CURRENT ISSUES IN THE AREAS OF ESTATE, TAX AND PERSONAL AND BUSINESS PLANNING
The information that follows summarizes some of the current issues in the areas of estate, tax and personal and business planning which may be of interest to you. Although this information is accurate and authoritative, it is general in nature and not intended to constitute specific professional advice. For professional advice or more specific information, please contact my office.
Family Business Divorce Issues. Because a divorce is likely to occur in any family, when planning for the family business, the disruption that a dissolution of marriage can cause should be carefully considered. A marital agreement, either in the form of a pre-marital agreement before marriage (sometimes referred to as an antenuptial agreement), or a post-marital agreement executed after the marriage, can be used in order to protect one of the marital party’s business interests in the case of a dissolution of marriage, but also in the event of death because of the resulting right of inheritance. When a buy/sell agreement is utilized in conjunction with the family business, so that the agreement will determine when a particular party will be obligated to sell and when another party may be obligated to buy, the buy/sell agreement should also consider making divorce a triggering event for the purpose of the buy/sell agreement. In such an event, the divorcing business owner may be required to sell his or her interest in the business, at a prescribed value or based on a valuation formula, and the payments for the buy-out might be made in accordance with a predetermined schedule. This can avoid the business interest from being part of the division of assets between the divorcing spouses and assure that the business interest will stay within a defined group of owners. If the business interest is a pass-through entity, such as an “S” corporation, a partnership, or a limited liability company, and if in fact the business interest is divided between the spouses or transferred entirely to the non-business owner spouse, a buy/sell agreement might provide that a former spouse who receives that business interest would lose any right to vote and would be entitled to nothing more than distributions of income, if there are any. This kind of an arrangement can at least protect, to a degree, the continuing owners from voting by the former spouse of a prior owner in regard to the business operations in ways that would adversely affect the enterprise or hinder the control by the continuing owners.
Insurance Mistakes (Continued). It is common for one life insurance policy to be exchanged for another. An advantage of such an exchange is that the economic benefits obtained under the old policy can be retained and rolled into the new policy, which may offer certain advantages or which may provide a better insurance or financial result. Life insurance policy exchanges can generally be accomplished on a tax-free basis. If the first policy was surrendered, there could be tax consequences associated with the receipt of the surrender value of the policy. However, if a policy is exchanged that is subject to a loan, and the new policy is not subject to a loan in the same amount, then the amount of the loan on the first policy that is discharged in the transaction will be treated as “boot” (i.e., as money received in the exchange), which can generate taxable income. To avoid this inadvertent problem, the new policy should be issued with a loan in an amount which is equal to the loan on the first policy. Another option would be to repay the existing loan before the exchange occurs. This tax problem is similar to the “phantom income” problem discussed in our January 2018 newsletter. The “phantom income” problem arises when a policy is surrendered or allowed to lapse that is subject to an outstanding loan.
Estate Transfers Through Your IRA. IRA withdrawals are not only taxable when the holder of the IRA receives money from the IRA, but also when the beneficiaries following the owner’s death receive distributions. Most inheritances are tax-free (unless there is a state inheritance tax which applies, or unless the federal estate tax applies, which is now rare due to the large exemption which is available), and no taxes occur except to the extent of income during the estate or trust settlement period. Since IRAs or other retirement accounts might be the biggest asset that a person has, passing IRAs to beneficiaries can have significant tax consequences. Previous issues of this newsletter have addressed various aspects of the tax consequences of IRA distributions. One point that we have made before, but which should be reiterated, is that when you are allocating your estate assets to beneficiaries, it is better to have IRAs and other retirement accounts pass to charities and other assets pass to family members and other non-charitable beneficiaries. If a person who tithes to his or her church during his or her life decides to leave 10% of his or her estate to a church or other charity, it would be better to quantify that dollar amount, and then fund that gift through an IRA or other retirement account, leaving more of the non-IRA assets to pass to family members and other individual beneficiaries. This approach to distributions will require a periodic review of your estate plan in order to verify that the proper amount will pass to the charity relative to the value passing to other beneficiaries, but it will result in a much greater tax-effective means of transferring assets while minimizing the tax consequences of those transfers.
Myths About 529 Plans. 529 plans are frequently referred to as “college savings accounts.” There are many misconceptions about 529 plans. One misconception is that it can only be used for a four-year undergraduate degree. It can actually be used for any eligible post-secondary institution, including a vocational school and a graduate school. Some people also believe that a 529 account must be used or that it will be lost. In fact, the funds are never lost, and if the funds are not used for qualified educational expenses, then a withdrawal penalty and taxes might be incurred. If a particular beneficiary does not use the funds, the beneficiary can be changed to someone else, including the person who set up the account. Some people think that there is an age limit for 529 accounts, but in fact there is no such age limit on those who can use the 529 account funds. Also, since a 529 plan is treated as the donor’s asset, and not the beneficiary’s, it should not have an impact on financial aid unless it is maintained by a parent; it should not have an impact on an account maintained by a grandparent or other relative. Finally, some people believe that a 529 plan can be established only for a child, when in fact, a 529 plan can be established for any specific beneficiary.
Additional Information. Future issues of this Newsletter will address other issues of current interest. Please contact my office with any questions that you might have.