NEWS

Fewer people currently are subject to transfer taxes than ever before. But gift, estate and generation-skipping transfer (GST) taxes continue to place a burden on families with significant amounts of wealth tied up in illiquid closely held businesses, including farms.

Fortunately, Internal Revenue Code Section 6166 provides some relief, allowing the estates of family business owners to defer estate taxes and pay them in installments if certain requirements are met.

Sec. 6166 benefits

For families with substantial closely held business interests, an election to defer estate taxes under Sec. 6166 can help them avoid having to sell business assets to pay estate taxes. It allows an estate to pay interest only (at modest rates) for four years and then to stretch out estate tax payments over 10 years in equal annual installments. The goal is to enable the estate to pay the taxes out of business earnings or otherwise to buy enough time to raise the necessary funds without disrupting business operations.

Be aware that deferral isn’t available for the entire estate tax liability. Rather, it’s limited to the amount of tax attributable to qualifying closely held business interests.

Sec. 6166 requirements

Estate tax deferral is available if 1) the deceased was a U.S. citizen or resident who owned a closely held business at the time of his or her death, 2) the value of the deceased’s interest in the business exceeds 35% of his or her adjusted gross estate, and 3) the estate’s executor or other personal representative makes a Sec. 6166 election on a timely filed estate tax return.

To qualify as a “closely held business,” an entity must conduct an active trade or business at the time of the deceased’s death (and only assets used to conduct that trade or business count for purposes of the 35% threshold). Merely managing investment assets isn’t enough.

In addition, a closely held business must be structured as:

• A sole proprietorship,
• A partnership (including certain limited liability companies taxed as partnerships), provided either 1) 20% or more of the entity’s total capital interest is included in the deceased’s estate, or 2) the entity has a maximum of 45 partners, or
• A corporation, provided either 1) 20% or more of the corporation’s voting stock is included in the deceased’s estate, or 2) the corporation has a maximum of 45 shareholders.

Several special rules make it easier to satisfy Sec. 6166’s requirements. For example, if an estate holds interests in multiple closely held businesses, and owns at least 20% of each business, it may combine them and treat them as a single closely held business for purposes of the 35% threshold. In addition, the section treats stock and partnership interests held by certain family members as owned by the deceased.

On the other hand, the interests owned by corporations, partnerships, estates and trusts are attributed to the underlying shareholders, partners or beneficiaries. This can make it harder to stay under the 45-partner/shareholder limit.

Contact us with questions.

© 2019

A common estate planning mistake that people make is to own property jointly with an adult child or other family member. True, adding a loved one to the title of your home, bank account or other property can be a simple technique for leaving property to that person without the need for probate. But any convenience gained is usually outweighed by a variety of negative consequences. Here are four:

1. Higher gift and estate taxes. Depending on the size of your estate, joint ownership may trigger gift and estate taxes. When you add a family member’s name to an asset’s title as joint owner, for example, it’s considered a taxable gift of half the asset’s value. And your interest in the asset — including any future appreciation — remains in your taxable estate. These taxes usually can be minimized or even eliminated by transferring the asset to an irrevocable trust.

2. Higher income taxes. Generally, property transferred at death receives a stepped-up basis, allowing your heirs to sell it without incurring capital gains tax liability. But if you add an heir to the property’s title as joint owner, only your interest in the property will enjoy this benefit. Any appreciation in the value of your heir’s interests between the date he or she is added to the title and the date of your death is subject to capital gains tax.

3. Exposure to creditors’ claims. Unlike property transferred to a properly designed trust, jointly held property may be exposed to claims by the joint owner’s creditors (and also claims from a former spouse).

4. Loss of control. A joint owner has the right to sell his or her interest to an outside buyer without your consent and the buyer may be able to go to court to force a sale of the property. In addition, when you die, the entire property will go to the surviving owner(s), regardless of the terms of your will or other estate planning documents.

If you currently jointly own property with a family member, contact us. We can suggest alternative estate planning techniques to ease any gift, estate and income tax liability, and limit your exposure to creditors’ claims.

© 2019

When you retire, you may consider moving to another state — say, for the weather or to be closer to your loved ones. Don’t forget to factor state and local taxes into the equation. Establishing residency for state tax purposes may be more complicated than it initially appears to be.

Identify all applicable taxes

It may seem like a no-brainer to simply move to a state with no personal income tax. But, to make a good decision, you must consider all taxes that can potentially apply to a state resident. In addition to income taxes, these may include property taxes, sales taxes and estate taxes.

If the states you’re considering have an income tax, look at what types of income they tax. Some states, for example, don’t tax wages but do tax interest and dividends. And some states offer tax breaks for pension payments, retirement plan distributions and Social Security payments.

Watch out for state estate tax

The federal estate tax currently doesn’t apply to many people. For 2019, the federal estate tax exemption is $11.4 million ($22.8 million for a married couple). But some states levy estate tax with a much lower exemption and some states may also have an inheritance tax in addition to (or in lieu of) an estate tax.

Establish domicile

If you make a permanent move to a new state and want to escape taxes in the state you came from, it’s important to establish legal domicile in the new location. The definition of legal domicile varies from state to state. In general, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere.

Each state has its own rules regarding domicile. You don’t want to wind up in a worst-case scenario: Two states could claim you owe state income taxes if you established domicile in the new state but didn’t successfully terminate domicile in the old one. Additionally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that your estate owes income taxes and any state estate tax.

How do you establish domicile in a new state? The more time that elapses after you change states and the more steps you take to establish domicile in the new state, the harder it will be for your old state to claim that you’re still domiciled there for tax purposes. Some ways to help lock in domicile in a new state are to:

• Buy or lease a home in the new state and sell your home in the old state (or rent it out at market rates to an unrelated party),
• Change your mailing address at the post office,
• Change your address on passports, insurance policies, will or living trust documents, and other important documents,
• Register to vote, get a driver’s license and register your vehicle in the new state, and
• Open and use bank accounts in the new state and close accounts in the old one.

If an income tax return is required in the new state, file a resident return. File a nonresident return or no return (whichever is appropriate) in the old state. We can help with these returns.

Make an informed choice

Before deciding where you want to live in retirement, do some research and contact us. We can help you avoid unpleasant tax surprises.

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People who live in states with high income taxes sometimes relocate to a state with a more favorable tax climate. A similar strategy can be available for trusts. If a trust is subject to high state income taxes, you may be able to change its residence — or “situs” — to a state with low or no income taxes.

What can a “trust-friendly” state offer?

In addition to offering low (or no) tax on trust income, some states:

• Authorize domestic asset protection trusts, which provide added protection against creditors’ claims,
• Permit silent trusts, under which beneficiaries need not be notified of their interests,
• Allow perpetual trusts, enabling grantors to establish “dynasty” trusts that benefit many generations to come,
• Have directed trust statutes, which make it possible to appoint an advisor or committee to direct the trustee with regard to certain matters, or
• Offer greater flexibility to draft trust provisions that delineate the trustee’s powers and duties.

If another state’s laws would be more favorable than your own state’s, you might benefit from moving a trust to that state — or setting up a new trust there.

Take states’ laws into consideration

It’s important to review both states’ laws for determining a trust’s “residence” for tax and other purposes. Typically, states make this determination based on factors such as:

• The grantor’s home state,
• The location of the trust’s assets,
• The state where the trust is administered (that is, where the trustees reside or the trust’s records are kept), and
• The states where the trust’s beneficiaries reside.

Keep in mind that some states tax income derived from in-state sources even if earned by an out-of-state trust.

Making the right move

To enjoy the advantages of a trust-friendly state, establish the trust in that state and take steps to ensure that your choice of residence is respected (such as naming a trustee in the state and keeping the trust’s assets and records there). It may also be possible to move an existing trust from one state to another.

We can assist you in determining if setting up trusts in another state would help you achieve your estate planning goals.

© 2019

Have you made substantial gifts of wealth to family members? Or are you the executor of the estate of a loved one who died recently? If so, you need to know whether you must file a gift or estate tax return.

Filing a gift tax return

Generally, a federal gift tax return (Form 709) is required if you make gifts to or for someone during the year (with certain exceptions, such as gifts to U.S. citizen spouses) that exceed the annual gift tax exclusion ($15,000 for 2018 and 2019); there’s a separate exclusion for gifts to a noncitizen spouse ($152,000 for 2018 and $155,000 for 2019).

Also, if you make gifts of future interests, even if they’re less than the annual exclusion amount, a gift tax return is required. Finally, if you split gifts with your spouse, regardless of amount, you must file a gift tax return.

The return is due by April 15 of the year after you make the gift, so the deadline for 2018 gifts is coming up soon. But the deadline can be extended to October 15.

Being required to file a form doesn’t necessarily mean you owe gift tax. You’ll owe tax only if you’ve already exhausted your lifetime gift and estate tax exemption ($11.18 million for 2018 and $11.40 million for 2019).

Filing an estate tax return

If required, a federal estate tax return (Form 706) is due nine months after the date of death. Executors can seek an extension of the filing deadline, an extension of the time to pay, or both, by filing Form 4768. Keep in mind that the form provides for an automatic six-month extension of the filing deadline, but that extending the time to pay (up to one year at a time) is at the IRS’s discretion. Executors can file additional requests to extend the filing deadline “for cause” or to obtain additional one-year extensions of time to pay.

Generally, Form 706 is required only if the deceased’s gross estate plus adjusted taxable gifts exceeds the exemption. But a return is required even if there’s no estate tax liability after taking all applicable deductions and credits.

Even if an estate tax return isn’t required, executors may need to file one to preserve a surviving spouse’s portability election. Portability allows a surviving spouse to take advantage of a deceased spouse’s unused estate tax exemption amount, but it’s not automatic. To take advantage of portability, the deceased’s executor must make an election on a timely filed estate tax return that computes the unused exemption amount.

Preparing an estate tax return can be a time consuming, costly undertaking, so executors should analyze the relative costs and benefits of a portability election. Generally, filing an estate tax return is advisable only if there’s a reasonable probability that the surviving spouse will exhaust his or her own exemption amount.

Seek professional help

Estate tax rules and regulations can be complicated. If you need help determining whether a gift or estate tax return needs to be filed, contact us.

© 2019