3 Last-Minute Income Tax Strategies

Photo credit: Lendingmemo

Photo credit: Lendingmemo

Scrambling as we approach April 18th? Here are three last-minute tax strategies to harness for proper management of the deadline.

If you need additional time to file your personal income tax return, file an extension:

The deadline to file your tax return is April 18, 2016 (April 19, 2016, if you live in Maine or Massachusetts).

If you cannot file your return on time, apply by the due date of the return for an extension.  You can receive an automatic six-month extension for your personal income tax return if you file Form 4868 by the tax filing deadline.  (If you are mailing the extension, you should mail it certified with a return receipt, so that you have proof of the mailing date.) The extension gives you until October 17, 2016 to file your 2015 return.

This extension is for filing only and does not allow you more time, without penalty, to pay your tax liability for 2015.  Although the extension will be allowed without payment, you will be subject to interest charges and possible late payment penalties on 2015 taxes not paid by April 18th (or April 19th in Maine or Massachusetts).

If the amount paid with Form 4868, plus withholding and estimated tax payments for 2015, are less than 90% of the amount due, you will be subject to a late payment penalty (one-half of 1% of the unpaid tax per month).

If you are out of the country on the tax filing due date:

You do not get an automatic extension for filing your tax return due to being out of the country on the filing due date.

The only exceptions are for US citizens and US residents who live and have their main place of business outside of the US, and for military personnel stationed outside the US.  If you qualify, you will be allowed an automatic, two-month extension until June 15, 2016, without the need to request it.  However, interest will be payable from the original April 18th/19th due date on any unpaid taxes.  If you cannot file within this two-month period, you should get an additional four-month extension by filing form 4868 by June 15, 2016.  Also, a late payment penalty may be imposed on any tax liability not paid by June 15, 2016.

Extension of time to file returns other than personal income tax returns:

An estate or trust, which has a due date of April 18th/April 19th, can apply for an automatic five-month extension, using Form 7004 (until September 15, 2016).

A private foundation has a filing due date of May 15, 2016 and can apply for an automatic three-month extension, using Form 8868 (until August 15, 2016). It can also file for an additional three-month extension if it provides an adequate explanation why the return cannot be filed by the extended due date.  The IRS will evaluate the application based on the organization’s efforts to fulfill the filing requirements, rather than on the convenience of their tax professional.  The IRS instructions provide that, if the foundation’s tax professional is unable to complete the return by the due date for reasons beyond its control, such as the financial statements or books and records require further review and analysis, the IRS will generally grant the additional three-month extension.

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McManus Weighs in on “Ways the Rich Waste Their Money” for GOBankingRates

GoBankingRates logoToday GOBankingRates, which has nearly 350,000 readers, launched an interesting slideshow, “21 Ways the Rich Waste Their Money.” For #6 and #7 on the list, journalist Lia Sestric shared two examples of wasteful spending flagged by John O. McManus, founding principal of McManus & Associates. From the slideshow intro:

When you’re rich, you have more money than you know what to do with. But unfortunately, sometimes having too much money can lead to waste.

From the slideshow, here are two ways some rich people waste their money, compliments of McManus:

  1. Buying Ridiculously Expensive Cars for Kids

Estate planning attorney, John McManus of McManus & Associates, said there’s no reason to buy outrageously expensive, exotic vehicles for teenagers and young adults — especially those who have a record of making bad judgment calls. “A 21-year-old is still developing the frontal lobe of the brain where all the judgment and discerning ability lies,” he said.

Although certain luxury cars might become classics, some might not be worth the hefty price tag in the end thanks to depreciation. “The disproportionate majority of exotic cars more typically depreciate instantly when they roll off the lot,” said McManus. “Even if they don’t, the slightest accident can impact value permanently, sometimes to pennies on the dollar.”

  1. Trying to Launch Their Kids’ Sports Careers

All parents want the very best for their children, and rich people have the money to make it happen. And those who want their kids to launch a career in sports are willing to pay the big bucks to make their dreams a reality.

“Club team dues alone can be $3,000 to $5,000 a year, plus tournaments, private training and out-of-state travel, including flights across the country,” said McManus. But spending thousands of dollars on club teams and sports for a young child can be a total waste of money if the child doesn’t even want to be an athlete.

Here are expanded thoughts from McManus:

[6.] Wealthy individuals buying outrageously expensive exotic vehicles for still-developing young adults is one of the single greatest abuses often tied to the privilege of affluence—one that I hope to see infrequently in my practice. There is no sufficient reason to lavish a $250,000 Aston Martin on an 18-year-old or even a 22-year-old college graduate. The suitor for this 3,500 pound missile should not be a 21-year-old still developing the frontal lobe of the brain where all the judgement and discerning ability lies. Further, while certain exotics such as the DB11 may become an instant classic, the disproportionate majority of exotic cars more typically depreciate instantly when they roll off the lot; even if they don’t, the slightest accident can impact value permanently, sometimes to pennies on the dollar.

For the 21 year old who demonstrates advanced capacity to drive within the speed limit—a rare occurrence since the slightest touch of the gas rockets the vehicle to 65 MPH—this only ameliorates part of the risk: these exotics have very low clearance and their undercarriage can be torn apart pulling off the street heading up an inclined driveway or approaching a speed bump without aplomb and great caution or the inexact science of delicately approaching the curb in favor of scraping the nose underneath by getting too close. Further, law enforcement, not to mention new acquaintances, attracted to glitter and bling, develop the “mistaken” impression that one’s child is spoiled, flush with cash, and, of course, above the law not inoculated from affluenza. Red vehicles, often the color of the exotics, are pulled over more than any other color. These realities should paint the picture of a stop sign in parents’ minds. It’s not arbitrary that auto insurance companies charge male drivers under the age of 25 more for insurance; statistically speaking, they’re involved in more car accidents. Teens and 20-Somethings think it’s cool to drive fast; the rich should not strap their kids to a 3,000-pound rocket and expect to protect their investment and, even more so, their child.

[7.] While some rich folks feel like they have plenty to burn, spending gobs of money on a child’s club or academy sports career, frequently starting in early elementary and continuing into early adulthood, is an extravagance, more times than not. Club team dues alone can be $3,000 to $5,000 a year, plus tournaments, private training and out-of-state travel including flights across the country. Clubs justify that it is necessary for greater visibility of your child for their future careers, but more frequently the top motive is to get greater visibility for the club, to increase membership, and garner more fees. It’s a rare event that challenging and diverse competition can’t be had within just a few hours of travel. From traveling teams to high-dollar private coaches, clinics and tournaments, many wealthy families wrap up their dollars and time away from family and siblings in athletic development for years, only to be met with a career-ending injury, a burned-out teen, or the reality that playing professional or getting recruited just isn’t in the cards. One brilliant and thoughtful coach said, “If you want to see your child a success in life, get them a tutor for their studies and worry less about this team sport” – that is rarely professed.

Certainly, playing sports offers an invaluable learning experience for young people and can contribute to a well-rounded adolescence, but parents should do a gut check every year to ensure they’re not throwing dollars or family time (with the whole family) down the drain to live vicariously through their children. Vacations are missed, resentment is bred and thousands of dollars may be irretrievable.

To see Sestric’s full slideshow for GOBankingRates, click here.

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Many Millionaires Are Down on the Stock Market – Should You Be?

Last Friday, Brian O’Connell penned a piece for TheStreet on what millionaires being down on the stock market means for regular investors. Here are thoughts from John O. McManus, founding principal of McManus & Associates:

With the wealthy keeping a tight rein on their dollars, the market remains flat to down. Because millionaires feel poorer, they’re spending less on creature comforts, which can cause the economy to slow. We saw this in the Great Recession – fewer vacations and pricey dinners, less frequently cut lawns and cleaned pools, and fewer wallets opened for cars, high-end fashion, jewelry and more. When millionaires are soured on the market, regular investors should view this as a red flag, because the rich tend to spend the most on guidance from top-notch advisors and can afford to be patient and invest for the long-haul. If millionaires are pulling out of the market or not investing, there’s no reason regular investors should do the opposite. That said, many millionaires may still be invested in the market, because they can afford to take a long view.

Click here to read O’Connell’s story, “Why So Many Millionaires Are Down on the Stock Market And What That Means to Main Street Retirees.”

How should your investment strategy shift in light of a shaky stock market? Set up a time for a discussion with McManus & Associates by giving us a call at 908-898-0100.

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MarketWatch Publishes Article on Cutting Capital Gains Authored by McManus

Sidebar_Logo_Marketwatch

 

5 ways to protect your estate from capital gains taxes

Published: Dec 25, 2015 6:04 a.m. ET

Traditional estate planning is being turned on its head

By JOHN O. MCMANUS

The time-honored approach to estate planning is being turned on its head by significant tax law changes that have taken effect in recent years.

Long-term capital gains tax rates now range from 25% to 33% (when you add together the top federal, state and local rates and Obamacare’s Medicare surtax). So now that the federal estate tax exemption is $5.43 million ($10.86 million for a couple’s combined exemptions), many Americans may no longer be exposed to federal estate taxes, making taxes on income and capital gains more prominent.

In fact, some legal practitioners who spent the first half of their careers zealously transferring assets out of their clients’ estates to avoid estate taxes now expect to spend the second half pushing assets back into their clients’ estates because the estate planning paradigm has changed.

What are the best ways to strategize around capital gains taxes to keep them as low as possible?

Rundown of the tax rules for gifts

To answer that, it helps to first understand the rules about gifts and taxes.

If you give assets to family members or put them into a trust to minimize estate taxes and the assets have appreciated significantly, when they’re sold, the gain (the amount that is taxed) is the difference between your original purchase price and the sale price at the current market value.

That purchase price is known as your “cost basis” (adjusted for any stock splits and dividends). With residential real estate, basis can increase depending on capital improvements to the property; for commercial real estate, basis can be adjusted due to depreciation. Examples of assets with a low basis: Exxon stock your grandfather gave you years ago when he was alive or the Brooklyn brownstone you bought in the 1970s that has appreciated in value by several million dollars.

Without strategic planning, $33,000 in capital gains taxes may be due when an asset is sold with a $100,000 gain, leaving the net proceeds at just $67,000.

When the owner of an asset passes away, the asset’s basis can shift upward, which shrinks the amount of gain that will eventually be taxed upon its sale. The basis then gets reset to the fair market value at the date of death. This is called a “step-up” in basis, and it is essential to many income and gains tax planning strategies. When assets are included in an estate, the Internal Revenue Service (IRS) gives you a capital-gains tax break because of the step-up in basis upon death.

5 capital-gains cutting strategies

Here are five ways you might be able to reduce your capital gains taxes through timely estate planning strategies:

First, consider undoing a trust. Assets that were gifted into trust are not part of an estate, but putting them back into the estate could avoid capital gains taxes.

For example, once a home has been given by a parent to a child and put into trust, the parent can’t live in the home without a lease and scheduled rent payments. But if you decide to live in the home without paying rent, terminate the lease, and create an agreement saying your intention is to undermine the previous trust transfer, the home gets clawed back into the estate.

Second, consider ”upstream gifting.” This is a strategy that involves transferring an asset up the generational chain to an older family member (like your parent) or a trust for the benefit of the older family member. This allows the asset to achieve a step-up in basis at the time of the parent’s death (inherited assets receive a step-up upon death but gifts have no step-up). Upon the parent’s passing, he or she would leave the asset back to the child who made the gift or to his or her descendants. The asset could then be sold, with the new high basis at current market value, free of capital gains tax, on the one condition that the parent survived the transfer from the child by at least one year.

Third, if you and your spouse have highly-appreciated assets, you could consider using a special type of trust. It’s a Joint-Exempt Step-Up Trust (JEST) or an Estate Trust or, if you live in Alaska or Tennessee, a Community Property Trust. Each lets the surviving spouse sell an appreciated asset without the imposition of any capital gains tax after the first spouse’s death. In effect, they provide the benefit of a step-up in basis to current market value upon the passing of the first spouse, so the surviving spouse can sell the appreciated asset without owing any capital gains tax.

These are valuable strategies because it is quite common for assets to be jointly owned between spouses, and the typical step-up in basis upon the death of the first spouse would apply to only 50% of the asset, rather than its full market value at the time.

Just make certain there is a separate side agreement saying this property is treated as community property.

Fourth, take advantage of the home sale tax exclusion. It lets homeowners exclude up to $250,000 of capital gain ($500,000 for a married couple) when they sell if they’ve owned and lived in the home for at least two out of the past five years before the sale.

Fifth, if you have a real-estate investment or artwork you bought as an investment, use a 1031 Exchange. This is a strategy that lets you delay capital gains taxation by rolling over the sale proceeds from the original asset into a new, similar property or piece of art — known as a “like-kind” investment. The new investment takes the original basis, which is carried over based on the original basis of the asset.

When it comes to your estate plan, it may be time to say “out with old and in with the new.”

John O. McManus is founding principal of McManus & Associates, a trusts and estates law firm based in New Providence, N.J.

This article is reprinted by permission from NextAvenue.org, © 2015 Twin Cities Public Television, Inc. All rights reserved.

http://www.marketwatch.com/story/5-ways-to-protect-your-estate-from-capital-gains-taxes-2015-12-25

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Forbes Confers with McManus on Intra-Family Loans

Forbes

 

Are intra-family loans now a steal? According to a recent story from Ashlea Ebeling of Forbes, the answer is a resounding “yes!” John O. McManus recently spoke with Ebeling on the topic, of which you should take note. From the article:

The terrifically low rate you can use for a short-term intra-family loan is just 0.56% for loans up to three years. Go out up to 9 years and the rate is 1.68%. For loans of 10-years-plus, it’s just 2.61%.

As Ebeling points out, intra-family loans are a good option for parents and grandparents who want to help buttress future generations with buying a house or opening a professional practice, for example. And what if you were to loan $1 million to a family member who then uses it for a private equity investment that doubles to $2 million? From the story:

“I’ve just made $1 million on her balance sheet instead of mine,” explains John McManus, an estate lawyer in New Providence, N.J. who just helped a developer father loan his son the money to invest in distressed commercial real estate in Newark.

Ebeling explains that there’s a new sense of urgency with interest-rate sensitive techniques such as intra-family loans, as the Fed will soon increase rates.

For those who wish to capitalize on the opportunity, McManus shares an important point: If you make a loan to your kids, you need clear terms and documents to back it up. An excerpt from Ebeling’s article:

“People aren’t fastidious about paying the loans back. If you’re not paying it back, then the IRS says you’ve made a gift,” McManus says. He recommends terms that require the kids to pay interest on an annual basis and tells clients to put reminders on their calendars to remind their kids to pay. In a pinch, parents can give kids annual exclusion gifts (for 2016, you can give $14,000 to as many individuals as you’d like without triggering gift taxes) to help them pay the interest. Another technique is loaning them a little extra so they’ll have the money in reserve to pay the interest. Note: Any interest the kids pay is taxable income to you, but if you’ve lent a child less than $10,000 in total, you don’t have to charge interest.

For more tips on intra-family loans, head on over to Forbes and read Ebeling’s full article “Tax-Free Transfer: Intra-Family Loans Are A Steal Now.” For help with setting up an intra-family loan and to take advantage of other estate planning techniques, contact McManus & Associates at 908-898-0100.

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InvestmentNews Features McManus Column for The Tax-Conscious Adviser

Below is an advice column on capital gains tax strategies by John O. McManus that was published by InvestmentNews for its regular feature, “The Tax-Conscious Adviser.”

Investment News

 

 

tax concious adviser

Estate plans require a fresh look

Thinking around bequests shifts as capital gains tax and estate tax exemption rise

Nov 29, 2015 @ 12:01 am

By John O. McManus

Significant tax law changes mean it’s time to dust off your estate plan. Long-term capital gains tax rates now range from 25% to 33%, with the combination of the top federal, state and local rates and the Medicare surtax. This hike in capital gains tax rates, coupled with the greater federal estate tax exemption, calls for a fresh look at planning strategies.

With the current $5.43 million federal estate tax exemption ($5.45 million for 2016), many people may no longer be exposed to federal (and possibly state) estate taxes. Thus, maneuvering around capital gains tax becomes the primary concern.

While basis is typically the purchase price less adjustments, basis can change or jump upward significantly upon inheritance, which is called a “step-up in basis.” With a step-up in basis, the value of the asset is determined to be the market value of the asset at the time of the step-up.

Historically, practitioners moved assets out of the individual’s estate while that individual was alive to avoid estate tax. However, when assets are gifted during a lifetime, the step-up in basis is not deployed. When assets are included in an estate, they may be subject to estate tax (in today’s environment, not always), but certainly the assets in the estate enjoy a step-up in basis and significant gains tax can be avoided.

UNDERMINE PRIOR GIFTS

How does one employ a step-up in basis when assets have already been irrevocably transferred during lifetime, theoretically surrendering the opportunity to obtain a step-up in basis? One strategy may be to intentionally undermine a prior gifting plan so that assets can be included in the estate to achieve the step-up in basis upon death, particularly if those assets would not otherwise be subject to estate tax.

Next, transferring an asset “up-stream” to a trust for the benefit of the donor’s parents allows an asset to get a step-up in basis upon the parents’ death and then the asset passes back to the donor or his or her descendants in trust. The asset could then be liquidated free of capital gains tax.

Another potentially avoidable problem is tied to older Americans each owning a half interest in their primary residence. After one spouse passes away, the surviving spouse may wish to sell the real estate, but only half of the property received the step-up obtained from the deceased spouse. Trying to move the entire residence to the infirmed spouse’s name prior to death is clever, but the IRS has significant restrictions. What you can do is employ a community property trust with a home (or situs) in Alaska or Tennessee, a joint-exempt step-up trust (JEST), or estate trust while both spouses are not facing imminent death. These moves can provide the benefit of a step-up in basis on the entire residence upon the passing of the first spouse, so the surviving spouse can sell the appreciated asset without the imposition of any capital gains tax.

The tax code permits owners of homes to exclude up to $250,000 of capital gain if they have owned and lived in their home for at least two years out of the five years before a sale. For a married couple, the amount is $500,000. With this strategy, one may be able to exclude some or all of the gain that is taxed on the sale of one’s principal residence. If a surviving spouse sells the home in the year their spouse passes away, they can still file jointly and use both exemptions.

1031 EXCHANGE

When working with investment property including residential rentals, a 1031 exchange enables one to postpone the capital gains taxation by rolling over the sale proceeds into a new investment. A separate corporation needs to be set up to receive the sale proceeds and make the new purchase (all within a short period of time of each other), but it is a wonderfully effective strategy.

Finally, when gifts of appreciated long-term assets are made to charity, no capital gains taxes are owed, because they are donated to charity, not sold in the donor’s name. If you’re holding securities with a loss, it’s better to sell them first, then take the capital loss for tax purposes, and thereafter donate the cash. A charitable remainder trust allows you to make the gift, retain an annuity stream back to the donor in a tax-efficient manner and later contribute it to a charitable entity run by the family making donations to favorite charities.

John O. McManus is an estate planning attorney and the founding principal of McManus & Associates.

http://www.investmentnews.com/article/20151129/FREE/311299996/estate-plans-require-a-fresh-look

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John O. McManus Featured Expert for Next Avenue (PBS)

The following article written by John O. McManus first appeared on Next Avenue (PBS).

Next Avenue logo

 

 

5 Ways to Keep Capital Gains Taxes Down

How traditional estate planning is being turned on its head

By John O. McManus

November 23, 2015

FEATURED EXPERT

The time-honored approach to estate planning is being turned on its head by significant tax law changes that have taken effect in recent years.

Long-term capital gains tax rates now range from 25 percent to 33 percent (when you add together the top federal, state and local rates and Obamacare’s Medicare surtax). So now that the federal estate tax exemption is $5.43 million ($10.86 million for a couple’s combined exemptions), many Americans may no longer be exposed to federal estate taxes, making taxes on income and capital gains more prominent.

In fact, some legal practitioners who spent the first half of their careers zealously transferring assets out of their clients’ estates to avoid estate taxes now expect to spend the second half pushing assets back into their clients’ estates because the estate planning paradigm has changed.

What are the best ways to strategize around capital gains taxes to keep them as low as possible?

Now that the federal estate tax exemption is $5.43 million, taxes on income and capital gains have become more prominent.

Rundown of the Tax Rules for Gifts

To answer that, it helps to first understand the rules about gifts and taxes.

If you give assets to family members or put them into a trust to minimize estate taxes and the assets have appreciated significantly, when they’re sold, the gain (the amount that is taxed) is the difference between your original purchase price and the sale price at the current market value.

That purchase price is known as your “cost basis” (adjusted for any stock splits and dividends). With residential real estate, basis can increase depending on capital improvements to the property; for commercial real estate, basis can be adjusted due to depreciation. Examples of assets with a low basis: Exxon stock your grandfather gave you years ago when he was alive or the Brooklyn brownstone you bought in the 1970s that has appreciated in value by several million dollars.

Without strategic planning, $33,000 in capital gains taxes may be due when an asset is sold with a $100,000 gain, leaving the net proceeds at just $67,000.

When the owner of an asset passes away, the asset’s basis can shift upward, which shrinks the amount of gain that will eventually be taxed upon its sale. The basis then gets reset to the fair market value at the date of death. This is called a “step-up” in basis, and it is essential to many income and gains tax planning strategies. When assets are included in an estate, the Internal Revenue Service (IRS) gives you a capital gains tax break because of the step-up in basis upon death.

5 Capital-Gains Cutting Strategies

Here are five ways you might be able to reduce your capital gains taxes through timely estate planning strategies:

First, consider undoing a trust. Assets that were gifted into trust are not part of an estate, but putting them back into the estate could avoid capital gains taxes.

For example, once a home has been given by a parent to a child and put into trust, the parent can’t live in the home without a lease and scheduled rent payments. But if you decide to live in the home without paying rent, terminate the lease, and create an agreement saying your intention is to undermine the previous trust transfer, the home gets clawed back into the estate.

Second, consider “upstream gifting.” This is a strategy that involves transferring an asset up the generational chain to an older family member (like your parent) or a trust for the benefit of the older family member. This allows the asset to achieve a step-up in basis at the time of the parent’s death (inherited assets receive a step-up upon death but gifts have no step-up). Upon the parent’s passing, he or she would leave the asset back to the child who made the gift or to his or her descendants. The asset could then be sold, with the new high basis at current market value, free of capital gains tax, on the one condition that the parent survived the transfer from the child by at least one year.

Third, if you and your spouse have highly-appreciated assets, you could consider using a special type of trust. It’s a Joint-Exempt Step-Up Trust (JEST) or an Estate Trust or, if you live in Alaska or Tennessee, a Community Property Trust. Each lets the surviving spouse sell an appreciated asset without the imposition of any capital gains tax after the first spouse’s death. In effect, they provide the benefit of a step-up in basis to current market value upon the passing of the first spouse, so the surviving spouse can sell the appreciated asset without owing any capital gains tax.

These are valuable strategies because it is quite common for assets to be jointly owned between spouses, and the typical step-up in basis upon the death of the first spouse would apply to only 50 percent of the asset, rather than its full market value at the time.

Just make certain there is a separate side agreement saying this property is treated as community property.

Fourth, take advantage of the home sale tax exclusion. It lets homeowners exclude up to $250,000 of capital gain ($500,000 for a married couple) when they sell if they’ve owned and lived in the home for at least two out of the past five years before the sale.

Fifth, if you have a real estate investment or artwork you bought as an investment, use a 1031 Exchange. This is a strategy that that lets you delay capital gains taxation by rolling over the sale proceeds from the original asset into a new, similar property or piece of art — known as a “like-kind” investment. The new investment takes the original basis, which is carried over based on the original basis of the asset.

When it comes to your estate plan, it may be time to say “out with old and in with the new.”

http://www.nextavenue.org/5-ways-to-keep-capital-gains-taxes-down/

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McManus Speaks to Year-End Tax Planning Strategies for Investment News

Investment News

 

Reporter Greg Iacurci tackled year-end tax planning strategies in a recent piece for Investment News. To help identify where the focus of advisers should be, Iacurci spoke with John O. McManus, estate planning attorney and founder of McManus & Associates.

The Investment News story, “Year-end tax planning strategies advisers should be considering,” encourages exploration of end-of-year tax considerations now, with just two months left in 2015. As Iacurci points out, “tax rules are largely unchanged,” so “tactics employed last year will more than likely still be relevant.”

Two important considerations? Tax-loss harvesting and moving assets into trust to avoid gains tax. From the article:

Financial markets haven’t been particularly strong this year, which provides an opportunity for advisers to do tax-loss harvesting, according to John McManus, founder of McManus & Associates.

Tax-loss harvesting involves selling assets that have incurred losses in taxable accounts to offset taxes due to gains elsewhere in the portfolio. It’s a strategy advisers especially turned to following recent bouts of market volatility.

“Given the markets have been flat, for sure you should be picking through your portfolio to find the pieces that have losses and harvest those,” Mr. McManus said.

Through Oct. 29, the S&P 500 index was up 1.5% for the year.

Market performance this year also creates a tax opportunity from an estate-planning standpoint, Mr. McManus added.

For example, there’s a federal tax exemption for assets up to $5.43 million, and anywhere from $675,000 to $5 million at the state level, when transferred upon death. For assets beyond these thresholds, tax rates are 40% and roughly 10%, respectively, Mr. McManus said.

However, clients can essentially accelerate the exemption by establishing a trust during their lifetime, forfeiting the exemption they would have gotten at death.

“This year, since the markets are flat, we’re poised to probably see some [market] growth going forward, so give the assets [to the trust] before the growth takes place,” Mr. McManus said. That way, there wouldn’t be any estate taxes on gains in the trust.

For more important strategies that should be examined to help minimize your tax burden going into the last two months of the year, read the full Investment News story here.

To take advantage of asset preservation opportunities before they expire with the New Year, contact McManus & Associates at 908-898-0100.

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Educational Focus Series: Top 10 Possibilities of Portability

A significant opportunity presented by Uncle Sam, portability was first introduced as part of Tax Relief Unemployment Reauthorization and the Job Creation Act of 2010. It was scheduled to sunset on December 31, 2012 but was made permanent with passage of the American Taxpayer Relief Act of 2012. McManus & Associates, a top-rated estate planning law firm with offices in New York and New Jersey, today released the “Top 10 Possibilities of Portability.” Part of the firm’s Educational Focus Series, the discussion was led by Founding Principal and AV-rated Attorney John O. McManus, who shared guidance on transferring unused federal estate tax exemption amounts and the critical steps that must be taken to utilize this important estate and income tax tool.

LISTEN HERE: “Top 10 Possibilities of Portability”

Photo by GotCredit.com

Photo by GotCredit.com

“Portability is one of the single best gifts that the IRS has given us,” commented McManus. “When people have failed to otherwise use gift tax exemptions, they now have the opportunity to pick up their late spouse’s exemption.”

In general, portability allows a surviving spouse whose husband or wife died after January 1, 2011 to use the Deceased Spouse’s Unused federal estate tax Exemption, otherwise known as DSUE. When one owns assets less than his or her lifetime exclusion amount and passes away first, portability has the potential to correct issues associated with unbalanced asset ownership between spouses and inefficient estate documents that leave all assets to the surviving spouse.

 Top 10 Possibilities of Portability

  1. Time is of the essence. To take Uncle Sam up on his offer, the decedent’s estate must make an election for portability on a timely-filed estate tax return.
    • The IRS may grant a reasonable extension of time to make an election if the taxpayer provides evidence to establish they acted reasonably and in good faith, and that granting relief will not prejudice government interests. Most often an extension of time to make an election is granted if the estate was not required to file a return.
    • The time limit on when the IRS can review the first deceased spouse’s estate tax return is extended until the statute of limitations runs out on the surviving spouse’s estate tax return (starting at 9 months and extension goes to 15 months).
    • The executor with counsel must include the computation of the DSUE amount for which the portability election is to be made.
  2. Executor in charge. Electing portability is the responsibility of an executor.
    • If there is no appointed executor, the “executor” for this purpose is any person in actual or constructive possession of property of the decedent (a “non-appointed executor”).
    • Multiple appointed executors are all required to sign an estate tax return in order for the return to be valid. There is no exception made for a return electing portability.
  3. Who makes the cut? DSUE can be used only by a citizen or permanent resident surviving spouse (not a non-resident alien), during his/her lifetime or at his/her death.
    • Portability is not available if the decedent was not a U.S. citizen or resident, unless otherwise provided by treaty.
    • If a decedent leaves property to a non-citizen spouse in a qualified domestic trust (QDOT), the DSUE amount of the decedent may be included in the surviving spouse’s applicable exclusion amount only after the QDOT assets have been distributed, the death of the surviving spouse, or early termination of the QDOT.
    • A non-US citizen surviving spouse is not able to use the DSUE amount from the deceased spouse to make lifetime gifts except in a situation in which the QDOT has been entirely distributed to the surviving spouse in a year prior to the surviving spouse’s year of death, the surviving spouse has become a U.S. citizen, or the gift was made by the surviving spouse in the year of death.
    • Same-sex surviving spouses who did not file for portability for a death after December 31, 2010 and before January 1, 2014 may file Form 706 and elect for portability retroactively, provided that the executor was not required to file an estate tax return.
  4. The ins and outs of portability. DSUE can be used during one’s lifetime and reported on Form 709 Gift Tax Return, or it can be used at death and reported on Form 706 Estate Tax Return.
    • Only the last deceased spouse’s unused exemption amount is portable. If the surviving spouse remarries and the second spouse dies, the surviving spouse can only use the DSUE of the second deceased spouse.
    • However, the surviving spouse may use the first deceased spouse’s DSUE by making lifetime gifts while the first deceased spouse is the surviving spouse’s last deceased spouse (second spouse has not died).
    • Portability does not apply to the generation skipping tax (GST) exemption outside of trust as this exclusion is separate from the unified transfer tax credit available for estate and gift taxes.
    • The ported DSUE does not index for inflation, which contrasts with the possibility to shelter from estate tax all growth in a credit shelter trust
  5. “Lifetime gifting” – pass it down. Use DSUE to make lifetime gifts, especially if the surviving spouse remarries.
    • Gift assets into grantor trusts for descendants up to the unused federal exemption amount, which would pass state estate tax-free.
    • Be careful in states that have a gift tax (Connecticut and Minnesota).
    • Grantor trusts allow the surviving spouse as the grantor to pay income tax to further grow the assets in trust.
    • The surviving spouse would need to give up control of the assets in trust, but could still borrow against those assets, as well as ”direct” the assets by appointing and removing trustees
  6. Continue to place trust in trusts. Portability is a valuable estate planning tool, but it does not negate the need for trusts to capture state estate tax exemptions and for asset protection.
    • Since state exemptions are not portable, continue to fund credit shelter trusts with the state estate tax exemption amount ($675,000 in NJ; $3,125,000 in NY; and $2,000,000 in CT). Within the credit shelter (state exclusion) trust, the state estate tax exemption is captured (sheltered) for the first deceased spouse’s estate so that both spouses fully utilize the state exemption amount lowering estate tax on their combined estates.
    • All growth in the credit shelter trust will also pass estate tax-free to the remainder beneficiaries (i.e. the children).
    • Amounts above the state exemption should also be in trust (a QTIP (marital) trust) as opposed to outright to provide asset protection for the surviving spouse against attack from third parties. Having the surviving spouse serve as trustee allows for flexibility.
  7. Look before you leap! Planning considerations have shifted with changed tax rates. The traditional strategy of funding a family trust and a marital trust for the surviving spouse now demands more in-depth analysis.
    • The capital gains tax rate has increased and is now a higher rate than state estate tax.
    • Instead of funding into a traditional credit shelter trust with only a step-up at the first spouse’s death, it may be better to fund certain assets into a GST exempt QTIP trust and get a second step-up at the surviving spouse’s death, as well as a GST exempt transfer. A GST-exempt QTIP would also provide for asset protection. This trust will be included in the surviving spouse’s estate but can utilize the ported DSUE to reduce federal estate tax on the second spouse’s death.
    • Low-basis assets (which will experience significant tax on sale) can then be captured in the estate of the surviving spouse to get a second step-up in basis on the surviving spouse’s death.
    • The DSUE will ensure that no federal estate tax will be due on the surviving spouse’s estate provided the total estate is under $10.86MM
    • A less significant state estate tax cannot be avoided, but the step-up in basis on the assets in the surviving spouse’s estate could save over $1.0MM in tax on the gains.
  8. All things considered… How and when to use portability should be evaluated on a case-by-case basis because estate plans are not one-size-fits-all.
    • A surviving spouse who has a DSUE amount should take this into account when negotiating a premarital agreement with a new spouse, and either obtain compensation for the DSUE amount that will be lost (since the new spouse impacts the amount to be ported) or have the new spouse create a lifetime credit shelter trust with assets comparable to the DSUE surrendered from the earlier spouse.
    • There must be an independent fiduciary (executor) who will elect what is in the best interests of the estate, as there may be inherent competing interests.
    • For some individuals, the portability election should be referenced in the estate plan. A provision directing the executor or trustee to elect portability of any unused exemption could be prudent, particularly if it is a second marriage and the children do not want their surviving step-parent to have the exemption or other situation where family tension is likely.
  9. States have yet to follow in the footsteps of Uncle Sam. Portability is not applicable on the state level.
    • Currently, there is no portability for the state estate tax exemption amount.
    • It is still necessary to capture the state estate tax exemption amount in a trust to ensure that both spouses’ state exemptions are maximized.
    • New York has been explicit that its move to equalize the state exemption with the federal exemption does not include portability.
    • Even when combining exemptions, there will likely still be a state estate tax.
  10. Should it stay or should it go now? It’s important to recognize that portability may not last forever.
    • Portability could disappear if the tax law changes; however, it attracted strong bipartisan support in Congress.
    • If portability is eventually repealed or modified, those who rely on it as an estate planning device could pay millions in unnecessary taxes if they have not already made the election.
    • Balancing the use of portability and trusts for the surviving spouse may provide the best protection against estate tax moving forward.
    • There must be a keen analysis performed after death to address the long term consequences, and if possible a pre-mortem analysis performed to assure that investment positions are still properly held.

For first-class assistance with estate and income tax planning, call McManus & Associates at 908-898-0100.

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