Asset Protection/Wealth Preservation, Tax And Estate Planning: 2020 Year End Notes12/02/2020 | By: Asher Rubinstein, Esq.
As this unprecedented year comes to a close, we offer some planning tips to our clients, colleagues and friends of the firm regarding their assets, tax and estate concerns. Foremost, there are some time-sensitive ways to save taxes that could result in much more money for your family.
I. The current exemption from federal gift and estate tax is at an all-time high ($11.6 million per person), which you should utilize now, before the favorable opportunity is lost. This is a way to get more to your heirs, less to the IRS, relatively easily.
- This exemption is scheduled to “sunset” in 2025, although Joe Biden campaigned to reduce the estate exemption to $3.5 million, and the gift tax exemption to $1 million, as soon as 2021. In addition, the gift and estate tax rate could increase to 45%. Any changes to the law could be retroactive to January 1, 2021.
- The IRS has stated that it will not “claw back” gifts made today, if the exemption is reduced in the future.
- This is a “use it or lose opportunity”. The exemptions have never been higher. Once the law changes, you will be limited to a much lower exemption from gift and estate tax.
- Example: You own a family business worth $10 million. You gift it to your daughter in 2020. No gift tax is due. Instead, you gift it in 2021. Assuming a $1 million exemption and a gift tax rate of 45%, you would owe $4,050,000 in gift tax: $10 million gift - $1 million exemption = $9 million x 45% tax = $4,050,000 in tax due. Same business, same gift, new year, $4 million to the IRS.
- If you’ve already gifted assets up to $5 million, you can now gift $6 million more, tax-free.
- Consider making such gifts in trust, which could provide tax benefits, family governance and asset protection from creditors.
- If you own a family limited partnership (FLP) or LLC, you can use discounted gifting to leverage even more than $11.6 million out of your taxable estate. Like calls to lower the gift and estate tax exemptions, politicians looking for revenue have also called for repealing the discounts on closely held entities like LLCs and FLPs. The strategy is currently available, legal and effective.
- We have additional strategies to get assets to the next generation with fewer taxes: Grantor Retained Annuity Trusts (GRATs), Qualified Personal Residence Trusts (QPRTs), Charitable Remainder Trusts (CRUTs), Dynasty Trusts and others. These trusts can be used for estate tax minimization, capital gains tax minimization, family management and asset protection. Please see our article, here.
Other strategies to consider now before taxes could go up in 2021:
- Accelerate income (e.g., bonuses, exercise stock options) in 2020.
- The Coronavirus Aid, Relief and Economic Security Act of 2020 allows a deduction of up to 100% of adjusted gross income (AGI) (up from 60%) for cash contributions to qualified charities.
- Politicians have also warned that capital gains tax could potentially double. It may be possible for someone to pay more than 50% tax on capital gains: 39.6% federal income tax rate + 3.8% net investment income tax (under the Affordable Care Act) + 0.9% additional Medicare tax (Affordable Care Act) + 8.82% New York State rate = 53.12% !
Consider a Charitable Remainder Trust. Contributing appreciated assets, such as stock, family businesses and real estate to a Charitable Remainder Trust is a good way to avoid capital gains tax. The Charitable Remainder Trust is tax-exempt. It may sell assets free of tax and invest the proceeds tax-free. You can enjoy distributions from the trust at very low tax-favored rates, and at the end of the trust term, the remainder will go to a qualified charity. You will receive a tax deduction equal to the present value of the remainder that will be left to charity. The benefits: tax free growth of trust assets, a low-tax income stream for you and your beneficiaries, philanthropy of your choice, a charitable deduction and significant capital gains tax minimization. Benefits can be further enhanced by creating a tax-exempt family foundation to serve as the qualified charity receiving the remainder from the charitable trust.
In addition to lowering estate taxes and getting more to your heirs and less to the IRS, proper tax and estate planning also provides the following benefits:
- Family governance and centralization of family assets
- Legacy and succession planning (including family business and personal assets)
- Income to beneficiaries
- Specific family concerns and special needs children
- Charitable considerations
- Locking in “basis” for appreciated assets in uncertain fiscal times. This is especially important because Biden also campaigned on eliminating the “step up” in basis on appreciated assets. This would mean that your heirs would either pay tax on unearned appreciation, or would inherit your basis, resulting in a large capital gains tax when your heirs sell.
- Gift tax planning
- Asset protection and wealth preservation
- Estate tax minimization on the state level.
II. Is Your Planning Up to Date, In Light of Coronavirus and Other Challenges?
A. Do you have the proper health care documents in place, in case you are ill?
The COVID pandemic has necessitated new terms to living wills and health care proxies, including:
(1) distinguishing between a ventilator to help a patient battle Coronavirus, versus life support, and (2) authorization to communicate with medical professionals via Zoom, FaceTime, etc.
B. Have you updated your trust(s) and will?
Year-end is a good time to reflect upon your estate wishes, whether they are current and whether your survivors will be able to inherit efficiently and privately. To this end, we offer the following questions to guide you:
- Do you have a revocable living trust for your successor to quickly take over managing your assets without court intervention?
- Are your appointments (executors, trustees, guardians, etc.) up to date?
- Have there been any significant life changes, such as births, deaths, marriages, etc.?
- Have your assets/net worth changed significantly, for better or worse?
- Have you sold your business, taken on investors, reached a vesting event?
- Has there been a change in your marital status or the marital status of your child(ren) or other beneficiaries?
- Have you become involved in a new business venture, LLC, partnership or investment (which might also give rise to asset protection issues)?
- Have you addressed your survivors inheriting your retirement accounts, in light of the new rules applicable to beneficiaries who inherit retirement accounts?
- Have you moved to a new state?
- Because of the gap between the federal and state estate tax exemptions, it is important to revisit trust documents because funding trusts with a dollar amount greater than a state exemption amount (e.g., to the maximum federal exemption) could trigger additional state estate tax. We have assisted clients with this issue in light of recent tax law changes.
C. If you have received any PPP monies, are you compliant?
D. If you are a landlord or a tenant, have you looked into renegotiating your lease(s)?
E. Have you moved recently, or are you working from home?
The pandemic has resulted in many people leaving metropolitan areas and high-tax jurisdictions and no longer commuting to offices. Be prepared for a residency tax audit. High-tax jurisdictions are known to challenge claims that taxpayers have severed ties and are living and working in low-tax jurisdictions.
New York City and New York State are particularly aggressive in auditing the tax returns of people who claim to have moved to a different state. In an audit, it will be up to the taxpayer to prove that he or she no longer has a tax nexus to the former state. Simply buying property in a new state is not enough. There are many factors that are used to establish tax residency. In a 2018 lawsuit, a taxpayer was found to still have a New York residence even though the taxpayer spent more than 183 days at his condo in Florida.
We can assist you in implementing a plan to support your new residency and break from your high tax state. We can also defend you in an audit from the state that is challenging your new residency and seeks to continue to tax you.
III. Asset Protection Concerns
Courts have been closed or working at a reduced schedule for much of 2020, but people and businesses are still suing each other. Are your personal and business assets protected from creditor threats?
We continue to utilize entities such as trusts, family limited partnerships (FLPs) and limited liability companies (LLCs), along with the laws of favorable jurisdictions, in order to protect our clients’ hard-earned assets from creditor threats and litigation.
The asset protection laws of offshore jurisdictions continue to interest both US and foreign clients. In 2020, we continued to establish offshore asset protection trusts, including for clients in Hong Kong and China who sought safe and stable jurisdictions at a time of increasing political, social and economic uncertainties in their home country.
Closer to home, the level of interest in offshore asset protection by our US clients peaks during each presidential election cycle and financial downturn, following rising doubts about government, banks and Wall Street. Our US clients have utilized offshore trusts for diversification, and as a hedge against political instability and economic uncertainty. During 2020, we have assisted clients in the US, Asia and throughout the world in achieving asset protection in jurisdictions that offer economic and political stability and strong banking laws.
We also note that in 2020, Connecticut became the twentieth US state to implement domestic asset protection trust (DAPT) laws. This follows similar legislation, including a 2017 Connecticut law that provides LLC members with stronger protections from creditors, including disallowing foreclosures on LLC interests and preserving charging orders as the exclusive remedy of creditors, as well as extending the benefit to single-member LLCs. Businesspeople are drawn to Delaware for its favorable corporate law and business-friendly courts. Asset protection clients consider Nevada, Wyoming and Delaware for their FLP and LLC formations. Connecticut is an increasingly interesting option.
There are multiple asset protections issues, from the effectiveness of single-member LLCs to the vulnerabilities of domestic asset protection trusts. Contact us for assistance.
IV. IRS Offshore Reporting Requirements
We remind clients of IRS reporting requirements for foreign assets:
For offshore financial accounts: the “FBAR” Form (FinCEN Form 114) and IRS Form 8938. Foreign life insurance and annuity policies are also reportable. Be sure to “check the box” on IRS Form 1040, Schedule B if you own or control a foreign account.
For foreign trusts, US grantors or beneficiaries of a foreign trust, or US recipients of a foreign gift: IRS Forms 3520 and 3520-A. The FBAR may also be due for US grantors and beneficiaries of foreign trusts.
For foreign corporations and LLCs: IRS Form 5471 and Form 8938.
Foreign retirement plans and mutual funds can be particularly complex. IRS Form 8621 and other reporting may apply.
Be sure to properly report all foreign income (including interest, dividends, capital gains, rents, royalties, etc.).
In addition, the IRS recently issued new rules by which domestic (US) LLCs owned by foreign individuals or trusts must obtain an IRS tax identification number and file an annual return (Form 5472) reporting the identity and foreign address of the non-US owner(s) and transactions between the non-US owner(s) and the LLC. The new rules challenge the use by foreign buyers of “anonymous” US LLCs to own expensive US real estate. The new regime also facilitates reporting from the IRS to the tax authorities of other countries.
We continue to represent US taxpayers who directly own or benefit from foreign assets. We can advise you on proper tax compliance and represent you before the IRS.
V. Reminder to Properly Maintain Your FLP/LLC
We take this opportunity to remind our clients that the proper maintenance of an FLP and LLC, and the respect of the FLP/LLC as a distinct legal entity, are crucial for both effective asset protection and estate tax planning. FLP and LLC clients must be aware of the following:
· Open and maintain a separate bank account for each entity. Do not put non-FLP/LLC assets into the FLP/LLC account.
· Do not commingle FLP/LLC and personal assets.
· Keep proper FLP/LLC books and records.
· Have an annual meeting of general and limited partners (and LLC members), review FLP/LLC business and accounts, and keep minutes of the meeting and resolutions approved during the meeting.
· Properly “paper” FLP/LLC transactions such as loans, sales, distributions, additional capital contributions, etc.
· Do not use FLP/LLC assets to pay for personal expenses. Do not treat the entity as a personal “piggy bank”. Keep a personal checking account outside the FLP/LLC and use it to pay personal expenses. Keep sufficient assets outside of the entity to pay for personal and living expenses.
· Make sure distributions are proper according to the entity’s governing documents (e.g., distributions are pro rata to all parties).
· Maintain proper capital accounts for each partner/member.
· Issue appropriate IRS Forms K-1 and file IRS Form 1065 and all other applicable tax returns (including state tax returns), each year.
· If individuals contributed notes in return for partnership/membership interests, then the requirements of the notes must be met; make regular interest payments and record them properly on the entity’s books and ledgers.
· Timely renew your FLP/LLC with the Secretary of State, annually. Pay any taxes and fees. Also renew your local agent.
· Obtain insurance in the name of the entity. This is particularly important if real estate has been transferred to an FLP or LLC.
· Have you designated a “tax matters” partner/member?
VI. Final Note to NYC Landlords and Real Estate Clients: New NY Landlord / Tenant Laws Are Decidedly Anti-Landlord and Necessitate Asset Protection
In 2019, the New York State Legislature enacted tenant protection legislation that significantly changed New York’s landlord-tenant and rent laws. The Housing Stability and Tenant Protection Act of 2019 (S. 6458 and A. 8281), imposes significant new hurdles and requirements upon landlords and property owners. The law has been called the most pro-tenant legislation in decades. This law, combined with the Coronavirus pandemic, presents the most significant challenges to landlords in decades.
While the real estate lawyers at Gallet Dreyer & Berkey, LLP can advise you on the new laws, our asset protection attorneys can advise and implement an asset protection plan for your personal and business assets to allow you to best withstand the impact of these laws and the lawsuits to come.
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We wish our clients and other readers a safe and healthy holiday season, and we look forward to a better 2021. We remain ready to assist you.
This memorandum is informational and general, does not constitute legal advice or tax advice, and should not be construed as tax advice or legal opinion specific to your situation. For legal advice specific to your situation, please contact us.