In today's edition, Ask the Expert tackles taxes associated with estate planning. Our featured expert is Jason Sweatt (88C), CPA, Global Tax Quality Managing Director with EY (Ernst & Young), a Big 4 accounting firm (one of the top four in the world) where Jason leads a team in governance of the complex tax technology solutions used by EY Tax around the globe. Jason has more than 37 years of experience in public accounting (tax) solving complex issues, with focus on tax quality, income taxes, indirect taxes, and firm management/leadership among others. Jason is a 1988 Berry graduate, earning a bachelor's degree in accounting. He is an active alumnus, whose service includes Berry's Planned Giving Council, Berry Alumni Council and the Alumni Career Network. He is also a member of the Berry Heritage Society. Jason was just chosen as President-elect of the Berry Alumni Council.
When it comes to using a will to transfer wealth, what are some key terms people need to know?
Let me start by saying that this is a complex area of law and tax law. A will is a key way to ensure the disposition of your assets follows your wishes and the planning done during your lifetime is not undone. While we're probably all familiar with the following words, there might be some finer points to know.
Executor: The person you designate to manage your estate and ensure that your wishes are carried out. Consider choosing a non-beneficiary executor to avoid conflict of interest.
Primary and contingent beneficiaries: Primary beneficiaries are individuals or organizations named in a will to receive assets or property. Contingent beneficiaries are backup beneficiaries in case the primary beneficiaries are unable to accept assets or if assets remain once your primary beneficiaries receive their inheritance. Without contingent beneficiaries, proceeds will often end up in probate where the state will disburse your estate according to state law.
Probate: Probate is simply a legal process for validating your will and overseeing the distribution of your estate. Not everything has to go through probate. Certain assets with named beneficiaries (like life insurance or retirement accounts), assets held in a living trust, and property held jointly with right of survivorship can bypass probate and go directly to the beneficiary.
Bequest: A specific item or amount of money you leave
to a person or organization through your will. This could be money, assets,
personal effects - anything.
Codicil: An amendment or addition to an existing will used to make changes without having to rewrite the entire document.
What is the difference between estate tax and inheritance tax?
The most important thing to understand about estate and inheritance taxes is who pays which tax. Estate tax is paid out of the estate of the deceased person while inheritance tax is paid by the person inheriting the assets - but there are still a few things you need to know.
Estate tax is a federal tax paid on the value of the estate by the estate itself if the value exceeds the exemption, which changes yearly. The current exemption is $14 million, but it has been as low as $1 million. While even $1 million seems like a lot, when you count all your assets (home, vehicles, vacation home, personal property, retirement, savings, etc.) the total value can add up quickly. Also, when you're planning your estate, you can't be sure what the exemption will be when you are gone.
The good news about inheritance tax is that only five states have it - Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania - and the rules vary by state. Maryland is the only state that taxes both the estate and your inheritance.
Do my heirs have to worry about income tax on their inheritance?
Yes and no. They don't have to pay income tax on the assets they've received as a bequest but if that asset is generating taxable income, that income is taxable to the beneficiary from the day they receive it. This can be beneficial if the heir is in a lower tax bracket than the person passing on the asset. One thing to watch out for is if the asset produces taxable income, but not current cash flow, which could be a challenge for the beneficiary. That's why it is important to consider the mix of assets given to each beneficiary.
The answer can also vary depending on whether trusts are
used in the estate plan, but using a trust depends more on whether the
beneficiary needs assistance managing what they will receive. You need to
remember that there are costs involved in creating and managing a trust, and
the administrative costs can outweigh the benefit, if a trust really isn't
needed. I encourage you to work with an advisor and think carefully about this
decision.
How can I maximize benefit to my heirs while minimizing taxes?
Tax advisors can recommend many techniques, but the challenge in this area is that there are so many variables such as the date of death, the mix of assets held on the day of death, the tax postures of the beneficiaries on that day, estate tax law in the year of death, and even where the person lived at the time of death. It's a good idea to have a conversation with your advisor.
Two common things people will do is hold assets with high values but low tax basis (generally what they paid for the asset) in their estate. If you sell an asset, taxable income is created, but if that asset goes to a beneficiary at your death, the tax basis is stepped up (reset) in the hands of the beneficiary, so income tax on that unrecognized gain at death is never paid. The beneficiary could immediately sell the asset and have no taxable gain or hold it for sale later and only pay tax on the future increase in value. However, if the estate is large enough to be taxed, estate tax may be owed on the value of the asset.
Another common strategy is to use annual gifting during a
person's lifetime, which moves assets out of your estate and avoids estate tax.
Currently, you can give up to $18,000 as an individual and $36,000 as a couple
annually tax free. The disadvantage of gifting is that there is no "step up"
basis like there is when assets pass upon death. You should take that into
consideration when you select assets to gift.
Are there tax benefits to naming organizations, such as Berry, as beneficiaries?
Charitable bequests have been a consistent and favorable part of estate and inheritance tax rules for many years and, unlike other considerations such as exemptions, these tax rules don't change regularly. Giving a bequest to a qualified charity, like Berry College, removes the asset from the estate and will, most likely, reduce the value of the estate and any taxes that might be due.
When giving a charitable bequest, it is important to specifically name the charity in your will. People sometimes miss the chance to fulfill their philanthropic goals by not being specific. For example, when you say simply, "I want 10% of my estate to go to charity" that leaves which charity open to interpretation. Don't give your executor free rein to choose what you mean by "charity." Be specific.
