Reuters Money
Tax, market conditions ideal for gifting a home
When Alice (who asked that her real name not be used) and her husband bought their vacation home 1983, they knew it was special: a 4,500 square foot beachfront house in the Crystal River, Florida area, with views of the sunrise, the sunset and the Gulf of Mexico.
After 55 years of marriage, Alice’s husband passed away in 1999 — the same year the couple put the home in a Qualified Personal Residence Trust, or QPRT. That way, she could pass it down to her sons and not incur huge hits on estate and gift taxes.
“We told our advisers that we wanted to pass this property down to our children, and for them to their children,” says Alice, who is now 91 — and still stays at the home with her family. “They suggested this as a way to get it out of our estate at a reduced value.”
Now, estate planners and wealth managers aren’t particularly known for displaying irrational exuberance. But that doesn’t mean they don’t get pumped when they see a chance for clients to have their proverbial cake — a sweet vacation home in Florida, for example — and eat it, too.
They get that kind of rush now with the QPRT, which allows a person or couple to gift up to two homes (in most cases, to children), yet still live there. And while QPRTs have been around for some time, experts say they’re making a comeback, largely because the clock is ticking on multimillion dollar IRS exemptions that make this strategy a major tax boon.
In December, Congress extended Bush-era tax cuts, keeping estate and lifetime gift tax exemptions at $5 million. But on Jan. 1, 2013, the extension expires and those limits (along with one for the generation-skipping transfer tax) return to $1 million, unless Congress intervenes. What’s more, homes once worth $5 million and up may be worth less today, thanks to the post-2008 real estate slump.
“This is one vehicle to look at right now,” says Madaline Creehan, a principal and wealth adviser at BAM Advisor Services in St. Louis. “It’s a rare opportunity. Absolutely, this could be the perfect time.”
Putting the special in special needs trusts
Tiffany Poland, 37, speaks candidly about the day she became a quadriplegic. “I was in a car accident 22 years ago when the state (of California) removed a stop sign off the street,” says Tiffany. “We sued [and won a settlement], but in order to keep the money we had to put it in a special needs trust,” she says.
People like Tiffany who have suffered a catastrophic injury or who face another serious disability like autism have unique financial planning needs.
Disabled individuals are entitled to benefits from federal and state programs that pay for most medical care, housing and other community services. But if they mess up their financial and estate planning, they could lose their ability to qualify for Medicaid and Supplemental Security Income. Regardless of socioeconomic level, disabled individuals should accept public aid.
Under federal and state laws, anyone 18 or older with disabilities can’t receive these benefits if their assets exceed $2,000. To navigate around that law, a special needs trust (also called a supplemental care trust) must be created so that the disabled individual doesn’t own the assets. As a result, “proper estate and financial planning is critical” so that the disabled person’s public aid is protected, says Susan Mesenbrick, national manager of Wells Fargo Private Bank’s Special Needs Trust group. That means it is essential to hire an estate lawyer and financial planner with special needs experience.
The market for such services is huge. An estimated 54 million adults — nearly 20 percent of the nation’s population have a mental or physical disability — and over 6 percent of American children between the ages of five and 15 suffer from a disability. To service that market, a number of financial services units such Wells Fargo Private Bank’s Special Needs Trusts, the MetLife Center for Special Needs Planning, MassMutual Financial Group’s SpecialCare group and Merrill Lynch Wealth Management work directly with families on the complex special-needs financial planning process.
Who’s In Charge?
A special needs trust can be directed in two ways: institutionally and individually. In a court-awarded settlement like Tiffany’s, the court directs the special needs trust. This is called an institutional or first party special needs trust. An individual special needs trust, is just that, created by a family member who has a dependent with special needs and wants to insure their quality of life after they die as well as protect their public aid. The most significant difference between the two is that with a first person trust, “the state has a lien on the trust and when the beneficiary passes away, Medicaid is paid back,” says Mesenbrink. With an individual trust, there are no payback provisions.
How to fix underwater charitable trusts
It was a perhaps inevitable problem after the market downturn: Charitable trusts that are underwater.
Charitable remainder trusts, or CRTs, are typically used by wealthy people who want to give a seven-figure gift to charity, and still retain an interest in the donation. They work like this: First, the donor puts the asset into a trust for charity. Then, the donor gets the income from the trust, and a charitable donation for tax purposes. At the end of the trust’s term, the asset (that is, the “remainder”) goes to charity.
The problem is that during the boom years, “people set them up with the idea that a 10 percent or 11 percent return was not difficult, so payout ratios may have been set at 8 percent,” says Joan Crain, a senior director of wealth strategies at BNY Mellon Wealth Management. Setting payouts too high has been a problem in all kinds of trusts, but for charitable trusts it’s especially problematic because the way they’re structured for tax purposes won’t let you simply go in and lower that payout target.
The result is that many of these CRTs — though no on really knows how many — are now underwater. While there aren’t a huge number of these trusts, there’s a lot of money at stake: In tax year 2007, an estimated 116,000 taxpayers reported CRTs on their tax returns, with a net asset value of nearly $96 million, according to Internal Revenue Service statistics.
When a charitable trust goes bad, the payouts start cutting into principal; each year, then, the donor will receive a smaller payout amount as the principal shrinks. In the worst case, the trust will run out of funds before the end of the term, and the nonprofit that expected the money simply won’t get it. For both the donor and the charity, that’s a rotten situation.
In recent roundtable discussions with financial advisers, Crain says, the problem of what to do with these trusts generates enormous interest: “It’s not unusual, and, because of market volatility and low rates on fixed income, there is no investment solution to the problem.”
What’s a wealthy donor to do? There are options, but none are perfect or simple.
I’m sorry, I’m not buying this:
“people set them up with the idea that a 10 percent or 11 percent return was not difficult, so payout ratios may have been set at 8 percent,”
the only people acting on those assumptions had no intention of leaving any equity in those trusts. This was a tax scam, pure and simple.
How to hire a trustee for your estate
Trusts, which provide a highly flexible and advantageous way to arrange your financial affairs, can reduce your tax burden, shift your assets to the next generation and transfer a house to a family member, among other numerous benefits.
It’s no surprise they have become increasingly popular estate planning vehicles over the years.
But what is surprising is that choosing the right trustee to oversee a trust is much more challenging than many family members realize.
A trustee, like a doctor, should be chosen with the utmost care. “It is a monumental task,” says Bill Fleming, a managing director at PriceWaterhouseCoopers. “I am looking for an alter-ego of myself,” he says. When making this important choice, a number of considerations should be taken into account.
Trustees, whether it is an individual or an institution, should be efficient, businesslike, organized and responsive. Sometimes a trustee is required to exercise broad discretion, such as deciding when family members should receive funds and at what times.
It could be that these decisions be made without any requirement that the family members be treated equally. Such scenarios require “a trustee who can be relied upon to understand and act on the grantor’s values and priorities,” says Larry Elkin, president of Palisades Hudson Financial Group as well as a certified financial planner and certified public accountant.
In many cases, the person best prepared to step into the grantor’s shoes is a family member. “They are generally more attuned to the dynamics and the personal relationships involved,” says Tucker Boynton, chairman of the trusts, estates and personal planning practice at Stradley Ronon Stevens & Young LLP.
Estate tax uncertainty: Planning for 2011
When you think about what the outcome of the highly political battle over the estate tax might be, just remember: Last year’s common wisdom that lawmakers would not allow the estate tax to expire for one year proved wrong. Even after the deaths of billionaires including George Steinbrenner; Janet Morse Cargill of the family that founded Cargill; Texas pipeline magnate Dan Duncan; and California real estate mogul Walter Shorenstein, the gap year has continued without any clarity.
Talk to estate attorneys and advisors and they laugh at their own predictions for the estate tax, whether past or future. With so many competing proposals, and heated rhetoric on both sides, it’s hard to see what will happen in the 13 weeks remaining till yearend. “It’s been an experience not unlike the market experience, where fear has taken hold and analytics have taken a backseat,” says Frank Dubreuil, national managing director at Bernstein Global Wealth Management in San Francisco.
The issue is, of course, that if Congress doesn’t act, either before yearend or retroactively in 2011, the estate tax will come back at a level that no one seems to want. Where the exclusion was $3.5 million (that’s $7 million for couples) in 2009 — a level at which it affected relatively few households — it will be $1 million (or $2 million for couples) in 2011. The tax rate would also rise, from 45% in 2009, to 55% in 2011.
Competing proposals in Washington place the exemption levels and tax rates all over the map, as Republicans (many of whom would like to permanently repeal what they refer to as the “death tax”) and Democrats (who want it reinstated) fight it out. The Obama Administration wants to return the estate tax to its 2009 level, with a $3.5 million exclusion and 45% rate.
Many states also levy their own estate taxes with a variety of rates and rules, which adds to the complexity for anyone trying to come up with a financial plan.
Despite the flux, there are numerous moves that wealthy people can take to minimize the impact of the estate tax on their heirs down the line. That’s because today’s depressed valuations let you get assets out of your estate and over to your kids or other beneficiaries with less gift tax, while low interest rates create additional opportunities for those who use trusts in wealth planning.
“It’s a lot easier to prepare for whether the exemption is $1 million or $3.5 million than it has been to prepare for the no-estate tax year, which we are already three-quarters of the way through,” says Cheryl Hader, an estate attorney at Kramer Levin Naftalis & Frankel in New York.
This is Amy Feldman, the post’s author, in response to Onlinereader8: If $2 million is gifted, you’d have to pay tax on that. So in our simplified example, assuming 50% tax, that would mean the $1 million remaining would pay the tax on the gift and the estate would be drawn down before death. Thanks for reading!
How to plan for a higher estate tax
John F. Wasik is a Reuters columnist and author of The Audacity of Help. The opinions expressed are his own.
The estate tax is in limbo this year, so if you are looking at a significant inheritance, death may pay some dividends.
As a vestige of the 2001 tax act, the so-called “death” tax disappeared this year, although convoluted rules on valuing estate assets often resulted in higher income taxes. With other issues such as the global financial meltdown, a recession, health care and financial reform dogging it, Congress didn’t get around to fixing the estate levy.
Don’t get any ideas. Death and taxes will still have a sting … eventually. Congress will likely do something about the tax before the end of the year – probably after the November election – so don’t count on a free ride. You’ll still need to do some cautionary estate planning.
While no one knows what Congress will do, it’s a fairly sure bet the tax will return in some form next year. Record budget deficits mean Congress will be looking for revenue sources. Unless Washington acts, the tax will jump back to the old, pre-Bush-era 55% rate, with a $1 million exemption in 2011. That’s quite a hike considering that last year, when the tax was still in effect, you could get a $3.5 million break per person at a top rate of 45%.
There’s little question that the estate tax and related rules are extremely complicated. An overhaul would require a comprehensive look at the myriad trusts and other vehicles used to reduce tax liability.
One of the biggest unanswered questions is whether the new tax – and I predict one is coming – will be retroactive. If we’re still mired in a downturn, I don’t foresee any Draconian tax changes. Congress usually opts for “grandfathering” (extending) a tax break into the past rather than imposing a huge, new tax.
Without growth, everything stings everyone in the end…
http://nbyslog.blogspot.com/2010/08/us-p ayroll-numbers-equivocal-if-you.html
