Skip to content
Jun 1 22

Planning With Life Insurance – Transfer For Value Rule

by Webmaster Admin

This month’s edition of Estate Planning Matters focuses on financial and tax planning issues that could arise when planning with life insurance. 

Remember that Internal Revenue Code (“Code”) Section 2042 causes inclusion of the proceeds of a policy on the life of an insured if an estate receives the proceeds or if the decedent retained significant control over the policy, for example, by retaining the right to change beneficiaries of the policy or to pledge the policy as collateral for a loan. The Code refers to these rights as “incidents of ownership” and includes the policy proceeds in the estate of the decedent if the decedent dies holding any of these rights on the policy.

Setting up an Irrevocable Life Insurance Trust (“ILIT”) provides an effective way to remove the value of the policy proceeds from the decedent’s estate. By owning the policy in the ILIT and naming the ILIT as the beneficiary of the policy, as well as including restrictions on the trust which do not permit the insured to serve as a trustee, the insured releases all incidents of ownership in the life insurance policy. Of course, removing the policy proceeds from the insured’s estate requires advance planning and the insured should consult with a competent estate planning attorney to properly draft and implement the Life Insurance Trust  

If the insured did not create an ILIT to own the policy prior to purchasing the policy, the insured has two options:  gift the policy to an ILIT or sell the policy to an ILIT. If the insured gifts the policy, then the insured has gifted the current value of the policy, likely far less than the death benefit of the policy. This may not matter to the insured; however, there’s another issue. Code Section 2035 will include the policy proceeds in the decedent’s taxable estate if the decedent dies within three (3) years of the transfer. For some clients the three-year rule poses a significant hurdle to estate planning with life insurance.

Selling the policy to an ILIT for fair market value allows the insured to remove the policy proceeds from their taxable estate immediately, without gift tax consequences, thereby avoiding the application of the three-year rule. However, the sale of a life insurance policy to an improperly structured ILIT could cause income tax consequences because of the “Transfer for Value” Rule. 

Generally, Code section 101(a) excludes the life insurance death benefit from taxable income. However, if the policy was transferred for valuable consideration, (which would be the case if the policy were sold), then the Code includes the policy proceeds in the policy owner’s income, due to the “Transfer for Value Rule.”  Unless an exception to the Transfer for Value Rule applies, the proceeds are taxable, except to the extent of the amount paid by the purchaser.

The Transfer for Value Rule contains the following safe-harbor exceptions:  (1) a transfer in which the transferee derives their basis from the transferor (gift); (2) a transfer to the insured, (3) a transfer to a partner of the insured, (4) a transfer to a partnership in which the insured is a partner, or (5) a transfer to a corporation in which the insured holds office or is a shareholder. 

Creating a trust that qualifies as a grantor trust with respect to the insured removes the sale from the application of the Transfer for Value Rule because this type of transaction is treated as a transfer to the insured. 

For example, let’s assume that Grace owned a life insurance policy with a $5 million death benefit. On the advice of her attorney, she sold the policy for $100,000 (its fair market value) to an irrevocable trust that her attorney drafted for Grace. Unfortunately, Grace’s attorney made a critical mistake and failed to ensure that the trust was a grantor trust with respect to Grace. 

One month later, Grace died and the Trustee of Grace’s trust received the $5 million death benefit but was shocked to learn that receipt of the policy proceeds resulted in $4,900,000 of taxable income to the trust. Since trust tax rates are very compressed, an income tax liability resulted in excess $1.8 million, leaving only $3 million for distribution to the trust’s beneficiaries.

Now let’s roll back the clock and assume Grace engaged a competent trust and estate planning attorney who created a grantor trust as to Grace, to purchase the policy. Again, the Trustee sold the policy to the trust for its $100,000 fair market value; however, under this scenario, because Grace’s attorney structured the trust as a grantor trust as to Grace, the sale fell into one of the safe-harbor exceptions to the Transfer for Value Rule, which transfer was deemed a transfer to the insured. When Grace died a month later, the receipt of the death benefit was not treated as taxable income and the Trustee was delighted to distribute the entire $5 million death benefit to Grace’s beneficiaries.

This edition of Estate Planning Matters, and the above example, demonstrate the complexities that arise when clients own and transfer their life insurance policies to trusts. It is vitally important to understand the relevant tax rules and planning strategies in order to properly advise clients in the area of planning with life insurance, especially since there are numerous tax traps for the unwary. 

May 1 22

Reasons Why Deferring Retirement Might Ward Off Dementia

by Webmaster Admin

We have all heard someone say it:

“I’ve decided to keep working beyond retirement age to keep my mind sharp.” Today, that widely held notion has some science behind it.

Three (3) researchers at the Max Planck Institute for Demographic Research in Germany have released a study showing measurable differences in cognitive decline between those who bow out of the workforce earlier versus later in life. Some of the differences were stark.

The team utilized data from the Health and Retirement Study, an extensive ongoing database of information of 20,000 Americans maintained by the University of Michigan. 

The authors of this study did not try to pinpoint an optimal retirement age — that would depend heavily on individual circumstances — but their results do suggest that working until age 67 (vs. retiring between age 55 and 66) can ward off the type of cognitive decline suffered by people with Alzheimer’s disease.

Subjects in the study averaged a full one-third reduction in typical cognitive declines observed in people aged 61 to 67. The positive effects can be enduring, say the study authors, lasting from age 67 at least through age 74.

One surprising finding was that it did not appear to matter exactly what kind of work participants did — whether it was highly brain-intensive or nearly mindless. It all seemed to offer some protective effects against cognitive decline.

Therefore, for many personal and financial reasons, we should consider the benefits of deferring retirement to protect and preserve our mental health and well being 

Apr 1 22

Effective Gift and Estate Tax Planning

by Webmaster Admin

Estate planning attorneys often tell clients that even if you do not have a large estate, you need an estate plan. 

Estate planning involves much more than planning to avoid the federal estate tax, although understanding the estate tax and its impact on a plan are certainly required. 

Until 1916, the United States did not have an estate tax. The Revenue Act of 1916 assessed taxes on estates (“Estate Tax”) based upon the value of an individual’s assets as of the date of death when President Woodrow Wilson signed this legislation creating the transfer tax. The first iteration of the Estate Tax allowed an exemption of $50,000 with rates ranging from one percent (1%) to ten percent (10%) on estates over $5 million. Thereafter, the rate jumped to twenty-five percent (25%) for estates of $10 million.

Originally, the Estate Tax was imposed to fund the United States’ involvement in the first world war, however even after that war ended, the Estate Tax stuckThe Revenue Act of 1924 increased the top tax rate to 40% on estates over $10 million and for the first time, added a gift tax on transfers during life (“Gift Tax”) when it became clear that wealthy individuals found a way around the Estate Tax by transferring wealth during their lifetimes. The Gift Tax was short-lived because it was repealed in 1926 while the Estate Tax rate was lowered to 1% for estates below $50,000 and 20% for those over $10 million. In the decade between 1932 and 1942, the Gift Tax was reinstated, and the Estate Tax and Gift Tax were increased while the exemption amounts were lowered. Estate Tax rates climbed to their all-time high of 77% for estates over $50 million in 1941.

After the Gift Tax became permanent, individuals again found a work-around to avoid taxation on transfers by skipping over their children and making transfers to their grandchildren. In response to this, Congress passed the Tax Reform Act of 1976 (“1976 Act”) introducing the Generation-Skipping Transfer Tax and unifying the Estate Tax, the Gift Tax, and the Generation-Skipping Transfer Tax. This unified regime exists to this day. The 1976 Act also capped the Estate Tax and Gift Tax at 70% for estates over $5 million. The Economic Recovery Act of 1981 phased in an increase in the unified tax transfer credit from $47,000 to $192,000 and a decrease in the maximum tax rate from 70% to 50% and eliminated the limits on estate and gift tax marital deductions. The Taxpayer Protection Act of 1997 phased in an increase in the amount excluded from taxes from $600,000 in 1997 to $1,000,000 in 2006.

In 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (“2001 Act”) reduced the maximum estate tax rates from 50% in 2002, to 45% where it remained until 2009 while increasing the exemption amount gradually until it reached $3.5 million. The 2001 Act repealed the Estate Tax and Gift Tax altogether in 2010 for this one year. In 2011, the exemption amount was raised to $5 million and adjusted for inflation, while the top tax rate was lowered to 35%. In 2013, the top tax rate was raised to 40% which is the current rate. 

The Tax Cuts and Jobs Act of 2017 temporarily doubled the exclusion amount from $5 million to $10 million, as adjusted for inflation, which is the current law and which is set to sunset on January 1, 2026, if not sooner.

In September of 2021, Congress released proposed legislation containing proposals eliminating the benefits of numerous tried and true estate planning techniques which would have had serious ramifications for many Americans. Those proposed changes included acceleration of the reduction in the estate tax exemption amount, taxation of formerly non-taxable transactions between grantors and grantor trusts, eradication of valuation discounts, elimination of stepped-up basis at death, and increased tax rates. Those changes were eliminated and now the Build Back Better Act seems to have become a distant memory with little chance of passage.

One of the many interesting things about the Estate Tax was that it was designed to prevent dynastic fortunes from transferring from one generation to the next. When one-third of the top 50 wealthiest Americans on Forbes’ annual list are heirs, it seems clear that the Estate Tax has failed in that respect. With the current exemption of $12.06 million, which is now at its highest amount in our nation’s history, individuals can transfer substantial assets by gift during life, or my testamentary transfer at death. Last year, only 1,275 estates in the entire country owed Estate Tax, despite the historic amassing of wealth by the very richest citizens.

For those individuals who desire to have a conversation with a qualified and competent estate planning attorney, for the purpose of discussing effective wealth transfer planning strategies for the disposition of their assets, it is certainly possible to create a plan where very modest or no gift or estate taxes would be due, essentially making the Estate Tax voluntary. 

If you have questions about whether your estate might be subject to Estate Tax at your passing, it is vitally important to talk to an estate planning attorney about your desires and concerns. Even if your total assets fall below the current exemption amount, you should plan for the transfer of your assets to your selected beneficiaries during life and upon your passing. The new year makes a great time to plan for the future and to ensure your legacy goals are achieved.

Mar 1 22

Protecting Your Digital Assets

by Webmaster Admin

In a world where a great deal of our personal and financial information is stored online, it is vitally important for you to have a Digital Estate Plan so that your family can access your digital assets in the event of your disability or death.

Today, there is a new kind of asset class requiring attention when creating or revising your estate plan: digital assets. 

So what needs to happen in order to protect your Digital Estate Plan and your assets?

Let’s start by defining a digital assetThese assets generally include social media, email accounts, online subscription services, personal images (photos and videos) stored online, blogs, online businesses, cryptocurrency, websites, web domains, gaming accounts and gambling websites.

Signing up for any of these accounts involves a lengthy terms of service agreement (TOSA), which we very often scroll past without reading and click “Agree.” What we do not realize is our agreement is a legally-binding contract with the platform or service provider, agreeing to all of the terms they have created. Many of these TOSAs include provisions which state that when the original account owner passes, the company may terminate their account, regardless of the value of the digital property or the wishes of the owner.

Most states have begun to adopt legislation for the specific purpose of addressing Digital Estate Plan assets after the owner of such property has passed away. Generally speaking, the company will allow the decedent’s executor or personal representative access to digital assets. 

Unfortunately, many tech companies stand by their contracts wherein protection of the original owner’s privacy is often cited as the reason contents cannot be shared with another person. Even if the executor knows the username and password of the deceased account owner, they may find that the account and all of its contents have been deleted. In some cases, the executor may only find a small portion of the online information available or be accused of committing fraud by logging on and using the decedent’s username and password.

Big tech companies often take the position the data and accounts were owned by the original account owner. As a result, they have a responsibility to protect the owner’s privacy. Therefore, they are not legally permitted to share data or content. 

The headlines of surviving family members trying to retrieve family photos, or police departments attempting to get evidence, represent a small portion of many individuals trying to access their loved one’s digital property. There are also millions lost in cryptocurrency from actual owners who forget their keys, or owners who never shared information with their loved ones about accessing crypto wallets.

What can you do to protect your Digital Estate Plan?

Our legal advice regarding your Digital Estate Plan is to:

1. Appoint a Digital Executor in your Last Will and Testament

2.  Provide your Digital Executor with the necessary documents and information to properly access your digital assets

3.  Create an inventory of your valuable digital assets

4.  Consider using an online program to keep track of your digital assets in order to establish a record of your digital assets. If you create a spreadsheet on your computer, you should encrypt it. Otherwise, in today’s digital world, your digital assets can be hacked and stolen. 

5.  Keep your inventory of Digital Estate Plan assets up-to-date every time you change a password or username, as well as acquire new digital assets.

6.  Decide what you want to happen to each of your digital assets after your death. For example, do you want your Facebook account changed to a “memorialized” account for a period of time? Or would you prefer this type of account to be shut down, immediately?

7.  Certain digital platforms have a process for assigning an executor—however, to date, not many have adopted specific rules. Therefore, it is important for you to find out what the policies are for all of your digital accounts.

8.  Do not share any of your digital asset information in your Last Will and Testament. Since your Will becomes a public document after your passing when it is filed with the probate court, anyone can gain access to the contents of your Will, jeopardizing the content and security your valuable digital accounts. Therefore, we highly recommend that you protect your digital assets in the same way that you would protect any of your traditional financial assets.

While digital assets are a relatively new asset class, your digital assets deserve the same level of protection as all other valuable assets which comprise your personal estate.

Feb 1 22

Double Your Gifts With Spousal Gift-Splitting

by Webmaster Admin
pile of gifts

It may be possible to double your gifting by using spousal “gift-splitting.” Spouses may elect to split gifts made to others. If they do so, they must split all the gifts made by the other spouse to others for that year. 

For example, let’s say John made gifts of $30,000 to each of his five siblings, Aaron, Betty, Charlie, Darlene, and Ed. Assuming these gifts qualify for the annual exclusion (because they are present interests gifts), if John makes the gifts alone, then each gift of $30,000 would be reduced by the annual exclusion of $16,000 and would result in use of $14,000 of his applicable exclusion ($12.06 million in 2022). So, he’d have used $14,000 x 5 = $70,000 for the gifts. 

Gift-splitting
However, if John’s spouse, Mary, desired to split the gifts, she may do so. However, she must split all the gifts or none of them. So, if Mary does not like Ed, she cannot choose to split the gifts to Aaron, Betty, Charlie, and Darlene, but not the gift to Ed. If she chooses to split all the gifts, she would be treated as making a gift of ½ of $30,000, or $15,000, to each of John’s siblings. 

As a result, Mary’s annual gift tax exclusion would cover her half of each of these gifts and neither John nor Mary would need to use any of their applicable exclusion amounts. Mary would consent to split the gifts by signifying such consent on John’s IRS Form 709 for the year of the gift, thus consenting to split all his gifts for the year.

Interestingly, gift-splitting is effective only for gift tax purposes, not for estate tax purposes. This can be quite important. For example, let’s say John made the gifts to his siblings in an irrevocable trust which included Mary as a beneficiary. If Mary made a gift to a trust of which she is a beneficiary, it could cause inclusion in her taxable estate under IRX Section 2036. However, if Mary merely splits the gift made by John, it would not cause inclusion in her taxable estate because she would only be considered to have split the gift for gift tax purposes and not estate tax purposes.

Spousal Gifting
Spousal gifting can be confusing. While U.S. citizen spouses can give an unlimited amount of money to each other, a gift to a non-U.S. citizen spouse does not qualify for the unlimited marital deduction. Instead, such a gift would need to qualify for the annual exclusion. In other words, it would need to be a gift of a present interest. There is also a limit for such gifts to a non-U.S. citizen spouse. In 2022 that limit is $164,000.

Spousal gift-splitting can be a useful wealth transfer planning technique to consider as you plan your gifting strategy for 2022!