Planning your next will and testament

Would you recognize the person who signed your will?

If you haven’t heard from your estate planning advisors lately, you soon may. In 2025, the amount exempt from federal estate taxes will grow to $13.99 million. For a married couple, should they both die in 2025, $27.98 million may be sheltered from estate taxes. However, under current law that amount falls roughly in half in 2026. Some politicians are advocating for an even lower exempt amount, or a higher tax rate. On the other hand, there is some support for eliminating the federal estate tax entirely. It’s tough for any estate plan to be optimal for all tax environments.

Surprised heirs
A recent item in The Wall Street Journal noted the growing phenomenon of childless older adults [“People Without Kids Are Leaving Money to Surprised Heirs,” October 2, 2024]. According to the Pew Research Center, 20% of U.S. adults never had children. In the absence of descendants, more distant relatives, as well as friends, become potential surprise heirs. A study at Yale determined that people without descendants give an average of 10% of their estates to charity—the overall average is closer to 3%. Charities have taken notice. Caring for pets after death can be a vexing issue for childless adults. The advent of pet trusts may resolve the problem, though laws on pet trusts vary from state to state. Typically, an individual agrees to care for the pet for the rest of its life, with support funds coming from a trust. After the pet dies, the caregiver may receive any balance left in the trust. Other changes to consider Taxes aren’t the only reason for conducting a will review, they are just the spur to get the ride started.

Obvious triggers include:
• birth of a child, grandchild or other potential heir;
• divorce;
• death of a beneficiary;
• marriage or remarriage;
• change in state of residence.

Other factors that can reduce the effectiveness of a will happen more gradually, over a longer period of time, and so may be less obvious. Changes in a beneficiaries’ needs or capabilities. Has a well-adjusted youngster become a troubled postadolescent? Is a troubled postadolescent of yesterday now making more money than you do? Changes in the lives of those around you need to be reflected in your estate plan. Has your estate become less liquid? Will your estate have enough cash to meet expenses and tax obligations? If you have hard-to-sell assets, such as real estate or family business interests, you’ll need special planning to avoid the forced asset sales from your estate at bargain prices. Are you satisfied with your selection for executor? Estate settlement can be a demanding job. For the larger, more complex estate, the services of an experienced corporate fiduciary—a trust organization such as us—can be a welcome, cost-effective means to lift a difficult burden from the shoulders of a family member.

Review your ENTIRE estate plan
Your will only directs the disposition of the property that will pass through your probate estate. That may be only a portion—and perhaps a relatively small portion—of the total financial resources that will be available to your heirs. The most important types of nonprobate property are jointly held property, interests in qualified retirement plans and life insurance proceeds. You must take such assets into consideration as you evaluate the strength of your will. Joint interests. Joint ownership of the family homestead with rights of survivorship has long been customary for married couples. It’s possible to have too much of a good thing—when investment accounts are also held in joint name, flexibility in estate planning is lost. There is no estate tax savings for jointly owned property, and there can be income tax costs. Retirement plans. In most cases, a surviving spouse will be the beneficiary of a pension or retirement account at the owner’s death. Life insurance. Insurance proceeds pass directly to
designated beneficiaries unless the beneficiaries already have died. A good alternative to explore is naming a trust as beneficiary, to provide the heir with professional investment assistance for this important sum. Ask us for details.

Our invitation to you

We specialize in estate settlement and trusteeship. We are advocates for living trusts. If you would like a “second opinion” about your estate plans, or if you have questions about how trusts work and whether a trust might be right for you, we’re the ones to whom you should turn. We’ll be happy to tell you more.

Elements of estate settlement
Winding up the financial affairs of any affluent individual may prove surprisingly complicated.
The steps include:
• Inventory the assets;
• Obtain insurance as necessary;
• Manage investments;
• Collect debts owed to the decedent;
• Pay debts owed by the decedent;
• Raise cash;
• File death tax returns
(federal estate tax and state estate or inheritance tax) if needed;

• File decedent’s final income tax return;
• Distribute assets or fund trusts in accordance
with the will; and
• Provide an accounting for the management of
the estate.
Someone coming into this task for the first time is likely to find it daunting. There are companies, such as us, that include estate settlement as a
core business function. We have the record-keeping systems in place, and we have the experience and expertise required to make estate settlement as painless as possible.

Rookie mistake?

The following story is not hypothetical. The facts are drawn from a published IRS letter ruling.
Husband created a trust to manage his assets after his death. His two children, who were apparently from an earlier marriage, were named as the trustees. Husband owned a substantial IRA at his death, and the IRA named the trust as the beneficiary. After Husband died, the entire IRA was distributed to the trust’s checking account. Wife understood that she was entitled to 25% of that IRA. Evidently there was disagreement about what that amount would be, but on September 29, Wife and the children reached a settlement agreement. The trust would attempt to create an IRA rollover for Wife’s portion of the proceeds. Wife established two IRAs for herself. On October 14, the trust sent the amount agreed to in settlement to Wife’s IRA 1, and on October 22, she transferred everything to her IRA 2. The reason for having two IRAs is unclear. When tax time came around early the following year, Wife received a notice from the trust that the distribution to her was taxable. This likely came as a shock to her, because she never had possession of the money, and the transfer was within 60 days of the agreement. Wife filed the letter ruling request, asking the IRS to waive the usual time requirements for an IRA rollover because of a mistake by a financial institution.

When did the 60 days for the rollover start?
The ruling does not state what the date was when the IRA proceeds were distributed to the trust. That was when the 60-day period for a rollover began, and evidently that was long before the settlement agreement was reached. There was no financial institution involved here. Wife’s complaint was that the trustees and their attorney advisor had a duty to her—a duty to preserve her opportunity for an IRA rollover of her inheritance, which they failed to do. After reviewing her argument, the IRS held, “The information you presented and documentation you submitted are insufficient evidence of financial institution error,” without additional analysis.

Tax consequences?
The tax result is much worse here than the loss of a roll-over opportunity. Wife will owe a 6% penalty tax on an excess contribution to an IRA for the amounts paid to her IRA by the trust. The penalty applies every year until the excess is withdrawn.

The trust will have to pay ordinary income tax on the entire amount of the IRA distribution in the tax year that it received the money. This could be a pretty substantial tax hit, because the income tax brackets for trusts and estates are much narrower than for individuals. Normally, when a trust is a beneficiary of an IRA, only the Required Minimum Distribution will be paid to the trust each year, not the entire value of the IRA. If a surviving spouse is to receive a portion of an IRA, he or she should be named directly as beneficiary or percentage beneficiary, to preserve all tax options for deferral on the money. Did the trustees, children of the earlier marriage, understand any of this when they authorized distribution of the IRA to the trust? The ruling offers no insight into this question, but it seems very unlikely. They acted out of inexperience, in a manner that seemed reasonable to them. The better course to avoid unexpected problems in estate settlement is to hire professionals, a corporate fiduciary such as us.

Cybersecurity
As “National Cybersecurity Awareness Month” came to a close, the IRS once again issued a warning for taxpayers to be vigilant with their electronic devices and online accounts. “It’s important to remember that the IRS does not use unsolicited email and social media to discuss personal tax issues, such as those involving tax refunds, payments or tax bills.” Suspicious emails should be forwarded to phishing@irs.gov. The Service also encourages taxpayers to use strong passwords and multifactor authentication. A virtual private network should be employed whenever one is on a public Wi-Fi network. The IRS itself needs work on cybersecurity as well, according to the Treasury Inspector General for Tax Administration (TIGTA). The IRS has a Practitioner Priority Service for assisting professional tax preparers, and this service has been targeted by hackers. Over a period of eight months, ending on April 16 of this year, some $462 million worth of fraudulent refunds were filed through this channel. The Service stopped 4,254 of the false claims, but 574 got through, with $47 million in improper refunds. Recommendations for beefing up security will be implemented. There’s no word on whether the perpetrators have been found or will be held to account.

Adverse determinations
Recently the IRS denied tax-exempt status to an organization established to promote the development and growth of pickleball. The Service found that the organization was not operated exclusively for exempt purposes and that it furthered a substantial nonexempt purpose, that is, promoting recreational community pickleball events for its members. Income tax returns will be required for the organization. They are in good company. Additional adverse determinations for tax-exempt status, issued the same day by the IRS, included:
• an organization founded to uplift rural communities through tourism because its tourism promotion activities further nonexempt purposes;
• an organization formed to operate and maintain a rural cemetery because its organizing document wasn’t signed by at least two authorized individuals;
• a farming business;
• a group organized to promote physical fitness and a healthy lifestyle in the restaurant and service communities;
• an organization formed to promote the sport of purebred dogs, responsible dog breeding, and dog owners’ rights;
• an organization established to help the less privileged and senior citizens with limited income after finding the organization’s activities weren’t limited to exempt purposes.
The amount of tax revenue at stake for these small organizations is likely to be minor, but the compliance cost may not be.

Trust accounting

“DNI? What’s that?”

In general, a trust-based wealth management plan has as its goals the preserving, protecting, managing and ultimately, the distribution of wealth that has already been accumulated. An irrevocable trust is handicapped in growing wealth by a tax code with much higher tax rates than most individuals face. A married couple filing jointly will pass through seven tax brackets before reaching the top 37% rate at $731,200 of taxable income. An estate or trust, in contrast, faces just four tax brackets, and the 37% tax rate begins at $15,200 of income (see the table below).

For that reason, most trusts distribute their income to their beneficiaries, rather than accumulating it. When the income is distributed in this fashion, it is taxable to the beneficiary, and the trust is allowed a deduction for the distribution. This approach reduces the overall income tax owed by the trust and its beneficiaries.

Distributable net income
But what is income, in the context of a trust? This is where complexity begins to set in. The taxable income of a trust will include, for example, interest, dividends, rents, royalties, and capital gains. A series of adjustments must be made to this figure to determine Distributable Net Income, or DNI. The DNI acts as a limit on what the trust may deduct from taxable income, and it is also a ceiling for the amount the beneficiaries will have to include on their tax returns. From taxable trust income, one subtracts deductions allowed for trusts and estates, such as administrative expenses and legal fees; adds back tax-exempt income; adds back capital gains that were not distributed to beneficiaries to be taxed on their tax returns; and subtracts the capital gains tax liability of the trust or estate. See your accountant or a trust officer for a more complete explanation.

Simple versus complex
A simple trust is one that, by its terms, is required to distribute all trust income every year, makes no distributions of principal, and makes no distributions to charity. With a complex trust, the trustee has broad discretion in distributing trust income; the trustee may make mandatory or discretionary principal distributions; and there may be charitable distributions.
Example. A simple trust has two beneficiaries, $90,000 of trust accounting income, and a DNI of $90,000. Beneficiary 1 has the right to two-thirds of the income ($60,000); Beneficiary 2 gets one-third ($30,000). The trust will be able to deduct the full $90,000, and so will owe no income tax.

To understand the allocation of DNI for complex trusts,
six concepts come into play under the IRS Regulations:
1. DNI is distributed to beneficiaries on a pro rata basis;
2. The “tier system” of distributions;
3. The separate share rule;
4. The 65-day rule;
5. Specific bequests; and
6. Distributions in kind.
Discussion of these concepts is left to the professional advisors.

A complex trust in action
Grandfather arranged for two revocable trusts—one for himself and one for Grandmother. Each trust is worth about $5 million, and each produces about $150,000 of income each year. The couple paid their income taxes jointly on the total from both trusts.
Over the years, Grandfather made tax-free annual exclusion gifts to his four children and six grandchildren.
When he started that program, the amount exempt from federal estate tax was much lower, and he thought he was lowering his eventual taxable estate. Those getting the gifts understood that they did not owe income tax on them.
Now Grandfather has died. His revocable trust becomes irrevocable, but the trust has wide discretion in the distribution of trust income. The possible income beneficiaries include Grandmother, if her own trust proves insufficient, and the four children. The trust will continue until the death of Grandmother. At that point, it divides into fourequal shares for the children. Grandfather’s trust is well below the threshold for the federal estate tax, $13.61 million in 2024, so that is not an issue. His trust was drafted so as to bypass Grandmother’s estate. Still, her $5 million trust could grow large enough to become taxable if the amount exempt from federal estate tax falls to about $7 million in 2026, as required under current law.
Accordingly, the trustee should probably not distribute income from Grandfather’s trust to Grandmother, if the income from her own trust is sufficient. In fact, she may want to continue Grandfather’s gift-giving program to the descendants.
The four children have very different financial situations. The oldest is retired, collecting Social Security and his Required Minimum Distributions from his 401(k) plan—he doesn’t need more income. The youngest is struggling financially after a divorce and some medical setbacks. The other two are in the middle in terms of financial resources and needs.
The trustee can take all these factors into account in deciding the best way to distribute the trust income. However the beneficiaries need to be made aware that, unlike the earlier tax-free gifts, they will be payingincome tax on these trust distributions.

Would you like to know more?
As you can see, the operation and tax reporting for a trust is no small matter. We are well qualified for all the tasks of trusteeship. It is a job that we do every day, with our full attention. We are staffed for it, experienced and always ready to serve.
When you are ready to take the serious step of including a trust in your long-term financial and wealth management plans, please call us to learn more about how we may be of service to you. We look forward to answering all of your questions.

Choices for surviving spouses

The shift away from pensions toward employee-funded retirement benefits, such as 401(k) plans, has led to a dramatic increase in the number and value of IRA rollovers. For many families, tax-qualified retirement savings may be the largest single component of family wealth. Such assets have special financial and estate planning issues to contend with. This is especially true when the primary beneficiary will be a surviving spouse.
The SECURE Act and SECURE 2.0 brought changes to the tax rules governing the Required Minimum Distributions (RMDs) from tax qualified retirement plans, including IRAs. The reason for RMDs is to make certain that the retirement savings face an eventual income tax. The tension is that the account beneficiary wants the money to last as long as possible. Keying the distribution requirements to life expectancy balances these two interests. The general rule now is that inherited retirement accounts must be distributed to beneficiaries during the ten years following the owner’s death. The general rule does not apply to surviving spouses.

Alternatives
A surviving spouse beneficiary may keep that status, or the survivor may elect to be treated as the owner of their retirement assets. As an owner, the spouse may roll the funds into his or her own IRA rollover.
Examples. John owns a large IRA rollover and has named his wife, Mary, as the surviving beneficiary. If Mary chooses to be a beneficiary, she will have to begin taking RMDs in the year when John would have reached his required beginning date (generally, when he would have reached age 73). If she makes the IRA her own, distributions can be delayed until she reaches her own required beginning date. If Mary is much older than John, and if he died well before his required beginning date, she is better off as a beneficiary. She will be able to defer the RMDs for many years, allowing the account to grow tax-deferred before tapping into it.
If Mary is much younger than John, she is more likely to choose to make the IRA her own, because then she can wait longer for her RMDs, maximizing the account value for her own retirement.
If John and Mary are close in age, this choice has little effect on the RMDs. In that case, Mary will want to take into consideration the fact that there will be no tax penalty for taking a distribution from an inherited IRA before reaching age 59½.
What if the IRA has been converted to a Roth IRA? In that event, she will likely want to make the account her own, eliminating the need for any RMDs during her lifetime. Roth IRAs don’t have RMDs for the owners, but inherited Roth accounts do have
RMDs. Seek professional advice Traditionally, the financial protection of a surviving spouse has been a key motivator for attending to the responsibility of having a will and an estate plan drafted. Getting professional tax and estate planning advice is doubly important when qualified retirement plan benefits will be a major component of the resources made available to the survivor. This brief review of the choices that will confront a survivor spouse is intended as preparation for meeting with advisors.

Beware the Social Security “Tax Torpedo”

In some situations, retirees face marginal tax rates approaching 50%!

Social Security benefits have potentially been subject to federal income tax since 1983. “Potentially taxable” means that lower income retirees won’t have to pay these taxes; there is an exemption. However, the thresholds for taxation were not indexed to inflation and have never been adjusted. That means that more and more retirees will be faced with this tax puzzle. The “tax torpedo” is the amount of additional tax liability generated by an additional dollar of retirement income.The starting point is Adjusted Gross Income (AGI), a number familiar to everyone who has ever filed a Form 1040. AGI includes wages, interest income, dividends, capital gains, pensions, and retirement plan distributions. To this figure one adds in nontaxable interest income, such as that from municipal bonds, and one-half of the Social Security benefits received. The result is “provisional income.”

Those with provisional income of less than $25,000 ($32,000 for married filing jointly) pay no taxes on Social Security benefits. For provisional income from $25,000 to $34,000 ($32,000 to $44,000 for married filing jointly), up to 50% of benefits are taxable. Above $34,000 ($44,000 for married filing jointly), up to 85% of benefits become taxable. Table one below provides the summary.
An additional dollar of taxable retirement income thus has the potential of pushing more of a retiree’s Social Security benefit into the taxable zone. Imagine a retiree needs to withdraw $1,000 from an IRA to pay bills. The withdrawal needs to be large enough to cover the income tax on the withdrawal, plus the additional tax on benefits.

The capital gains “bump zone”
Now add this wrinkle. In the bottom tax bracket, the tax rate on long-term capital gains is 0%. However, as income goes higher, there is the possibility of the capital gains being pushed into taxable territory. Writing in The New York Times, Peter Coy offered this example for a single taxpayer. A single taxpayer in the 12% tax bracket has at least $2,000 of long-term capital gains and needs to take a $1,000 withdrawal from his IRA. Tax consequences? The tax on the IRA withdrawal is $120. The withdrawal may push $1,000 of the capital gain into the 15% bracket, for a tax of $150. The increase in provisional income exposes an additional $850 worth of Social Security benefits to the 12% income tax, for $102. Finally, the addition of the Social Security benefit to taxable income pushes still more of the capital gain into the 15% bracket, triggering a tax of $127.50.
The total tax cost of the $1,000 withdrawal is $499.50, very nearly a 50% tax rate. That’s the “tax torpedo” in action.

At higher income levels
Once 85% of Social Security benefits are fully included in a retiree’s taxable income, there is no longer a need to factor in this tax angle when making discretionary retirement withdrawals or investment decisions. However, a new tax torpedo then shows up on the radar. Medicare Part B monthly premiums are not flat, they go higher as modified adjusted gross income goes up, ranging from $174.70 at the low end to a maximum of $594.00. One dollar of additional income over the threshold can mean hundreds of dollars in higher premiums. The premiums are based on modified adjusted gross income from two years earlier, and are adjusted annually. The table below shows the breakpoints for 2024.

Planning ahead
One approach for reducing exposure to the tax torpedoes is to convert retirement resources to a Roth IRA for greater flexibility. Such conversions create ordinary income in the year that they occur, and so should be spread out over a number of years, if possible, to smooth the tax impact. The conversions should be completed before starting to receive Social Security benefits to avoid triggering more taxes on them. Keep in mind also that a conversion two years before joining Medicare will likely boost the Part B premiums for at least a year.
Required Minimum Distributions from retirement accounts must begin at age 73, and these have the potential to push more benefits into the taxable zone. (Roth IRAs do not have required distributions during the life of the owner.) For the philanthropically minded, a Qualified Charitable Distribution (QCD) will avoid adding to adjusted gross income (limit of $100,000 per year). A QCD satisfies the minimum distribution requirement.

Put us on your team
You may want to consider professional help in preparing and implementing your retirement plans. We specialize in two areas of personal financial management:

• Helping clients to achieve financial independence, using tax-sensitive techniques as appropriate.
• Helping clients to maintain financial independence by providing unbiased investment advice and trusteeship.

For specifics on how we might help you, see our asset-management specialists.

The most popular names for babies
The Social Security Administration manages an extensive website at ssa.gov, full of useful information for retirees and pre-retirees. In the course of collecting applications for new Social Security numbers as babies are born, the agency has also compiled a record of baby names. At https://www.ssa.gov/oact/babynames/index.html you will find the home page for this data, and it is quite interesting. The most popular names may be displayed:

• by state;
• by decade;
• by change in popularity from 2022 to 2023;
• as the top 100 names in the last 100 years; or
• as the top 5 names for boys and girls for each year in the last 100 years.

Only three boys’ names – James, Michael and William – are on both lists, and no girls’ names are on both. The most popular name for a baby boy in 2023 was Liam. That name entered the top five in 2014 and has held the number-one spot since 2017. The most popular name for a baby girl, Olivia, entered the top five in 2003, and it has been number one since 2019.
The most popular boy’s name, James, has been ranked as low as 16th, and the most popular girl’s name, Mary, has been ranked as low as 135th.

Termination of a Marital
Trust during life
Sally and Alvin created the Anenberg Family Trust in 1987 to manage their family business. When Alvin died in 2008, the Family Trust divided into new trusts, including a QTIP Marital Trust for Sally and trusts for Alvin’s descendants.
In 2011, the trustee for Sally’s trusts filed a petition to terminate the Marital Trust, which was granted in 2012. In August 2012, Sally made two gifts of stock worth $1.6 million each to two trusts, and in September 2012 she sold the balance of her holdings, worth about $22 million, to the trusts for Alvin’s descendants in exchange for promissory notes. The gift tax return reported the $3.2 million transfers.
After Sally died in 2016, the IRS concluded that she owed a $9 million gift tax on the termination of the QTIP trust.
The estate took the matter to the Tax Court, which ruled that “The Commissioner would have us treat the circumstances here the same from a gift tax perspective as we would treat a termination of the Marital Trusts that was followed by a hypothetical distribution to Sally of the value of her qualifying income interest only, with the value of the remainder interests distributed to Steven and Neil. But the two situations are not remotely the same.” No gift tax was due on this Marital Trust termination.

The smell test
A Virginia couple purchased 85 acres in Georgia for $1.35 million. They subdivided the property into two parcels, 44 and 41 acres. Next, they donated a conservation easement over the 41-acre parcel to Liberty County, Georgia.
On their 2007 partnership tax return, the couple claimed a charitable deduction of $5.1 million for the conservation easement donation. Only $748,702 could be claimed in that tax year; the rest was carried forward.
The IRS audited the couple in 2015 and disallowed the carryforwards for tax years 2010 and later (the statute of limitations had expired for earlier years). They took the matter to the Tax Court and lost.
The couple appealed to the Fourth Circuit Court of Appeals with no better luck. The Court identified a variety of errors in their legal arguments. “But more remarkable was their attempt to claim a $5.1 million deduction for a limited easement estate on property that they had purchased in fee simple for $652,000 only a year earlier. Such a claim simply does not pass any reasonable smell test, much less the tax law’s requirements.”
The Court sustained a 40% gross valuation misstatement penalty.