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Thursday, November 9, 2017

Change to Estate Tax Exemption Limit for 2018

While the House and Senate are considering competing tax proposals, including a proposal to eliminate the federal estate tax, it is worth noting that the IRS has release Revenue Procedure 2017-58 which provides inflationary updates for a number of provisions in the Internal Revenue Code.

Assuming that the Republicans do not pass a bill that modifies the existing estate tax and gift tax structure, for 2018:

  1. US Citizens and Permanent Residence Aliens can pass on $5,600,000 per person upon death or during their lifetime.  The federal estate tax exemption is also known by several other terms including the lifetime gift exemption, the basic exclusion amount, and the unified applicable exclusion amount.   The exemption is being increased by $110,000 from its 2017 limit of $5,490,000;
  2. The annual gift tax exclusion will increase to $15,000 per person, per donee.  This is up from $14,000 in 2017; and
  3. The annual exclusion for gifts made to a non U.S. Citizen spouse has been increased to $152,000.  This is up from $149,000 in 2017.


This revenue procedure does not change any laws.  It is simply designed to inform taxpayers of any changes in tax provisions as a result of inflation. 

Friday, November 3, 2017

Proposed Tax Policy By Republicans Would Enable Wealthy to Pass On A Massive Income Tax Deduction to Their Heirs Upon Death

As most of you know, I generally try to avoid political discussions and I really try to avoid commenting on proposed tax policy before it becomes law for the simple reason that most proposed law changes never get enacted.  However, I feel compelled to talk about what I believe is a major flaw in the proposed “Tax Cuts and Jobs Act”.

Before I do, I think it is important to have a quick discussion on the background of estate and gift taxes, social policy and the purpose of an estate tax.  As many of you know, the United States has a 40% federal estate tax and gift tax that kicks in when someone transfers assets in excess of about $5.5 million (either upon death or through gifting).  Note, the amount that can be passed on tax free is doubled for married couples.  Additionally, there is no tax when one spouse dies and leaves assets to a surviving citizen spouse.  So to be clear, the estate tax currently affects very few people, about 5000 per year.

Proponents of an estate tax feel that it is a socially beneficial tax because it prevents wealth from being concentrated in the hands of a few.  Moreover, because wealth generally equals power, it also means that you are avoiding concentrating power in the hands of just a few individuals.  Opponents of an estate tax feel that if a person has already been taxed on their income, they should be able to do what they want with the money, including giving it away to their heirs without having to pay another tax.  They also object to the fact that frequently a decedent’s wealth is illiquid, because they own real estate or a business, and they are forced to sell assets off in order to pay the taxes.

However, I won’t go into the merits of either argument, as that is not the purpose of this article.

Specifically, my concern is that under the new tax act proposed by the Republican party leaders, they would like to repeal the federal estate tax while maintaining both the step-up in basis provisions under Section 1014 of the Internal Revenue Code and the ability of taxpayers to depreciate their rental property under Section 179. 

In order to understand the gobbledygook that I just said, you need to understand depreciation and you also need to understand basis. The simplest way to understand depreciation is that the government gives you the ability to deduct the cost of an asset over its useful life.  Different assets have different depreciation schedules.  For purposes of this article, you should know that rental property (but not the land) can depreciated over 27.5 years.  So, if you purchased land and a building for $4 Million, and the building was worth $2.75 million, you would be able to deduct $100,000 per year on your taxes for close to three decades.

The simplest way to understand basis is that the basis of an asset is generally the price you pay for something.  In other words, if you pay $20 for Apple stock, your basis is $20.  If you sell it for $100, you have an $80 gain.  With a 20% capital gains tax rate, the tax on that would be $16.

Basis in real estate is more complex because it is increased by capital improvements and decreased by depreciation.  So if you bought that building for $4 million, and spend $200,000 fixing up the bathrooms, the new basis will be $4,200,000.  (Let’s allocate $2.95M to the building and $1.25M the rest to the land.)  If you sell it for $5 million, there will be $800,000 of gain.  To take this example further, let’s say you have been renting this building out for 30 years and depreciated it that entire time, you would have received a tax deduction for about $110,000 each year.  However, because you had depreciated the property, the basis in the land would still be $1.25, but the basis in the building would be $0.  Therefore, upon a sale, there would be a total gain of $3.75M.  Equally as important, $2.95M of that gain would be treated as ordinary income and the balance would be treated as capital gain.  (Total taxes of about $1.4 million.)

Under the current tax laws, whenever a person dies, the beneficiary of that person’s estate receives a new basis in all assets owned by the decedent.  This concept is known as receiving a step-up in basis.  The original policy reasoning behind allowing for a step-up in basis is that it would be unfair for a person to pay both an estate tax and a capital gains tax when the asset was sold. 

So in the example above, if you had kept that building until your death, it would have received a new basis equal to $5 million, then if your kids sold it for $5 million, there would be no gain on the sale, therefore would have been NO TAX.  As mentioned, the proposed tax law does not change this.
More importantly, since the heirs would receive the property with a stepped up basis of $5 million dollars, they could decide to depreciate it AGAIN and receive a tax write-off of close to $150,000 per year for another 27.5 years. 

The policy of having a step-up in basis makes sense so as to avoid a double tax, but it also makes sense because so many people have trouble tracking what they originally paid for things.  Accordingly, the government thought that a step-up would make it easier to track basis.  Back when the estate tax threshold was $1,000,000, everyone benefited from this step-up rule, and it was not a significant tax policy concern because wealthier individuals would be paying the estate tax instead of a capital gains or income tax.  Basically, back before 2001, only people with less than $1 million dollars could take advantage of this loophole.

Under the current law, people with assets under $5.5 million ($11M for married couples) can take advantage of this loophole, but the estate tax still prevents the ultra-wealthy from doing so. 

Under the tax law proposed by the Republicans, not only would the ultra-wealthy become eligible for this loophole, they could do it over and over again at every generation, meaning that you are effectively giving birth to a class of individuals who will be born with a tax deduction.  Literally passing on a rental property to an heir means you would be passing on the ability to deduct have a reduced income for income tax purposes.  Taken to an extreme, this would consolidate wealth and power in the hands of a few individuals.  This will stifle social mobility as land will become the most valuable commodity and create a feudalistic system similar to what existed in Europe for ages.

As far as I am aware, all other countries that have an estate tax also have a step-up in basis rule to avoid a double tax.  Countries that do not have an estate, inheritance tax or some other sort of death tax, do not allow the basis of a decedent’s assets to be adjusted on death because that would mean a person’s assets could never be taxed.

The solution to this problem is quite simple though.  Keep the estate tax.  Alternatively, don’t allow a step up in basis upon death.  I am not currently suggesting that we remove the depreciation deduction provision as I believe that we should encourage people to buy property.  As long as they pay tax on it sometime, society will be fine.

In summary, the proposed tax law allows for the creation of a new and more powerful class of land owners by combining 3 tax breaks that were not meant to be combined:
  1. Repealing the estate tax (meaning that wealthy land owners pay no tax upon their death);
  2. Maintaining the Section 1014 step up in basis for all assets  - This means that if a real estate mogul purchased land and buildings for $20,000,000 and it was worth $200,000,000 at the time of the mogul’s death the heirs would inherit it at a new basis of $200 million.
  3. Allowing for depreciation of rental Property. During the mogul’s lifetime, he could depreciate the property get a tax deduction of over $700,000 per year and upon the mogul’s death, his heirs could do it again at a much higher level.
By combining these three provisions, the heirs described above would receive a property worth $200 million tax free. They could then either (i) sell the land and buildings for $200 million dollars and never pay any estate tax, income tax or capital gains taxes; or (ii) keep the real estate and depreciate it from its new stepped up basis of $200 million, not just the original $20 million purchase priceThe heirs of mogul, after paying no taxes ever on this property, would be able to receive approximately a $6 million annual tax break for doing nothing other than inheriting property!

What makes this amazing is that this can happen at EVERY GENERATION! Each time a parent passes away, the heirs would inherit tax free and then they would get to depreciate the property with a new increased basis. People would literally be born into a situation where they are inheriting millions of dollars worth of tax deductions.

Tuesday, October 3, 2017

Can the Trustee of a New Jersey Special Needs Trust Buy Clothing?

Although the federal government clearly changed the rules in 2005 to allow a Trustee of a First Party Special Needs Trust to buy an unlimited amount of clothing for person receiving Medicaid and SSI, there is still a lot of confusion regarding this issue in New Jersey.

New Jersey Administrative Code Section 10:71-4.11, which was enacted in 2001, states that if a Trustee of a Special Needs Trust purchases clothing for someone who has qualified for Medicaid or SSI, it will be considered income to the beneficiary and could reduce the beneficiary's government benefits.  Moreover, if the trust allowed distribution for purchase of clothing, it had the possibility of having the entire trust counted as an asset that may disqualify the beneficiary from benefits.  THIS IS OLD LAW.

To quote from the new law, POMS S.I. 01130.430: "A change in the regulations, effective March 9, 2005, establishes that the resource exclusion for household goods and personal effects no longer has a dollar limit. As a result, beginning with resource determinations for April 2005, SSA no longer counts household goods and personal effects as resources to decide a person’s eligibility to receive Supplemental Security Income (SSI) benefits."  The 2005 law goes on to define "personal effects" to include clothing.

There are several reasons why things are still so confusing:

  1. New Jersey has not updated the Administrative Code to reflect the change of law on the federal level by POMS S.I. 01130.430.  The Social Security Regulations clearly override any state rules with respect to eligibility for Medicaid and SSI benefits.  So when Social Security updated its rules in 2005, the NJ rules were automatically updated as well.
  2. When looking up the NJ rule online, there is a lot of bad, old information on many websites.
  3. When looking up the NJ Administrative Code, which is free on Lexis-Nexis (thank you by the way), unfortunately it has the most recent year next to the Code.  That has the unfortunate side effect of making it look like a new and current law, even if it is not.
So, to be clear - a Trustee of a Special Needs Trust (regardless if it is a first party trust or a third party trust) can buy clothes for the beneficiary and not be concerned that such expenditures will be counted as income or that the beneficiary will lose his or her government benefits.  That being said, if you are spending an excessive amount on clothes, you should probably expect extra scrutiny from the government and potential problems because they could make the argument that the person is just taking the clothes back in exchange for cash, and the fight wouldn't be worth it.

Thursday, September 7, 2017

Keep an Eye on Your Credit - Equifax Breached

In perhaps one of the largest security breaches ever, the credit reporting agency Equifax has admitted that criminal hackers have had access to over 143 Million consumers' files, including names, Social Security Numbers, birth dates, addresses and driver's licenses.  Make sure you monitor your credit very carefully with a reputable agency.  For more information, see this USA Today news article.

Wednesday, August 30, 2017

Terry Pratchett's Executor Destroys Unpublished Work of Author

As a fan of the works of Author Terry Pratchett, in particular Going Postal and Making Money, I got a chuckle out of this story in the New York Times.  As some of you are aware, Terry Pratchett died in 2015.  One of his last wishes was that all of his unpublished works be destroyed by a steamroller.  A few days ago, Rob Wilkins, his estate manager posted a picture of a steamroller running over a hard drive.

Compare what Terry Pratchett did with what the Administrator of Prince's estate is doing.  Comerica Bank and Trust, as Trustee of Prince's estate, is slowly analyzing all of Prince's unpublished works and the plan is to release an album shortly to maximize the value of the estate.  Whether or not Prince would have wanted the works to be released is debatable, but because he did not leave clear instructions, an Administrator is obligating to exploit the assets as best it can so that his heirs receive the most money possible.

Remember, if you have written any books or have any other intellectual property where you wish to control of their disposition after you pass away, you must leave specific instructions for what you want done in your last Will and Testament (or other estate planning documents).  You may also name a separate executor or agent to manage your intellectual property (who may be distinct from the person managing the rest of your financial affairs).

Friday, August 18, 2017

Will the New Jersey Estate Tax Repeal Become Permanent?

As most of my estate planning clients are aware, I have been very cautious regarding whether or not New Jersey will keep a $2,000,000 estate tax exemption beyond 2017 or allow for a full repeal. However, it is worth noting that the front-runner for Governor, Phil Murphy, released part of his tax and spending plan today.  See this article on NJ.com: http://www.nj.com/politics/index.ssf/2017/08/murphy_tax_plan_would_raise_13_billion_heres_whod.html

As part of the plan, he stated that he has NO intentions of re-introducing the estate tax.  Accordingly, there is probably a good chance that the repeal of the NJ Estate Tax does become permanent.  Only time will tell though.

Wednesday, August 9, 2017

NJ Has Finally Released 2017 Estate Tax Return and Calculator

As I know many of you have been waiting anxiously, I wanted to make sure that you are aware that the New Jersey Division of Taxation has finally released the 2017 Estate Tax Return form.  They have also released an estate tax calculator so that we can accurately prepare the return.  The NJ 2017 Estate Tax Calculator can be downloaded from the NJ Department of Treasury website.

The New Jersey Estate Tax Calculator is important because the new estate tax law was crafted with a slight flaw in it because it has a circular calculation.  (This means the tax can't be calculated without reference to the tax, which in effect, changes the tax, over and over again.) For example, if you were to look at the statute, you may think that if you had an estate of $2,001,000, the estate would be taxed at 7.2% on the $1,000 that you were over the $2M threshhold.  This is not true.  According to the calculator, the tax is $66.82, not $72.  As the numbers get higher, this obviously becomes more important.

Anyway, the good news is that if you are an executor, administrator or involved in an estate of someone who passed away in 2017, you can now start the process of filing a New Jersey estate tax return.