The Perils of Joint Accounts

I hear this question all too often.  A client will come in, thinking they have a great solution, and propose, “Should I put my bank and brokerage accounts in joint name with one or all of my children?” In almost all cases the answer is an emphatic “No!”

First and foremost, when you title an account in joint name with someone else you are actually making a gift of half of its value. So if Ethel puts her brokerage account worth $1 million into joint name with her daughter Francoise, she just made a gift of $500,000 to Francoise (half of the value of the account).  Because the most anyone can gift tax free is only $15,000, titling an account worth more than $30,000 would require the filing of a federal gift tax return. In my example, Ethel would have to file a return that would either reduce her gift and estate tax exemption, or if she’s already used up her exemption she may actually have to pay gift tax.

Second, if Ethel’s daughter Francoise is experiencing any legal or financial problems, Ethel may have put her account at risk. If Francoise is going through a divorce, for example, a forensic accountant may discover the asset and it might be at jeopardy depending upon circumstances. The same holds true if Francoise has creditor or bankruptcy problems.

Third, titling the account jointly will likely thwart Ethel’s estate plan. Assume that Ethel has a will that says that upon Ethel’s death all of her assets are to be divided equally between her three children.  If the account is titled jointly with rights of survivorship with Francoise, Francoise would inherit the account outright despite Ethel’s contrary intention in her will. Even if the account is held jointly as tenants in common, Francoise owns half of it and the other half would be distributed in thirds according to Ethel’s will.

Francoise might be altruistic and wish to share the account equally with her siblings. But she might have a gift tax problem herself. If she tries to divide the account that she legally owns, she is making a gift in excess of the $15,000 annual gifts that she can give tax-free.

Fourth, accounts owned jointly do not enjoy the full “step-up” in tax cost basis that would otherwise occur. Assume that Ethel owns 1000 shares of ABC Company Stock that is worth $100 share but she paid $10/share many years ago. If Ethel sold all of her shares she would recognize a $90,000 capital gain. But if Ethel dies still owning the shares, her children inherit them at the date of death value for tax cost basis purposes. So if her beneficiaries sold the shares shortly after her death for the $100,000 there would not be any capital gain and therefore no capital gain tax to pay.

But if Ethel places the account in joint name with Francoise during Ethel’s lifetime, on Ethel’s death Francoise only gets a one-half tax cost step up. In this case, Francoise would recognize a $45,000 capital gain if she sold the shares for $100,000. ($100,000 sales price less $5,000 basis in half the shares and $50,000 basis in the other half of the shares).

Hopefully you are convinced that placing assets in joint name with children isn’t a good idea. So what should you do if you want your child to be able to transact business on your accounts – particularly if you become disabled and unable to manage your own affairs?

This is where revocable living trusts really shine. Ethel can create a revocable living trust and name herself as her initial trustee but also name Francoise as her successor trustee in the event of a disability. Francoise can then transact business on all of Ethel’s accounts that the trust owns. It is not a gift to Francoise since she is acting as a fiduciary for her mother. On Ethel’s death the trust avoids probate and rightfully distributes the accounts to all of Ethel’s children (if that is her wish).

Another alternative is a durable power of attorney. Ethel can sign a durable power of attorney that would name Francoise as her attorney-in-fact to transact business on all of Ethel’s accounts. You should know that the Florida law governing durable powers of attorney changed significantly back in 2011. If you have a durable power of attorney created before that date, you should consult with your estate-planning attorney to determine if yours needs updating.

The bottom line is that you shouldn’t put accounts and assets in joint name with your adult children. There are reasonable alternatives that don’t carry all of the disadvantages associated with joint accounts.

The Sheppard Law Firm is located in Fort Myers and Naples by appointment.

© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.

New Tax Law Provides Estate Planning Opportunities

You may be aware that the Tax Cuts & Jobs Act was enacted at the end of last year, and that it provided certain income tax cuts to individuals and corporations. It also raised the federal estate tax exemption to more than $11 million per person. What you may not know is that this new law provides huge income tax planning opportunities that you can build into your estate plan, allowing for significant savings during your lifetime.

In order to understand the theory, you need to first understand what the federal estate tax is and how the transfer of assets into partnerships and trusts opens up opportunities for capital gains and income tax savings.

The federal estate tax is a transfer tax on the value of your assets at the time of your death. It is, essentially, a tax on your balance sheet. Your estate tax exemption however, is not just something that is available to your estate after your death. The estate tax exemption is also part of a gift tax exemption.

You can make $15,000 annual tax-free gifts to anyone that you choose. To the extent that you make gifts to anyone in excess of that amount, you must file a Federal Gift Tax Return Form 709 reporting the excess. You don’t actually remit tax to the IRS until you have consumed your $11+ million exemption. The exemption that you have remaining at the time of your death is what you can apply to your estate. If the value of your estate at the time of your death does not exceed the unused exemption amount, then there is no federal estate tax due.

So how does this provide you current income and capital gains tax planning opportunities? Stay with me here.

Because everyone has a large federal estate and gift tax exemption, this opens doors to creating trusts that sprinkle income among beneficiaries, even the grantor himself, without fear of actually having to pay any transfer tax. Suppose, for example, you have a family business and you wish to distribute some of its income to children or grandchildren.  You can create a trust that sprinkles the income among those beneficiaries who then pay the income tax at their lower marginal rates. The increase in the transfer tax exemption provides you the means to create trusts that accomplish just that, especially if the value of your estate is below the current federal threshold of $11 million.

Capital gains taxes are yet another consideration under the new law. Generally speaking, when I die, my estate achieves what is known as a “step-up” in tax cost basis equal to the date of death value of assets at the time of my death. The theory behind this is because there is an estate tax on that value then the capital gains should be eliminated.  The step-up doesn’t hold true for qualified retirement accounts, such as IRA, 401(k) and 403(b) accounts.

Because the federal gift/estate tax exemption is so high, taking maximum advantage of this step-up to eliminate capital gains is of paramount importance for our loved ones, especially in estate plans for married couples. Under the federal estate tax law of several years ago, dividing assets and using each spouse’s separate exemption was of primary importance. Now, for many married couples, it might be better to have inclusion of the assets in each spouse’s estate as he or she passes. This way, the family achieves a “double” step-up. As always, individuals should check with a qualified estate planning attorney to determine if their estate plans should be amended to take advantage of the new law.

Partnership tax law can also be used to minimize capital gains. Here, you might create trusts that benefit younger family members and gift low basis assets (those that have not appreciated greatly) to that trust. That trust then contributes those low basis assets to a LLC or to a partnership. You also form another type of trust funded with high basis assets (those that haven’t appreciated much). That trust then contributes those high basis assets into another LLC or partnership. A new general partnership is formed (call it the Parent Partnership) and both of the existing partnerships contribute their underlying assets into the Parent Partnership.

After the tax law’s requisite holding period, the Parent Partnership is dissolved and the assets are distributed to the various trust/partners and ultimately to the beneficiaries, except the low basis assets are distributed in the liquidation to the older generation. When the older generation dies the step-up in tax cost basis is achieved eliminating the capital gains on those assets. This is known as a “swap technique”. The new tax law opens the door to this and similar planning strategies.

These strategies are not without significant risks if improperly established. Failure to comply with the complicated partnership and income tax laws could result in a deemed sale, accelerating the very taxes that one is trying to minimize.

The swap technique is beneficial not only for wealthy retirees, but also for wealthy middle-aged individuals who have a living, cooperative parent. Assuming that parent doesn’t have a taxable estate (one that exceeds $11 million) then one could use that parent’s exemption and subsequent step-up at death advantageously, minimizing capital gains exposure during the lifetime of the middle-aged child.

The Tax Cuts & Jobs Act is scheduled to sunset on January 1, 2026. It may also be likely that Congress passes a Technical Corrections Act of some kind closing loopholes. Consequently, the application of any strategy should be carefully considered with your legal and tax advisors before jumping in.

The Sheppard Law Firm is located in Fort Myers and Naples by appointment.

© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Tax Reform Slashes State & Local Tax Deduction

Many of you have heard that the Tax Cuts & Jobs Act of 2017 that was signed into law just before year-end slashes the state and local tax deduction to $10,000. Many homeowners will pay far more in property taxes than they will be able to deduct on their federal income tax return. This includes many in Florida who own residences both here and somewhere else.

Is there anything that you can do? Actually, there is. I recently returned from the Heckerling Estate Planning Conference that is hosted by the University of Miami Law School. It’s a week-long conference that’s similar to attending one year of law school in about 40 hours. Top estate planning professionals from around the country attend this annually, picking up high-level continuing education credits. This was my 25th consecutive year of attendance.

Two well-known national experts on these subjects, Jonathan Blattmachr and Marty Shenkman, discussed the use of irrevocable trusts coupled with the use of LLCs to achieve the income tax deduction.  While the strategy isn’t for everyone, the theory goes that by contributing residences to an LLC that generates income (either from the rental of the property or from the contribution of other income-producing assets) and by having the LLC owned by a certain type of irrevocable trust, the property tax deduction limitations won’t apply.

The trusts must be drafted in such a way as to achieve the intended result, and every family will have different objectives and goals. Consequently, there isn’t a “cookie cutter” form that will get the job done. Instead, this is a true advanced estate planning technique that actually saves money for the family during the grantor’s lifetime.

Pretty cool — at least to a trust attorney!

There’s always a rub, as you might imagine. A technique like this would likely invalidate Florida homestead status and thereby remove the Save Our Homes property tax cap ceiling. But it could certainly work for northern residences that don’t have the homestead requirements that Florida law imposes.

An additional consideration rests in whether this law will remain in place for any period of time. The new tax act was passed by a thin margin, with no support from any of the Democrats in Congress. What happens in the next election is anyone’s guess — and the high tax states like New York, Massachusetts and Minnesota are unlikely to want this law on the books for very long.

Beware — undoing the transaction won’t be so easy or without consequence. Because the federal estate and gift tax exemption rose to $11.2 million per person, however, making intra-family gifts back and forth might be possible, which could mitigate that problem.

The new tax law sunsets, by the way, on January 1, 2026. You might remember that when George W. Bush was in office he signed into law tax reform that repealed the federal estate tax in 2010. That happened to be the year that billionaire George Steinbrenner died. Coincidence? In any event, that law sunset in 2011 and the estate tax returned. It seems that as the political pendulum swings, so does the tax law.

The new law provides all sorts of planning opportunities. With the estate tax affecting fewer people, those with large unrealized gains will be looking to plan their trusts to achieve maximum step-up in tax cost basis, minimizing capital gains for loved ones who inherit appreciated assets. The funny thing is, that in order to accomplish this the strategies run counter to the planning that one usually embarked on to minimize the estate tax.

Creative use of family partnerships during lifetime could also result in lower tax bills for many wealthy families. I plan to write about these strategies in future columns.

Just as they warn in those crazy television shows where people jump off mountains wearing flying squirrel suits — don’t try these strategies at home! There’s much to consider and one should consult a highly qualified professional well versed in these matters before diving in.

As one of the speakers at the Heckerling conference said, “They’re going to have to close the loopholes in The Cuts & Jobs Act. Once good attorneys help clients figure all of this out, the $1.5 trillion price tag the Congressional Budget Office predicted will be just a drop in the bucket to what this really will end up costing the government.”

The Sheppard Law Firm is located in Fort Myers and Naples by appointment.

© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.