Estate Planning Checkup

We periodically get medical checkups to make sure we are physically healthy. It also is a good idea periodically to have an estate planning checkup to make sure your estate plan is in good shape. We often use the following checklist to help our clients review their plans.

• When was the last time your estate plan documents were reviewed and updated?
• Have there been any changes in federal or state law that will affect your documents?
• Have there been any changes in your personal situation requiring any changes, such as:
• an increase in your net worth
• a divorce, death, or remarriage
• children growing older and requiring less or more supervision of assets at your death
• the birth of grandchildren you want to protect
• special needs beneficiaries, including beneficiaries with substance abuse issues needing protection
• concern about a child's marriage
• elderly parents or other relatives now needing assistance
• charitable gifts you desire to make
• Are you still comfortable with the people you have designated to be guardians for any minor children?
• Are you still comfortable with the people you have designated to make legal and medical decisions if you become incapacitated?
• Are all of your personal assets properly titled and funded to your Trust to avoid probate?
• Are all of your business assets properly titled and funded to your Trust to avoid probate
• Have you purchased any new personal or business assets recently, and are they properly funded to your Trust?
• Are the beneficiary designations for any life insurance on your life appropriately designated to your Trust?
• Are the beneficiary designations for any retirement plan accounts and IRAs appropriately designated to your spouse and/or your trust?
• If you have executed an Irrevocable Trust to hold life insurance have you:
• properly gifted funds to the Trust annually for premium payments?
• properly prepared and documented Crummey notices annually
• has the trustee periodically reviewed the appropriateness of the insurance policy and regularly reviewed and updated life insurance as appropriate?

     If the answers to any of these questions cause your client's concern or if they are unable to answer any of these questions, you know it is time to suggest they visit their estate planning professional to discuss and possibly change estate planning documents.

Alan Ferrara

How the Investment Income Tax Effects Trusts and Estates

The American Taxpayer Relief Act of 2012 imposes a 3.8% tax on the net investment income (NII) of individuals, estates, and trusts to the extent that the taxpayer's adjusted gross income exceeds the applicable thresholds. While the threshold amount for married and single filers are relatively high, the threshold for an estate or trust is only $11,950 for the tax year 2013. Therefore, if the undistributed NII of an estate or trust exceeds $11,950, the excess is subject to the 3.8% Medicare tax.

A trust or estate is only subject to the NII tax if the trust or estate contains undistributed net investment income. Therefore, the trust or estate can avoid this tax entirely by distributing its net investment income to its beneficiaries. With some trusts, especially those that contain mandatory distributions of all income or where the trustee regularly distributes all the trust income to pay the beneficiaries’ expenses, this is simple. However, for trusts that seek to minimize income distributions, such as Supplemental Needs Trusts for beneficiaries receiving government benefits, avoiding this tax becomes more problematic.

In situations where the distribution of trust income has the potential to create problems the Trustee must weigh the benefits of tax avoidance against the drawbacks of giving income to beneficiaries who may waste it or actually do harm to themselves. In these situations, rather than distributing income to avoid the NII tax it may be better to restructure the trust's investments to avoid receipt of NII. Investing in tax-exempt investments such as municipal bonds or tax-deferred investments or accounts such as life insurance or deferred annuity contracts can avoid the net investment income. It may also make sense to select investments producing growth but little or no income. Trustees can sell such assets later when cash is needed for distributions.

Another, less common concern, is that the value of income generated by a trust will exceed the liability threshold for a beneficiary as an individual. This issue may be addressed by including a number of permissible, but not mandatory beneficiaries in the trust, such as including grandchildren as permissible beneficiaries of a trust for their parent. This allows the trustee to make distributions to a number of trust beneficiaries who do not otherwise have sufficient income to subject themselves to this 3.8% Medicare tax, and  spreads the income among taxpayers potentially eliminating the tax liability altogether.

It is important for trustees and personal representatives of trusts and estates containing significant income generating investments to review those entities as soon as possible in order to determine the best results for each trust or estate. Clients should discuss the options with their professionals in order to maximize tax savings.

As a reminder, the IRS treats income distributed from a trust within the first 65 days following the year-end as distributed in the prior year. For example if a Trustee makes distributions from a trust of income earned in 2013 in the first 65 days of 2014, the beneficiaries report that income on their 2013 income tax return. This gives some flexibility in planning, but Planners should not delay acting to avoid problems. 

Alan Ferrara