Ask the Experts – April 11

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client transferred his life insurance policy to an ILIT to avoid having the death benefit included in his gross estate. I’ve heard that if he dies within three years from the transfer, the death benefit will be brought back into his estate. Is this correct? Does the fact that he paid a gift tax based on the cash value affect the amount he would owe for estate tax purposes?

Answer: Yes, under Section 2035, the entire death benefit will be included in your client’s gross estate if he dies within three years from the date of the transfer to the ILIT. However, the fact that your client paid a gift tax (or used a portion of his unified credit to pay the tax) would lower the amount he owes for estate taxes.

For example, let’s say your client has given away enough money that he’s already used up his $5.34 million lifetime exclusion amount (as of 2014). Also suppose he owns a life insurance policy with a cash value of $600,000 and a death benefit of $1 million. If he transfers the policy to his ILIT in 2014, he will incur a $240,000 (40% of $600,000) gift tax in 2014. If he survives for three more years, the entire $1 million death benefit will be excluded from his gross estate.

On the other hand, let’s say he dies within three years from the transfer. Section 2035 brings the full value of the death benefit back into his gross estate, and ordinarily the $1 million death benefit would incur a $400,000 estate tax (40% of $1 million); however, your client would get credit for the $240,000 gift tax he has already paid, resulting in an estate tax of $160,000 ($400,000 less $240,000).

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Ask the Experts – February 27

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers. Here’s the question of the day.

Question: A client’s husband died in 2011 leaving his entire estate to her. His estate was small enough that no estate tax return was filed. Does the deceased husband’s unused estate tax exclusion amount automatically transfer to his surviving spouse? If not, is it too late to elect to have it transfer?

Answer: The deceased spouse’s unused exclusion amount (or “DSUE amount”) doesn’t transfer to his surviving spouse automatically—she must file an estate tax return (Form 706) on behalf of the deceased spouse’s estate. However, she should still have until the end of 2014 to make the portability election.

Portability is an estate planning option that allows a deceased spouse to transfer his unused estate tax applicable exclusion amount ($5.34 million in 2014, indexed for inflation) to his surviving spouse.

For example, if your client’s husband died in 2011 without having used any of his $5 million exclusion amount, his wife can add her husband’s full $5 million unused exclusion amount to her own current $5.34 million exclusion amount. Therefore, when the wife dies, she can pass up to $10.34 million.

Generally, to make the portability election, an estate tax return must be filed within 9 months from the deceased spouse’s date of death. Since no estate tax return was filed on behalf of her deceased spouse’s estate, she missed the 9-month window.

Ordinarily, your client would be out of luck, but the IRS recently issued Revenue Procedure 2014-18, extending the 9-month deadline for spouses who died in 2011, 2012 or 2013 and who were not required to file a federal estate tax return—qualifications your client probably meets.

Therefore, for taxpayer in the same position as your client, instead of the 9-month deadline, the deceased spouse’s estate has until the end of 2014 to file Form 706. For a spouse who died this year (or who dies thereafter), the ordinary 9-month rule still applies.

For those filing Form 706 late pursuant to Revenue Procedure 2014-18, the following language must be included at the top of the form in capital letters:

FILED PURSUANT TO REV. PROC. 2014-18 TO ELECT PORTABILITY UNDER § 2010(c)(5)(A).

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Question of the Day – August 13

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: I have a client who is doing estate planning. The client has net assets worth $10 million, with a farm making up $9 million of net worth. If the farm is left to charity, is its value included in the client’s estate for federal estate tax purposes?

Answer: A taxpayer’s gross estate consists of the fair market value of all assets in which the client has an ownership interest at death.

To arrive at the value of a decedent’s taxable estate, certain deductions are permitted against the value of the gross estate, including:

The client’s share of debt against assets included in the gross estate
Certain final expenses
Certain expenses associated with settling the estate
The value of qualified charitable gifts

In the example, the gross estate would include all the value of the client’s assets–$10 million. The estate would be entitled to a deduction of the amount left to a qualified charity–$9 million in the example. That would make the taxable estate $1 million.

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Question of the Day – May 8

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers. Here’s the question of the day.

Question: My client’s attorney has recommended that she and her husband do generation skipping tax (GST) planning. What is GST planning?

Answer: The GST is an extra tax imposed—in addition to possible gift or estate tax—when there’s a transfer to grandchildren or to a family generation more remote than children. The current GST rate is 35%.

Why does the GST exist? It fills the tax avoidance loophole that might otherwise exist in federal or gift tax situations.

Here’s an example that helps illustrate the point. Say that Grandpa Munster is planning his estate. Due to his old age and his careful investment planning, he has accumulated an estate worth $10 million.

Under some circumstances, Grandpa might be expected to leave his estate to his son Herman. However, Grandpa is convinced that Herman and his wife Lilly do not need the inheritance, as they are self-sufficient. Grandpa would like to leave his estate in trust to his grandson Eddie instead.

If there were no GST, at Grandpa’s death, Eddie would inherit the estate with about a $1.6 million reduction for estate taxes based on the $5.12 million 2012 exemption and tax rate of 35% on the excess.

What’s wrong with that?

From the government’s perspective, under Grandpa’s estate plan the opportunity to collect estate tax at Herman’s generation was missed. Grandpa “skipped” one generation of the estate tax through his by-pass of Herman’s generation.

To close that potential loophole, the generation-skipping tax (GST) was created. With the GST, the federal government collects estate tax plus generation skipping tax if Grandpa’s estate plan skips Herman in favor of Eddie. Since the current generation-skipping tax rate is the same 35% rate as the federal estate tax rate, the government has removed all the tax incentive for the older generation to transfer wealth directly to grandchildren and great-grandchildren.

GST planning usually involves using the GST exemption–$5.12 million in 2012—to shelter amounts set aside for grandkids from the GST tax.

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Question of the Day – December 20

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Here’s the question of the day.

Question: My client owns a working farm, which is also a prime parcel of real estate for residential development. How would the farm be valued for federal estate tax purposes?

Answer: Most assets are valued at their fair market value, which means that it’s the price a willing buyer would pay a willing seller.

Section 2032A of the Revenue Code provides that the administrator of an estate can elect a special use valuation for a farm under certain circumstance. That means the land can be valued as a working farm—often yielding a low value—rather than as a potential parcel for development, which would produce a higher value for estate tax purposes.

Here are the requirements for making the Section 2032A election:

1. On the date of the decedent’s death, the property must be in use as a farm or in a trade or business other than farming.

2. The net value of the property must equal at least 50% of the decedent’s gross estate.

3. At least 25% of the gross estate (less debts and unpaid mortgages on all property in the gross estate) must be qualified farm or closely held business real property.

4. The property must pass to a member of the decedent’s immediate family.

5. The real property must have been owned by the decedent or a member of his family and used as a farm or in a closely held business for an aggregate of five years or more of the eight year period ending on the date of the decedent’s death.

The maximum reduction of the decedent’s gross estate under this provision is $1,000,000, indexed for inflation. The indexed amount for 2011 is $1,020,000.

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Question of the Day – September 27

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client recently passed away. The client was receiving payments under a period certain immediate annuity. Is the annuity included in the client’s estate for estate tax purposes?

Answer: Yes.

If an immediate annuity contains a refund or period certain feature, the post-death payments are includable in the gross estate for federal estate tax purposes under Revenue Code Section 2033 if payable to the estate, or Revenue Code Section 2039 if payable to a named beneficiary. Where the death benefit is payable as periodic payments over some time period, the present value of the remaining payments is included. Present value is determined by reference to IRS regulations and applying its relevant discount rate.

The same Revenue Code Sections reach the annuity death benefit paid when death occurs prior to annuity starting date. Where the death benefit is paid in a lump-sum, that figure is included in the gross estate.

In case of a joint and survivor annuity purchased with the decedent’s premium payment, the value included in the gross estate will be an amount equal to the premium an insurance company would charge on the date of death for an identical single life annuity on the survivor. Of course, remaining payments to a surviving spouse might qualify for the unlimited marital deduction.

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Question of the Day – September 2

Today’s question is answered by John Lensi, VP of Sales at Impact Technologies Group based out of Charlotte, North Carolina.

Question: “What should I tell my customers about estate taxes now?”

Answer: Don’t wait, act now!

There are a lot of diverse opinions on what the future has in store for estate & wealth transfer taxes on the federal and state level. Recent history has told us legislators are unpredictable and with a major election year in 2012, any ‘permanency’ with estate tax legislation in my opinion is not in the near future. I’m anticipating an eventual a 1-year extension to the current estate tax law before congress ever gets serious about doing anything on a longer-term basis. Congress has too many other pressing issues to deal with than estate tax legislation and recent history has demonstrated they have difficulty agreeing on anything anyway.

High net worth clients can’t continue to sit around and wait for congress to enact a more ‘permanent’ legislation before planning their wealth transfer. My advice would be building in flexibility into client estate plans so adjustments when and if needed can be made going forward. Establish plans based on today’s legislation and work with a competent advanced sales attorney who will make the appropriate changes when the time comes. Death can occur anytime, so waiting until the ‘right time’ can be a foolish ‘plan’ in itself. Besides, if new life insurance is needed as part of the wealth transfer plan, delaying only increases the cost of the insurance (solution) and often, because of health and other underwriting reasons, prevents a HNW client from qualifying.