Adding “alpha” to client relationships may be easier through effective estate and tax planning than with investment manager selection or portfolio construction. Potential changes to the tax code illustrate many of those planning opportunities.
Yulissa Zulaica, an estate planning specialist, spoke on June 1 at the FPA NorCal Conference, which was held virtually. She is a partner at the law firm of Johnston, Kinney and Zulaica, LLP.
Zulaica identified many of the key areas where advisors can add value through estate planning. Use this article as such – a list of opportunities worth investigating – and consult an attorney like Zulaica for specific guidance. Advisors should work in a “trio” that includes an estate planning attorney and accountant to provide clients with the best outcomes.
Zulaica began by stressing that each relationship is unique, and advisors must understand their clients’ goals and preferences. She gave an example of using charitable trusts, which she said are effective but only for certain clients. If a client is not charitably inclined or has a legacy that is not intended for a charity, then a charitable remainder trust (CRT) is not appropriate.
She has a client with several hundred million dollars, and they want to protect it from irresponsible children. That requires carefully drafted trusts and other arrangements.
The gift and estate tax exemption is $11.7 million, adjusted for inflation, but that is scheduled to sunset in 2026 to approximately $6 million unless there is a change. The maximum tax rate is 40%, and some states impose additional taxes. Bernie Sanders’ proposed “99.5%” act would change the exemption to $3.5 million and GRATs, a popular estate planning strategy, would have a minimum of 10 years. GRATs, she said, have been attacked as a tool that benefits primarily the wealthy and she speculated that some legislation restricting them will be passed. There are also proposed changes to life insurance plans that are used for gifting purposes, and clients “probably need to do some gifting now,” she said.
President Biden has proposed getting rid of the step-up in basis at death, which she said would be a “big change” for many clients’ estate plans. Another bill would impose capital gains taxes on sale of assets that are inherited.
She cautioned about IRS rule 2505, which says that the gift exemption is determined at the end of the year. Sanders could make his plan (if passed) effective in 2022, and it would be applied retroactively to gifts made in 2021. That provision will be fought, but there are no constitutional issues to prevent this from happening, she said.
California has passed “prop 19,” which constrains the ability of parents to transfer property to children tax efficiently without having the property reassessed. She discussed strategies to avoid those consequences, including having the children set up an LLC.
There is legislation pending that will affect incomplete gift non-grantor (ING) trusts, which allow the transfer of assets out of state to avoid state income taxes.
If a trust is set up out of state, she said, it will be taxed in the state of your residence, with some exceptions. If the trust has a contingent interest, meaning the grantor controls distributions, then tax may be paid into the state where it is set up. This is the “Paula case,” which is specific to California.
If a client moves out of a state to establish a new residence, they need to register to vote and get a driver’s license in that state. Start early, she said, and file a non-resident return if they anticipate a liquidity event.
When someone dies and a client gets an inheritance, they have nine months to disclaim it.
It may be beneficial to have parents set up trusts rather than allowing assets to be part of the estate.
Nonresident spouses and beneficiaries have a much lower estate tax exemption – $60,000. A green card treats you as a resident for income tax purposes, but not for estate tax purposes.
Form 8971 reports the basis of an asset to the beneficiaries and is required if an estate tax return is due.
If there is a taxable estate, it may make sense to cash out a retirement account, because it avoids the decedent (IRD) deduction, and the estate will pay tax on the gross amount. For the same reason, a Roth conversion may be appropriate.
She said the subject of choosing fiduciaries as trustees has come up more often than many others. Fiduciaries can be an individual, a private-professional fiduciary, or a bank or corporation. Choose someone you trust and who knows when to ask for help, she said. Don’t use co-trustees, which creates more complex administration and requires two signatures. Parents want to be fair, she said, and there can be an order in which children serve as trustees in succession. If trust is out of state, it may require an out-of-state fiduciary. A non-professional trustee should be paid a fee; it is generally restricted and is typically $60 to $100/hour. In some cases, it may be a percentage of assets, but a 1% fee is excessive, she said. Private fiduciaries are paid $100 to $200/hour.
It is harder to choose the guardian for minor children, she said, which are typically friends or family. The ages of the children matter. Choosing grandparents as guardians may be unwise, even if they are in good shape. The older children get, the more rooted they are in their community. If the guardian is abroad, it makes it difficult to get a formal appointment if that becomes necessary.
Trustees must follow prudent investment rules and cannot invest in, for example, pre-IPO companies.
Qualified small business stock (QSBS) can be used for a company that has less than $50 million in assets and is a C corp. With QSBS stock, each shareholder taxpayer gets a $10 million exclusion. This allows up to $10 million of capital gains tax to be avoided, and probably won’t go away under the Biden administration, she said. This applies to any liquidity event, including an IPO.
Should you get a formal qualified appraisal for real estate? Yes, she said, even though it costs $500 to $700. It is needed to qualify for the full exclusion under gift tax provisions. Don’t rely on a comparative market analysis (CMA) from a broker, Zulaica advised. There is also an issue with the statute of limitations, which applies if a valuation is not from a qualified appraiser.
To avoid litigation with all estate-related issues, make sure you understand what “keeps clients up at night,” she said, such as special needs children or homophobic parents who have gay children. These issues can be addressed by including a clause in a will that kicks in if the estate is contested. It is often helpful to bring children and heirs together with the client to review what is in the estate plan, she said.
If clients are charitably inclined, you should discuss CRTs, DAFs, family foundations and other strategies. CRTs are best for highly appreciated assets, which avoids capital gains taxes and creates an income tax deduction.
If a client has a foreign account, there are substantial penalties if you don’t file for taxes.
Who is a U.S. person for tax purposes? A green card will suffice for income tax purposes, but not for estate and other transfer purposes. The IRS uses a subjective test based on facts and circumstances, and it depends on the intent to stay in the U.S. indefinitely. A green card is not determinative of intent, she said. Green card holders can sign an affidavit that the U.S. is their home country, and they intend to stay here. If you have non-resident clients, you need to set up certain types of revocable trusts and set up a qualified domestic trust for a spouse.
If a client plans to retire to another country, they may need two wills and an attorney in that country. Some countries may require you to set up a corporation to buy a home, which triggers some reporting
Advisors must understand when there are separate versus community property issues. Be careful of commingling funds when there are separate properties.
Pre- and post-nuptial agreements can affect estate plans. For example, they can affect how beneficiaries are changed in life insurance policies
Robert Huebscher is the CEO and publisher of Advisor Perspectives.
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