Michigan Estate Planning Blog

What Is the Primary Purpose of a Revocable Trust?

 

There are many basic tools of estate planning, which become more effective when they are coordinated and complement each other. For asset protection and tax planning, aligning strategies is critical for success, says a recent article from Kiplinger, “Revocable Trusts: The Most Common Trusts in Estate Planning.” The benefits of revocable trusts include letting the grantor—the person making the trust—have control of assets.

As the name implies, revocable trusts are more flexible than irrevocable trusts. The grantor of a revocable trust may change the terms of the trust whenever they wish, transfer property in and out of the trust, and change beneficiaries at will.

A revocable trust has many benefits. One benefit is that assets placed in a trust are not subject to probate when the estate is settled, keeping the terms of the trust and the nature of the assets private. A revocable trust allows for a step-up in basis, which can reduce or, in some cases, eliminate capital gains taxes.

The language of the trust provides instructions for managing and disposing of the assets upon the grantor’s death. A revocable trust can also be designed to protect assets for beneficiaries, set certain conditions for asset distribution, or require the funds to be used for specific costs, like education or home purchase.

There are some limitations to be aware of, which should be discussed with your estate planning attorney. If the goal is to protect assets for the grantor, an irrevocable trust is better. For example, if the grantor was involved in litigation and lost, a revocable trust’s assets could be recovered as part of the judgment. This is because the grantor still has control of the assets.

If the assets were in an irrevocable trust, the grantor would have no access to them, which adds a layer of protection.

The grantor needs to consider trading control of and access to assets for protection from court judgments and creditors.

You and your estate planning attorney should discuss which trust is better for your situation. A revocable trust is an excellent tool for estate planning, but an irrevocable trust provides more protection and can potentially shield assets from taxes.

Many people of modest means find that a revocable trust serves their interests well. In contrast, people with higher estate values find a combination of revocable and irrevocable trusts allows them to structure trusts to meet their goals.

Reference: Kiplinger (April 4, 2024) “Revocable Trusts: The Most Common Trusts in Estate Planning”

What Is a ‘Step-Up’ in Basis in Estate Planning?

Let’s say that you have a condominium in New York that’s currently being rented out, and you retired to Florida. You plan to sell the apartment within the next year or two, which is in your name, not your trust.

However, the question arises if you didn’t sell it and put it in trust, would the condo get the stepped-up basis if it were sold after we pass away, asks Market Watch’s recent article entitled, “Will our condo get a step-up in basis if we put it in trust?”

The answer is yes for revocable trusts and most irrevocable trusts.

Trusts can be beneficial for out-of-state property to avoid two probate processes upon the death of the owners, one in their state of residence and one where the out-of-state property is located. These are usually revocable trusts. Irrevocable trusts may be used for other purposes, such as asset protection.

The “step-up” in basis concerns the calculation of the capital gains on the sale of property. The capital gain is the difference between net proceeds on sale and the basis. The initial basis is the purchase price of the property. The cost of any improvements may be added to it.

So, for instance, if you paid $500,000 for your condominium and spent $100,000 replacing the kitchen, the basis would be $600,000. If you sold the apartment for $1 million, your capital gain would be $400,000.

The step-up in basis is another adjustment that occurs when an owner dies. At that time, the basis is adjusted to the date-of-death fair market value of the property. This is commonly called a “step-up” in basis because real-estate values typically increase over time, so the new basis is typically higher than the old one.

In the example, if the condo had a market value of $1 million upon the death of the owner, that would become the new basis. If the property were sold, any capital gain would be only an increase in value after death.

To receive a step-up in basis on a property upon the death of the owner, it must be in their taxable estate. All property in a revocable trust created by the decedent is in their taxable estate.

Whether an irrevocable trust is in the decedent’s taxable estate depends on how it’s drafted. Ask an experienced estate planning attorney to draft an irrevocable trust for estate inclusion and consequently a step-up in basis if that’s your goal.

Reference: Market Watch (April 7, 2023) “Will our condo get a step-up in basis if we put it in trust?”

 

New Considerations in Planning and the Stepped-Up Basis

New circumstances give rise to new abilities for estate planners. This, in turn, is creating some new and difficult choices. With the new ability to minimize estate taxation, known as “portability,” there is now a choice between the automatic portability plan and the old standby of the trust-based plan, notably the credit shelter trust plan. One important detail driving the choice is the “step up in basis,” as pointed out in a recent Forbes article titled “Portability Plans Vs Credit Shelter Plans Round 1: Step Up in Basis.” As you may know, the laws surrounding estate and wealth transfer planning underwent a tumultuous change with ATRA. Time was, we spent our planning sessions looking over our shoulder to see what the status of the estate tax was, but that is a gentler beast these days. Nevertheless, there are new competing concerns for which to plan. The old planning techniques aren’t necessarily less useful today, but our motivations may have changed. To learn more about the old tricks, there are a few related Forbes articles worth perusing: “Planning for Married Couples After ATRA: The Simple Portability Based Plan” and Part 2 thereto. So what’s the lesson on the step up in basis? A “step up in basis” is a somewhat subtle effect, but one that’s not to be overlooked. After all, the basis of an asset will determine the taxable value to your heirs, so to have the basis stepped up at various stages can only help cut the overall tax bill. Consequently, any plan that lets you do this can be useful. It’s not quite so simple but, depending upon the assets, simply using the “portability plan” can help realize the greatest tax savings and the original article runs through the scenarios to show you some hard math on how it works. Whether you have an old plan in place or if you’re just now looking to set up your estate plan, there are simply more considerations to be made these days and assessments like cost basis can make all the difference. It’s important to seek competent estate planning legal counsel to help chart the best course for your assets and the needs of your family.

Reference:

Forbes (April 8, 2014) “Portability Plans Vs Credit Shelter Plans Round 1: Step Up in Basis”

            Forbes (March 18, 2014) “Planning for Married Couples After ATRA -- Part I”

            Forbes (March 25, 2014) “Planning for Married Couples After ATRA -- Part 2”

For more information, see www.jerryreiflawyer.com

Easing The Tax Bite When Selling Your Business Saginaw, MI

Is any of your personal wealth tied up in your business? Well, for some people, the business is their current life, both in time and wealth. Consequently, it can be an especially rude shock to see so much of that wealth snatched away in taxes paid upon the sale of that business. The tax bite is a bit bigger these days, too. So, whatever you can do to shelter the business sale from taxation can mean a world of difference for your retirement and even for the whole family. Turns out there are more than a few important tools at your disposal. First, why is the tax bite bigger these days? The American Taxpayer Relief Act of 2012 (ATRA) befriended a new surtax added through Obamacare and this friendship brought the capital gains tax up from last year’s 15% to 20%, or even a whopping 23.8% for some earners. But wait, there’s more. An extra provision of ATRA is set to add yet another 1.2% as of the new year. Then add state taxes. It just adds up, and that is really bad math for you. So what are some tools and ways to lessen the tax bite? Depending on your business, your needs, and your timeline, consider three tested tools discussed in a recent Forbes article titled “Selling Your Business? 3 Ways To Cut The Tax Bite.” While you will want to read the original article, here are the three ways: • The ESOP Plan, • The Qualified Small Business Stock Plan, and • The C-to-S Corporation Conversion Plan. Essentially, the plan (as far as capital gains taxes) is to either find a way to defer the taxation until you leave assets to your heirs (to secure the capital gains eliminating stepped-up basis), to fall under a discounted category, or to actually change the form of the business so as to skate right below that low ceiling. There are a few more ways of doing any one or all of these steps cleanly and efficiently, especially with those with the foresight to plan well in advance.

Reference: Forbes (September 6, 2013) “Selling Your Business? 3 Ways To Cut The Tax Bite”

For more information, see www.jerryreiflawyer.com

 

 

Some Surprising “Winners” in Fiscal Cliff Deal Saginaw, Michigan

They say a true compromise is when everyone walks away a little unhappy. If that’s true, then the American Taxpayer Relief Act passed by Congress and touted as narrowly avoiding a Fiscal Cliff, was the truest of compromises. While no one got everything they wanted, there are some surprising winners in the deal. Business writer Kent Hoover of the Business Journal (Minneapolis-St. Paul) outlined his take on The 5 Winners of the Fiscal Business Awards: • Small Business. Most small businesses avoided higher taxes when the threshold for increases was set at $450,000 instead of $250,000. Small business owners also should benefit from the $5.12 million estate tax exemption ($10.24 for a married couple), especially with the annual inflation adjustment. Finally, small business owners can immediately expense up to $500,000 in capital expenditures (such as new equipment), instead of having to claim depreciation over time. (Without the deal, the Section 179 annual expensing limit would have fallen to $25,000.) • Physicians. Popularly known as the “doc fix,” Congress blocked a scheduled 26.5 percent decrease in Medicare reimbursements to doctors. (Beware, though, this block is only temporary, and doctors could face a decrease in 2014.) • Manufacturers and Technology Companies. Many of these companies will take advantage of the research and development tax credit, which provides incentives for companies to do R&D in the U.S. • Utilities. Congress kept the capital gains and dividends rate at 15 percent for households earning below $450,000 (20 percent for households above that threshold). This is in contrast to taxation at ordinary income tax rates as high as 39.6 percent for wealthy Americans. According to Hoover, “That would have been bad news for companies, notably utilities, that offer dividends in order to attract investors and raise capital. The steady income that dividends provide loses its attractiveness when it's taxed at such a high rate.” • Wind energy, Hollywood and NASCAR. What would any tax code be without special-interests? This deal is no different. The wind energy industry gets a production tax credit for projects that begin construction this year. Hollywood studios get tax breaks for doing their television and film production in the U.S. And NASCAR fans – for some reason Congress saw fit to extend a tax break for "motorsports racing track facilities." For a look at some of the other industry-specific tax breaks, hop on over to The Wall Street Journal blog, “From NASCAR to rum, the 10 weirdest parts of the ‘fiscal cliff’ bill.”

Reference: Minneapolis-St. Paul Business Journal (January 3, 2013,) “The 5 winners of the Fiscal Cliff Business Awards are ...

For more information, go to www.jerryreiflawyer.com