeping your financial affairs private.
Is probate ever desirable? Sometimes. Under certain circumstances, for example, you might feel more comfortable having a court resolve issues involving your heirs and creditors. Another possible advantage is that probate places strict time limits on creditor claims and settles claims quickly.
How do you avoid it?
There are several tools you can use to avoid (or minimize) probate. (You’ll still need a will — and probate — to deal with guardianship of minor children, disposition of personal property and certain other matters.)
The right strategy depends on the size and complexity of your estate. The simplest ways to avoid probate involve designating beneficiaries or titling assets in a manner that allows them to be transferred directly to your beneficiaries outside your will. So, for example, you should be sure that you have appropriate, valid beneficiary designations for assets such as life insurance policies, annuities and IRAs, and other retirement plans.
For assets such as bank and brokerage accounts, look into the availability of “pay on death” (POD) or “transfer on death” (TOD) designations, which allow these assets to avoid probate and pass directly to your designated beneficiaries. Keep in mind, though, that while the POD or TOD designation is permitted in most states, not all financial institutions and firms make this option available.
What if your estate is more complicated?
For larger, more complicated estates, a revocable trust (sometimes called a living trust) is generally the most effective tool for avoiding probate. A revocable trust involves some setup costs, but it allows you to manage the disposition of all your wealth in one document while retaining control and reserving the right to modify your plan. It also provides a variety of tax-planning opportunities.
To avoid probate, it’s critical to transfer title to all your assets, now and in the future, to the trust. Also, placing life insurance policies in an irrevocable life insurance trust can provide significant tax benefits.
The big picture
Avoiding probate is just part of estate planning. We can help you develop a strategy that minimizes probate while reducing taxes and achieving your other estate planning goals.
© 2023
September 20, 2023
Planning ahead for 2024: Should your 401(k) help employees with emergencies?
The SECURE 2.0 law, which was enacted last year, contains wide-ranging changes to retirement plans. One provision in the law is that eligible employers will soon be able to provide more help to staff members facing emergencies. This will be done through what the law calls “pension-linked emergency savings accounts.”
Effective for plan years beginning January 1, 2024, SECURE 2.0 permits a plan sponsor to amend its 401(k), 403(b) or government 457(b) plan to offer emergency savings accounts that are connected to the plan.
Basic distribution rules
If a retirement plan participant withdraws money from an employer plan before reaching age 59½, a 10% additional tax or penalty generally applies unless an exception exists. This is on top of the ordinary tax that may be due.
The goal of these emergency accounts is to encourage employees to save for retirement while still providing access to their savings if emergencies arise. Under current law, there are specific exceptions when employees can withdraw money from their accounts without paying the additional 10% penalty but they don’t include all of the emergencies that an individual may face. For example, while participants can take penalty-free distributions to pay eligible medical expenses, they can’t take them for car repairs.
Here are some features of pension-linked emergency savings accounts:
- The accounts can only be offered to employee-participants who aren’t highly compensated. In general, a highly compensated employee is one who is a 5% or more owner of a business or has compensation in the preceding year that exceeds an indexed limit (for 2024, $150,000 or more of compensation in 2023).
- Plan sponsors can automatically enroll employee-participants in these accounts at up to 3% of their salary. Plan participants may opt out of making these contributions or pick a different rate to be taken from their pay.
- Annual contributions are capped at the lesser of $2,500 (indexed for inflation) or an amount chosen by the plan sponsor.
- Contributions to pension-linked emergency savings accounts are made on a Roth after-tax basis. Contributions reduce an employee’s other retirement contributions that can be made to a plan.
- A participant must be allowed to make withdrawals from his or her account at least once per month. No reason needs to be provided and a participant must not be subject to any fees or charges for the first four withdrawals from the account each plan year. (However, subsequent withdrawals may be subject to reasonable fees and charges.)
Another option to help employees
In addition to these accounts, SECURE 2.0 adds a new exception for certain retirement plan distributions used for emergency expenses, which are defined as unforeseeable or immediate financial needs relating to personal or family emergencies. Only one distribution of up to $1,000 is permitted a year, and a taxpayer has the option to repay the distribution within three years. This provision is effective for distributions beginning January 1, 2024.
Determine whether there’s time
In addition to what is outlined here, other rules apply to pension-linked emergency savings accounts. The IRS is likely to issue additional guidance in the next few months. Be aware that plan sponsors don’t have to offer these accounts and many employers may find that they need more time to establish them before 2024. Or they may decide there are too many administrative hurdles to clear. Contact us with questions.
© 2023