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There are many occasions in life when it makes sense to revisit your estate plan. These may come in the form of milestones, unanticipated events involving the beneficiaries or the fiduciaries of the estate, a change in assets or a change in applicable law. It’s important to consider the impact these events may have on your estate plan so that you can seek the appropriate advice regarding any changes that should be made.
The milestones in life that may require a revision to your estate planning documents include purchasing a residence, getting married, having children, having grandchildren, and approaching advanced age. Not only are these events life-changing in their own right, but they may require—or cause you to want—significant changes to your plan. Of particular importance among these events is childbirth or adoption and subsequently appointing a guardian or guardians for your minor children. Also, putting a flexible and practical plan in place before reaching advanced age will give you peace of mind and facilitate the management, and ultimately, the disposition, of your property.
Unanticipated events that impact your life or the lives of your loved ones may also require changes to your plan. Divorce (of you or a beneficiary) often prompts a person to revisit his or her estate plan. Sometimes, there are laws in place that make automatic adjustments in your estate plan in the event of divorce. However, these laws vary by jurisdiction and in application and may not reflect your wishes. It is also better to proactively make the changes rather than rely on default, fallback provisions. The death of a beneficiary or fiduciary or a change in your relationship with a beneficiary or fiduciary may also trigger changes to your documents. In addition, careful attention must be paid in the event that you have a beneficiary with special needs who may or may not require government assistance.
A change in assets, large or small, may require attention to your estate plan. For instance, a significant change (or expectation of a significant change) in asset value due to appreciation, investment, increased income, inheritance or trust distribution or termination may not only warrant changes, but may present an excellent opportunity to do additional tax planning. A major liquidity event (or anticipation of a major liquidity event) like the sale of a business may be a good time to revisit your plan. In addition, the acquisition of a different asset or the change in title of an asset may require an adjustment. For instance, assets such as retirement accounts, IRAs, and life insurance policies typically have a designated beneficiary and pass to that beneficiary directly, outside of your probate estate. The disposition of these assets should be coordinated with your overall dispositive scheme so that you can maintain a cohesive estate plan.
Lastly, a change in applicable law is an important time to have your estate plan reviewed. This may happen by a mere change in tax code (income, estate, gift or generation-skipping transfer) or other substantive law, whether local or Federal. A change in applicable law may also be occasioned by a move to another jurisdiction—domestic or internationSome estate plans may be flexible enough to deal with changes in the law but it is crucial to have plans analyzed to confirm this, and if they don’t, to make necessary adjustments.
Please do not hesitate to contact us if you have any questions or if you would like to revisit your estate plan.
Earlier this summer, the Supreme Court unanimously sided with a trust in its fight to reclaim more than $1.3 million in income taxes paid to North Carolina. Although the case likely will not have broader implications in other states, it serves as a reminder of the importance of state income tax planning when creating and administering trusts. With proper planning, these taxes can be minimized and, in some cases, even eliminated. In high-tax states like New York, where combined city and state income taxes are approximately 13%, this can mean significant savings, particularly when compounded over time.
As with individuals, whether or not a trust owes income tax to a state (and on what income) is determined by whether or not the trust is a resident of that state. Although there tend to be common factors that states use to determine if a trust is a resident (e.g., where the grantor (i.e., the creator) of an irrevocable trust is resident, where the trustees and/or beneficiaries are resident, and where the trust is administered), each state has its own rules and there is no uniform approach. When unaccounted for in the planning process, this lack of uniformity can result in a trust being resident in more than one state, leading to greater income tax exposure, not less. When accounted for, however, it can lead to opportunities. Depending on the circumstances, some or even all of these factors can be controlled, allowing the thoughtful practitioner either to “select” the state(s) where a trust will reside or to take advantage of income tax exemptions offered by states for resident trusts. The following example can help illustrate the point:
Jane, a New York resident, wants to create an irrevocable trust for her children that will own a portfolio of publicly traded securities. Under New York law, the trust will be a resident since Jane is a resident. If Jane selects a fellow New Yorker as trustee, the trust will pay New York income tax. If Jane selects a California resident as trustee, the trust will avoid New York income tax due to an exemption for resident trusts meeting certain criteria, including no New York trustees. However, a California resident trustee causes the trust to be subject to income tax there. If Jane instead selects as trustee a resident of Florida, a state which has no income tax, the trust would only pay Federal income tax.
Also, it is important to note that these opportunities are not present just at the time of a trust’s creation. Changes to existing trusts can often be implemented to reduce or eliminate state income tax.
With the current Federal gift and estate tax exemption of $11,400,000 per person ($22,800,000 per married couple), there is an opportunity to transfer significant wealth gift and estate tax free and there are many reasons to use a trust to do so. Minimizing or eliminating state income tax liability on trusts is an important component in preserving that wealth and knowledge of the complex and nuanced state residency rules is the key to doing so.
Client X comes to your office in early December and says to you, “I am going to earn a lot more this year than I ever did in any one year. I want to contribute some of it to charity but I don’t know exactly what I want to do with it yet. Is there any way that I can give it away this year and decide what to do with it next year or over the next several years? Can I make the contribution with a request that it be used for something specific? I’ve never done anything like this before; I usually just make a lot of small gifts to a number of different charities.”
As some of our readers know, there are a number of ways to accomplish Client X’s goals. We are going to begin by discussing private foundations. In subsequent newsletters, we will discuss public charities, donor advised funds, and the differences between grant-making private foundations and private operating foundations, as well as other topics related to charitable giving.
What is a private foundation? A private foundation is an entity, typically a non-profit corporation or a trust, that receives contributions from one main donor, and generally makes grants to one or more public charities over time (this type of foundation is referred to as a “grant-making foundation”). Private foundations, like other entities that qualify for tax-exemption under Code § 501(c)(3), must use its assets for religious, charitable, scientific, literary, or educational purposes.1
Contributions to a private foundation of cash, or cash equivalents, are generally deductible for income tax purposes up to 30% of the donor’s adjusted gross income. Tax deductions for cash contributions in excess of the 30% limitation may be carried forward for up to five (5) years. Contributions to a private foundation of publicly traded stock – equal to its full fair market value – are generally deductible for income tax purposes up to 20% of the donor’s adjusted gross income. There are additional rules and limitations dependent of the type of property being contributed.
Private foundations are subject to a number of restrictive rules.2 The foundation, at the risk of it and its managers becoming subject to substantial excise taxes, will not (1) fail to distribute one percent (1%) or two percent (2%) of its net investment income; (2) engage in any act of self-dealing; (3) retain any excess business holdings; (4) make any investments that will jeopardize its ability to carry out its purposes; and/or (5) make any taxable expenditures, such as using foundation assets for lobbying and/or political activity or making a grant to a non-charitable entity.3 Finally, a private foundation must distribute at least five percent (5%) of its assets for charitable purposes each year.
1. Section 501(c)(3) of the Internal Revenue Code of 1986, as amended (the “Code”), reads in its entirety, as follows: [c]orporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
2. See sections 4940 through 4945 of the Code.
3. To save this grant, the foundation should exercise expenditure responsibility.