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How to Prepare for Higher Taxes

Taxing the appreciation of property on gifting or at death as capital gains or ordinary income is under scrutiny as a means of raising significant revenue for the federal government. The Biden administration has proposed this but proposing and passing into law are two very different things, observes Financial Advisor in the article “How Rich Clients Should Prepare For A Biden Estate Tax Regime.”

The tax hikes are being considered as a means of paying for the American Jobs Act and the American Families Act. Paired with the COVID-19 relief bill, the government will need a total of $6.4 trillion over the course of a decade to cover those costs. Reportedly, both Republicans and Democrats are pushing back on this proposal.

A step-up in basis recalculates the value of appreciated assets for tax purposes when they are inherited, which is when the asset’s value usually is higher than when it was originally purchased. For the beneficiary, the step-up in basis at the death of the original owner reduces the capital gains tax on the asset. Taxes are reduced significantly, or in some cases, completely eliminated.

For now, taxpayers pay an estate tax on the value of the assets and the basis of appreciated assets is stepped up to fair market value. The plan under consideration would treat appreciated assets owned at the time of death as sold, which would trigger income tax and subject those assets to estate tax.

Biden’s proposal would also subject many families to the estate tax, which they would not otherwise face, since the federal estate tax exclusion is still historically high—$11.7 million for individuals and $23.4 million for married couples. Let’s say a widowed mother dies with a $3 million estate. Most of the value of the estate is the home she lived in with her spouse for the last four decades. Her estate would not owe any federal tax, but the deemed sale of a highly appreciated home would generate income tax liability.

The proposal allows a $1 million per individual and $2 million per married couple exclusion from gain recognition on property transferred by gift or owned at death. The $1 million per person exclusion is in addition to exclusions for property transfers of tangible personal property, transfers to a spouse, transfers to charity, capital gains on certain business stock and the current exclusion of $250,000 for capital gain on a personal residence.

How should people prepare for what sounds like an unsettling proposal but may end up at a completely different place?

For some, the right move is transferring properties now, if it makes sense with their overall estate plan. Regardless of what Congress does with this proposal, the estate tax exemption will sunset to just north of $5 million (due to inflation adjustments) from the current $11.7 million. However, the likelihood of the proposal passing in its present state is low. The best option may be to make any revisions focused on the change to the estate tax exemption levels.

Reference: Financial Advisor (June 28, 2021) “How Rich Clients Should Prepare For A Biden Estate Tax Regime”

What Taxes are Due When Children Inherit Home?

The first issue to address is whether the will addresses how inheritance taxes will be paid, says nj.com recent article entitled “My adult kids inherited a home. What taxes are due?” The mortgage may say the estate itself will pay it before anything is paid out to beneficiaries, or it may not mention anything.

Iowa, Kentucky, Nebraska, New Jersey, and Pennsylvania are the only states that impose an inheritance tax, which is a tax on what you receive as the beneficiary of an estate.

Maryland is the one state that has both an inheritance tax and an estate tax. Its inheritance tax is up to 10%. As to the others, Nebraska’s inheritance tax can be as high as 18%. Kentucky and New Jersey both taxes inheritances at up to 16%. Iowa’s inheritance tax is up to 15%, as is Pennsylvania’s.

Spouses and certain other heirs are usually excluded by the state from paying inheritance taxes.

A child may have an issue if there’s not enough liquidity in the estate, separate from the house to pay the taxes. If the beneficiaries plan to keep the home, they’d need to take an additional mortgage.  They’d also need to find enough cash to pay the inheritance taxes due.

In the example above, if the deed is transferred to a niece and nephew, the executor should hire a licensed real estate appraiser and pay for a date of death appraisal on the property. That appraisal will determine how much capital gains was exempted at the sister’s passing. It will also establish a new basis for capital gains purposes for the niece and nephew.

If the heirs simply do nothing and move into the house, the inheritance tax will come due. In New Jersey, it’s due eight months from the date of death.

If the inheritance tax isn’t paid, liability for the unpaid tax will attach to the executor personally, often in the form of a certificate of debt attached to some asset belonging to the executor, like his or her house.

To make sure this is handled correctly, consider speaking to an experienced estate planning attorney, who can walk you through the process.

Reference: nj.com (June 14, 2021) “My adult kids inherited a home. What taxes are due?”

Does My State have Inheritance Tax?

There are several states with an inheritance tax. They include Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania. Maryland is the only state to impose both an inheritance tax and a state estate tax.

Forbes’s recent article entitled “Is There a California Estate Tax?” says that even if you live outside these states, it does not necessarily mean that your inheritance will be tax-free.

Twelve states and DC impose estate taxes. These include Hawaii, Washington, Massachusetts, Oregon, New York, Minnesota, Illinois, Vermont, Maine, Rhode Island, Connecticut and Maryland.

There may be other taxes due at the state level for those inheriting assets, investments, retirement accounts, or real estate.

The estate tax is a tax levied on the estate, when a person dies before the estate is passed on to the heirs and beneficiaries. Federal estate tax only applies to large estates, regardless of which state you live in. Estate taxes vary from state to state.

There is one state that imposes a gift tax: Connecticut. That state’s Department of Revenue Services says that all transfers of real or personal property by gift, whether tangible (like a car or jewelry) or intangible (such as cash) that are made by you (the donor) to someone else (the donee) are subject to tax, if the fair market value of the property exceeds the amount received for the property.

The federal gift tax applies to all states. For 2021, the annual gift-tax exclusion is $15,000 per donor, per recipient. A giver can give anyone else—such as a relative, friend, or even a stranger—up to $15,000 in assets a year, free of federal gift taxes.

Even if your state doesn’t have a state estate tax, there’s still a federal estate tax. This goes into effect for estates valued at $11.7 million and up, in 2021, for singles. The estate tax exemption is $23.4 million per couple in 2021.

With proper tax planning and estate planning, you have the ability to pass an estate much larger than this without being subject to the federal estate tax. The estate tax starts at 18% and goes up to 40% for those anything over the $23.4 million threshold.

Talk to an experienced estate planning attorney for questions about taxes and estate planning.

Reference: Forbes (May 4, 2021) “Is There a California Estate Tax?”

How Do I File Taxes on a CARES 401(k) Withdrawal?

Several bills were passed by Congress to ease financial challenges for Americans during the pandemic. One of the provisions of the CARES Act was to allow workers to withdraw up to $100,000 from their company sponsored 401(k) plan or IRA account in 2020. This is a big departure from the usual rules, says an article from U.S. News & World Report titled “How to Avoid Taxes on Your CARES Act Retirement Withdrawal.”

Normally, a withdrawal from either of these accounts would incur a 10% early withdrawal penalty, but the CARES Act waives the penalty for 2020. However, income tax still needs to be paid on the withdrawal. There are a few options for delaying or minimizing the resulting tax bill.

Here are three key rules you need to know:

  • The penalties on early withdrawals were waived, but not the taxes.
  • The taxes may be paid out over a period of three years.
  • If the taxes are paid and then the taxpayer is able to put the funds back into the account, they can file an amended tax return.

It’s wise to take advantage of that three-year repayment window. If you can put the money back within that three-year time period, you might be able to avoid paying taxes on it altogether. If you are in a cash crunch, you can take the full amount of time and repay the money next year, or the year after.

For instance, if you took out $30,000, you could repay $10,000 a year for 2020, 2021, and 2022. You could also repay all $30,000 by year three. Any repayment schedule can be used, as long as all of the taxes have been paid or all of the money is returned to your retirement account by the end of the third year period.

If you pay taxes on the withdrawal and return the money to your account later, there is also the option to file an amended tax return, as long as you put the money back into the same account by 2022. The best option, if you can manage it, is to put the money back into your retirement account as soon as possible, so your retirement savings has more time to grow. Eliminating the tax bill and re-building retirement savings is the best of all possible options, if your situation permits it.

If you lost your job or had a steep income reduction, it may be best to take the tax hit in the year that your income tax levels are lower. Let’s say your annual salary is $60,000, but you were furloughed in March and didn’t receive any salary for the rest of the year. It’s likely that you are in a lower income tax bracket. If you took $15,000 from your 401(k), you might need to pay a 12% tax rate, instead of the 22% you might owe in a higher income year.

Reference: U.S. News & World Report (April 23, 2021) “How to Avoid Taxes on Your CARES Act Retirement Withdrawal”

Do I Need to Pay Taxes on Life Insurance Proceeds?

Life insurance is designed to pay out a death benefit to your beneficiaries, if you die while the policy is in effect, usually in a lump sum. Fox 6’s recent article entitled “Is life insurance taxable?” explains that when large amounts of money change hands, taxes are usually a given. However, that’s not the case with most life insurance.

There are some special situations that may involve taxes, like inheriting a large estate or electing to receive policy benefits in installments. However, there are strategies you can leverage to avoid paying taxes on life insurance.

Beneficiaries don’t usually have to pay taxes on money received from a life insurance policy because the IRS doesn’t consider life insurance proceeds as taxable income. If you have an accelerated death benefit rider and need to access your own policy’s proceeds due to a terminal illness, that also won’t be taxed.

While you most likely won’t have to worry about taxes on a life insurance payout, there a couple of exceptions:

  • If all the policyholder’s assets meet the IRS’ federal estate tax threshold ($11.7 million in 2021), the policy’s proceeds could be taxable
  • If you elect to get the policy benefits in incremental installments instead of a one-time life insurance payout, you’ll have to pay taxes on any interest that accrues
  • If a person takes out a life insurance policy on someone other than himself – or herself, then policy’s benefits are considered a gift, and any monetary gifts above $15,000 are taxable; and
  • If the policyholder dies with an outstanding cash value loan, the policy’s death benefit could be used to settle it. Any amount the policyholder borrows beyond what they’ve paid into the policy is taxable.

These situations usually concern beneficiaries, but there are a few situations that could leave the policyholder responsible for taxes. In addition to taking out a policy loan, when you sell or surrender your policy and the cash value exceeds the amount you’ve contributed through premiums, the excess is taxable.

There are strategies for getting around this situation:

  • To avoid taxes, you can work with your life insurance company to legally transfer the policy to a new owner, such as the beneficiary so the policy’s proceeds aren’t included in the estate. However, this will place the responsibility for making premium payments and the ability to change the policy in the new owner’s hands.
  • An irrevocable life insurance trust or ILIT irreversibly transfers ownership of the policy to the trust, removing it from the taxable estate.
  • Installment payouts accrue interest and may be taxed, but a lump sum payment isn’t.

Talk to an experienced estate planning or elder law attorney about life insurance and how it can fit into your estate planning strategy.

Reference: Fox 6 (April 14, 2021) “Is life insurance taxable?”

Will Inheritance and Gift Taxes Change in 2021?

Uncertainty is driving many wealth transfers, with gifting taking the lead for many wealthy families, reports the article “No More Gift Tax Exemption?” from Financial Advisor. For families who have already used up a large amount or even all of their exemptions, there are other strategies to consider.

Making gifts outright or through a trust is still possible, even if an individual or couple used all of their gift and generation skipping transfer tax exemptions. Gifts and generation skipping transfer tax exemption amounts are indexed for inflation, increasing to $11.7 million in 2021 from $11.58 million in 2020. Individuals have $120,000 additional gift and generation-skipping transfer tax exemptions that can be used this year.

Annual exclusion gifts—individuals can make certain gifts up to $15,000 per recipient, and couples can give up to $30,000 per person. This does not count towards gift and estate tax exemptions.

Don’t forget about Grantor Retained Annuity Trust (GRAT) options. The GRAT is an irrevocable trust, where the grantor makes a gift of property to it, while retaining a right to an annual payment from the trust for a specific number of years. GRATS can also be used for concentrated positions and assets expected to appreciate that significantly reap a number of advantages.

A Sale to a Grantor Trust takes advantage of the differences between the income and transfer tax treatment of irrevocable trusts. The goal is to transfer anticipated appreciation of assets at a reduced gift tax cost. This may be timely for those who have funded a trust using their gift tax exemption, as this strategy usually requires funding of a trust before a sale.

Intra-family loans permit individuals to make loans to family members at lower rates than commercial lenders, without the loan being considered a gift. A family member can help another family member financially, without incurring additional gift tax. A bona fide creditor relationship, including interest payments, must be established.

It’s extremely important to work with a qualified estate planning attorney when implementing tax planning strategies, especially this year. Tax reform is on the horizon, but knowing exactly what the final changes will be, and whether they will be retroactive, is impossible to know. There are many additional techniques, from disclaimers, QTIPs and formula gifts, that an experienced estate planning attorney may consider when planning to protect a family legacy.

Reference: Financial Advisor (April 1, 2021) “No More Gift Tax Exemption?”

Does New COVID Relief Bill have an Impact on Seniors?

Money Talk News’ recent article entitled “6 Ways the New COVID-19 Relief Law Affects Retirees” provides a look at some of the changes retirees can expect from the new legislation.

  1. Stimulus payments for dependent adults. A first noticeable way in which the third round of stimulus payments is different from the first two is that dependents of all ages can qualify. Therefore, a household that supports a disabled senior will receive an additional $1,400 payment for that senior, if the household claims the person as a dependent on their federal income tax.
  2. Funding for ailing pension plans. The American Rescue Plan Act includes several terms concerning pension plans, one of which calls for the Treasury Department to transfer funds to the Pension Benefit Guaranty Corp. so that certain financially troubled multiemployer pensions can continue to pay out full benefits. That will help more than one million Americans. The PBGC operates insurance programs for single-employer and multiemployer pensions.
  3. Eligibility for the earned income credit for 2021. One of several changes the legislation made to the earned income tax credit — which is for working taxpayers with low to moderate incomes — is striking the maximum age of 64 for the 2021 tax year. As a result, seniors who work may be eligible to claim the earned income credit, when they file their taxes in 2022. The usual eligibility requirements for the credit require you to have at least one qualifying child or, if you don’t have a qualifying child, you must be between 25 and 65.
  4. Higher taxes for some gig workers. However, this COVID-19 relief law isn’t all good news for all taxpayers. Retirees (and anyone else) who earn some extra money with gig work might face more taxes in the future. This will help offset the cost of the American Rescue Plan Act, generating an estimated $8.4 billion in additional tax revenue for the federal government through fiscal year 2031. Companies with gig workers may report more payments than in the past, so the IRS will have a better idea of who is earning income from gig-economy jobs. This change may come as a surprise for some who’ve underreported income in the past.
  5. Tax relief for forgiven student loans. Under the Act, student loan debt that’s forgiven in 2021 through 2025 can be excluded from the debtor’s gross income. That will shield the canceled debt from federal taxation. Prior to this, such canceled debt generally was considered taxable income by the IRS. This will apply to student loan debtors of all ages. However, that group includes a growing number of retirees, as 20% of all student loan debt — around $290 billion — is owed by people age 50 and older, according to a 2019 AARP report. That’s five times more since 2004.
  6. New or expanded tax credits for health premiums. Retirees who aren’t yet 65 and as a result don’t have Medicare health insurance, might benefit from tax credits in the Act that help eligible individuals with two other types of health insurance. The law creates a refundable, advanceable tax credit for COBRA continuation coverage premiums. It is for people who are eligible for COBRA from when the Act was signed into law (March 11) and Sept. 30, 2021.

Reference: Money Talk News (March 16, 2021) “6 Ways the New COVID-19 Relief Law Affects Retirees”

What are Most Costly Mistakes with Social Security?

Motley Fool’s recent article entitled “5 Social Security Oversights That Could Cost You Thousands” says that these five Social Security mistakes could cost you thousands in your retirement.

  1. Claiming Social Security early while you’re still working. You can claim your Social Security retirement benefit as young as age 62, but your benefits will be permanently reduced when compared with the amount you would receive if you waited until your full retirement age. Social Security will also penalize you for continuing to work while collecting benefits, if you are younger than your full retirement age.
  2. Failing to claim Social Security by your 70th birthday. Once you hit age 62, your benefit increases the longer you wait to claim, until you reach 70. You don’t have to claim your benefit by your 70th birthday, but there is no more benefit for waiting at that point.
  3. Delaying past your full retirement age to claim Social Security spousal benefits. If you’re claiming Social Security benefits based on your own income record, it’s smart to wait past your full retirement age to start taking benefits. However, if you’re claiming based on your spouse’s benefits, there’s no benefit to delay beyond your full retirement age to claim. As a result, married couples of similar ages who have vastly different earned incomes have a dilemma: for you to claim spousal benefits, your spouse also has to have begun claiming benefits based on his or her own earnings record. This combination makes it less worthwhile for the primary breadwinner spouse to wait to collect benefits, if the spouse is expecting to take spousal benefits.
  4. Taxes on Social Security benefits are not adjusted for inflation. Originally, Social Security benefits weren’t taxed. However, in 1984, the government started taxing Social Security benefits once a person’s combined income reached $25,000. Even now, the income level where Social Security starts to get taxed is still at $25,000. Because there is no adjustment for inflation, this makes more of people’s Social Security income taxable. This easily costs even moderate-income retirees thousands of dollars of spendable income over the course of their retirements.
  5. “Tax free” income counts toward making Social Security taxable. Even traditionally tax-free sources of income, like the interest from in-state municipal bonds, is included in the calculations to see how much of your Social Security will be considered taxable. Therefore, seniors who own tax free municipal bonds as part of their retirement portfolio may be surprised to find that those bonds are what’s causing their Social Security to be taxed. Seniors who find themselves in that situation may want to reevaluate their choice to be invested in those tax-free municipal bonds.

Despite how simple Social Security may appear, these five situations show how mistakes can cost thousands of dollars.

Reference: Motley Fool (March 14, 2021) “5 Social Security Oversights That Could Cost You Thousands”

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