Bangerter, Lund and Associates - Certified Public Accountants - Certified Public Accountants

Title tactics
Even if you have a properly executed will, some of your assets may not be covered by its provisions. For instance, any assets that you own as joint tenants with right of survivorship (JTWROS) will pass directly to the surviving co-owner after the first death. Again, this may lead to unforeseen results.

Example 2. Matt Thomas and his brother Nate pooled their money to buy a lakeside cabin when they were young adults. They owned it as JTWROS. Both brothers married and had children; their families used the cabin for many vacations and watched the house grow in value.

Matt died and left his assets to his wife and their two children in his will. However, Matt and Nate had never changed ownership of the cabin from JTWROS. As a result, this valuable property passed to Nate rather than to Matt’s intended heirs.

That’s not to say that JTWROS is a poor way to hold property. On the contrary—JTWROS offers advantages. Assets held this way go to the co-owner without going through probate, a process that governs assets that pass under a will. Avoiding probate can save time and money. However, you should evaluate property titling as part of your estate plan to avoid results such as the one the hypothetical Thomas family experienced.

Beneficiary blunder
Properties held as JTWROS are not the only assets beyond the reach of your will. IRAs, employer retirement plans, life insurance policies, and various other types of assets pass to named beneficiaries. Again, improper beneficiary designations can send an inheritance in the wrong direction. The following example is based on a real case that went all the way to the U.S. Supreme Court.

Example 3. Phil Chandler worked for a major company for many years, building a six figure amount in his 401(k) account. His wife Peg was the beneficiary. When Phil and Peg divorced after a lengthy marriage, they worked out a comprehensive property settlement, which included Peg relinquishing her rights to Phil’s 401(k).

The catch? Phil never changed his beneficiary designation. When he died, the plan administrator saw that Peg was the beneficiary and paid her the account balance. Phil’s daughter sued to get the money but lost the case. To avoid such an outcome, you should make certain your beneficiary designations reflect your wishes and check them periodically to keep them current.

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Income Tax and Estate Planning With Your Parents

Taxpayers in high brackets may enjoy family tax savings by shifting taxable income to relatives in low brackets. However, the so-called kiddie tax limits the impact of shifting income to children. Shifting income to parents who are in a low tax bracket may be much more effective. Moreover, such income shifts can be profitably paired with participation in a parent’s estate plan.

Recent legislative changes have tightened the kiddie tax rules. Many youngsters are now considered kiddies; full-time students under age 24 are included, for example. For these youngsters, unearned income over $1,900 will be taxed at their parents’ rate in 2011.

The kiddie tax does not apply to parents. Your parents may have relatively low income and substantial tax deductions, perhaps from unreimbursed medical expenses. In such a situation, you may be able to take advantage of their low tax bracket.

Senior strategies
Some examples can illustrate incomeshifting to low-bracket parents.

Example 1. Roger and Kate Donovan are in the top 35% federal income tax bracket. Kate’s parents are in their late 70s, with taxable income—after all deductions—of around $40,000 a year. Kate’s father has $200,000 in a traditional IRA, all in pretax money. Because Kate’s parents live comfortably on their current income, her father has been taking only the required minimum distribution from his IRA.

In 2011, married couples who file joint tax returns can have up to $69,000 of taxable income and remain in the 15% federal income tax bracket. Therefore, Kate’s father can convert an additional $29,000 of his traditional IRA to a Roth IRA this year and owe only 15% on the taxable income generated by the conversion. Kate’s father executes this conversion and names Kate, his only child, as the Roth IRA beneficiary.

The Roth IRA conversion will add $4,350 to the federal income tax bill owed by Kate’s parents. To ease that burden, Roger and Kate might increase the birthday, anniversary, and holiday presents they give to her parents. In 2011, each individual generally can give up to $13,000 each, to any number of people, without incurring gift tax.

By making a Roth IRA conversion, the family is able to take money from the traditional IRA at a low 15% tax rate. Kate’s father can execute similar partial conversions each year, until he has moved all the money from the traditional IRA to a Roth IRA at a low tax cost.

Roth IRA owners never have to take required distributions. Moreover, all distributions from a Roth IRA are tax free after five years and after age 59½. (The age requirement does not apply to Roth IRA beneficiaries.) If Kate’s father has a pressing need for money before the five-year mark, he can withdraw the converted amount without owing income tax because he will already have paid income tax on the Roth IRA conversion. Otherwise, the money can keep growing inside the Roth IRA until it passes to Kate, who can take tax-free withdrawals.

Pretax money in a traditional IRA eventually will be subject to income tax, paid either by the account owner or by the beneficiary after the owner’s death. In this example, if the money is left in a traditional IRA, some withdrawals might end up being taken by Kate, who is in a high tax bracket.

Give and get
Other families may benefit by transferring assets from middle aged children to elderly parents, with the understanding that those assets eventually will pass back to the children.

Example 2. Brian and Jean Russell are in the top 35% federal income tax bracket. They have been helping to support Brian’s widowed mother, who has scant income beyond Social Security checks. Instead of making periodic cash gifts to Brian’s mother, Brian and Jean transfer $200,000 worth of dividend paying stock to her. The Russells bought that stock many years ago for $50,000. In 2011, each individual has a $5 million gift tax exemption, so Brian and Jean can make this gift without paying gift tax. (Gifts over $13,000 a year reduce the giver’s estate tax exemption, now set at $5 million.)

Assume the transferred stock pays a 4% dividend. If so, Brian’s mother will receive $8,000 per year in extra income: 4% of $200,000. Assuming the dividends are “qualified,” which is the case for most investment income dividends, low bracket taxpayers owe 0% tax. As long as Brian’s mother keeps her taxable income at $34,500 or less this year, she will owe no tax on the dividends. Brian and Jean would have owed 15% tax on the dividends if they had kept the shares.

In this example, Brian’s mother revises her will so that Brian will inherit the shares she now owns. Suppose Brian’s mother dies when those shares are worth $215,000. If Brian’s mother has lived for more than one year after the gift, Brian will have a $215,000 basis (cost for tax purposes) in the inherited shares. He can sell them for $215,000 and owe no tax. Therefore, no one will ever owe capital gains tax on the shares’ appreciation from $50,000. However, if Brian’s mother dies before a year has passed since the gift, he will not get a step up in basis.

These are a few ways that high bracket taxpayers might take advantage of parents’ low brackets. Our office can go over your personal circumstances and suggest ways to save taxes by teaming up with low bracket parents.

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Don’t Take a Vacation From Estate Planning

According to the National Association of Realtors’ 2011 Investment and Vacation Home Buyers Survey, there are 7.9 million vacation homes in the United States, Many people like the idea of going to their own place for weekends and longer stays. Owners may dream of seeing children and grandchildren get together for wonderful family experiences at a treasured vacation home.

These experiences may happen during the owner’s lifetime, but reality can be quite different after the owner’s death. If a vacation home owner leaves the house to more than one heir, serious disputes can arise. The new owners may not agree on capital expenses or who should pay them.

Example. Jim and Karen Warner bought a New Jersey beach house decades ago. Over the years, their children and then grandchildren spent time there. Jim died and left the beach house to Karen, who left it equally to their three children at her death.

The oldest child, Chris, now works for a software company in California and never uses the New Jersey beach house. Sarah, a prosperous real estate attorney in New York, uses the house often with her husband and her three children. Emily, the youngest, is an aspiring but as yet unsuccessful actress and novelist who uses the house infrequently. After a severe winter, Sarah wants to hire a roofer for extensive and expensive repairs, but Emily doesn’t think they’re necessary. Chris doesn’t bother to respond to calls or emails about the roof contract; he doesn’t intend to pay one-third of the cost if a roofer is hired.

Avoiding acrimony 

Such an outcome may be the norm rather than the exception if a vacation home is simply left to more than one individual. Therefore, if you own a vacation home, it should be integrated into your estate plan. Be realistic about the prospects of the new owners handling the bequest without disputes.

One solution is to sell the vacation house while you are alive, perhaps when family use has declined. Any profit probably will be taxed as a long-term capital gain, which now qualifies for a favorable tax rate. The sales proceeds can be given or bequeathed to your heirs, who can buy their own vacation home or use the money for other purposes. If you do not sell your vacation home while you are alive, your designated heir or heirs could inherit during a weak real estate market and therefore be stuck with ongoing expenses as well as a property that’s difficult to sell.

Another approach is to leave the house to just one child while equalizing inheritances. In the Warner family example, Karen might leave the house to Sarah, the attorney who is most likely to use the house, and bequeath other assets of comparable value to Chris and Emily. Without the beach house to promote discord, Sarah might invite her siblings for occasional visits.

Alternatively, the owner of a desirable vacation home might place the property in trust or in a limited liability company (LLC). Some funding could be provided to cover the operating expenses, and the trust or LLC documents could describe a procedure for the buyout of a beneficiary who would rather have cash than the right to use the home. If this arrangement appeals to you, our office can help you determine the necessary funding to keep your vacation home a family retreat.

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