Private Clients Update - Volume 2018, Issue 1

Pepper Hamilton LLP

Year-End Reminders

For 2018, the estate, gift and generation-skipping transfer tax exemption is $11.18 million per person ($22.36 million for a married couple). The exemption is projected to increase to $11.4 million per person in 2019 ($22.8 million for a married couple). The increased exemption under the 2017 Tax Act is scheduled to revert back to $5 million per person, adjusted for inflation, beginning on January 1, 2026. The IRS recently issued proposed regulations that, if adopted, will eliminate a concern about gifts made using the increased exemption amount in 2018 through 2025. The regulations provide that such gifts will not be "clawed back" and included in your estate if you die in a later year during which the exemption is lower. Therefore, if you make gifts that are not taxable under the increased exemption amount in effect before 2026, you will not incur additional gift taxes on those gifts if the exemption amount goes down in 2026.

The temporarily increased exemptions present various estate planning opportunities. However, it may also create unwanted results. Many existing estate plans distribute assets based on a formula that is keyed to the applicable exemption amounts. These formulae, coupled with the increased exemptions, could result in unanticipated consequences for estate plans created before 2018. You should review your estate plan with us to ensure that these unexpected consequences do not arise.

The annual gift tax exclusion for 2018 is $15,000 per donee ($30,000 per married couple) and is projected to remain the same for 2019. We encourage you to consider making gifts before year end if you have not used your annual gift tax exclusion for 2018.

With the end of the year around the corner, now is a great time to consider year-end tax planning as well as whether any changes need to be made to your estate plan. You should be sure that gifts intended to be made this year are completed before year end (for gifts made by check, the checks must be cashed before the end of the year). For income tax planning, consider deferring income until next year and accelerating expenses to 2018 if possible.

Titling Assets to Take Advantage of Current Tax Law

For many years, estate planners recommended that married couples divide their assets between them to take advantage of the estate, gift and generation-skipping transfer tax exemption amount of the first spouse to die. However, with the addition of portability (the ability to carry over the remaining exemption amount of the first spouse to die) and the increased exemption amount, many married couples are opting to own assets jointly. Property owned as joint tenants with right of survivorship or as tenants by the entireties will pass to the surviving owner upon the death of the first spouse by operation of law, and the assets are not subject to probate. In addition, property owned jointly is generally better protected from creditors than individually owned assets. Joint ownership is not recommended for all married couples, but is worthy of consideration. Married couples for whom joint ownership is a viable option are sometimes able to simplify their existing estate plan to eliminate the need for certain trusts that were designed under prior law. Moreover, the surviving spouse receives a step-up in basis for one-half of the assets at the death of the first spouse, and the beneficiaries of the surviving spouse’s estate receive a full step-up in basis at the death of the surviving spouse. The increase in
basis is important to avoid future capital gains taxes on the sale of the assets received.

Pets Are Part of the Family Too

Whether you have one house pet or what some might call a small farm, you may want to consider who will care for your feathered or four-legged friends and how they will be cared for should they outlive you. One option is to create a trust for the support of your pets, funding it with an amount necessary for their care, and naming a trustee to be responsible for applying the trust funds for the care of your pets. Did you know the money that your pet receives might be subject to inheritance tax?

The Pennsylvania statute recognizing pet care trusts has been in place since 2006, but the inheritance tax consequences of pet care trusts remain uncertain. In Schrock Estate, a 2015 case decided in Westmoreland County, the decedent left her estate in trust for the benefit of her horses upon her death. The court held that the trust was not subject to inheritance tax because an animal is not a "person" subject to taxation under the Inheritance Tax Act. In contrast, in King Estate, the Chester County Orphans’ Court issued an opinion this year that a transfer from a pet owner to a pet care trust is subject to inheritance tax because pets are not included in the list of transferees exempt from tax. If that result was not bad enough, the court upheld the Department of Revenue assessment at the rate of 15 percent, applicable to recipients other than immediate family. While the issue has not yet been decided with certainty, the Department of Revenue has made clear that it will continue to assess tax on pet care trusts at a rate of 15 percent — a position now supported by at least one county court in the King Estate case.

Estate Planning in a Rising Interest Rate Environment

Many estate planning techniques involve split-interest transfers, in which an individual makes a gift and retains a partial interest in the transferred property. The key to these estate planning techniques is how the remainder interest is valued. This is tied to interest rates published monthly by the IRS. The applicable interest rate for split-interest gifts is known as the "7520 rate." The value of a retained annuity interest is higher when the 7520 rate is low, thus reducing the amount of the taxable gift. As interest rates increase, the amount of the taxable gift increases.

The 7520 rate was at an all-time low, but has been gradually increasing. Before interest rates rise further, we suggest considering planning strategies that are most successful in a low interest rate environment. In particular, you may want to consider a grantor retained annuity trust (GRAT). In a GRAT, a taxpayer transfers assets to a trust and retains an annuity interest for a specified term. When the term expires, the remaining amount in the GRAT is transferred to the remainder beneficiaries. A GRAT is a powerful technique that operates best in a low interest rate environment.

Alternatively, as interest rates begin to rise, charitable remainder trusts and qualified personal residence trusts begin to look more attractive again as estate planning tools. If you are interested in learning more about split-interest gifts, please contact a member of Pepper’s Private Clients Group.

Charitable Income Tax Planning Opportunities Under New Tax Act

The 2017 Tax Act, which went into effect this year, increased the standard deduction for 2018 to $12,000 for unmarried individuals, $18,000 for heads of household, and $24,000 for married individuals filing jointly. It limits itemized deductions for state and local taxes, including real property taxes. The 2017 Tax Act also limits the deduction for mortgage interest and eliminates deductions for such items as income tax preparation, employee business expenses and investment expenses. Because the 2017 Tax Act significantly limits other itemized deductions, the allowable itemized deductions, including the charitable deduction, may not exceed the standard deduction. There is no charitable deduction for taxpayers who do not itemize deductions.

"Bunching" charitable gifts that would otherwise have been given over multiple years into one year can help to take advantage of the charitable deduction. Bunching can increase the deduction enough for the taxpayer to exceed the threshold for itemizing. If you are uncomfortable giving an increased amount to a particular charity or charities in one year, you may consider creating a donor-advised fund (DAF). A contribution to a DAF allows you to take a deduction for the full contribution amount in the year of the gift, while maintaining some control over the investment of the funds before designating a gift to particular charities. The DAF also allows you time to decide how and when you would like the funds to be disbursed to specific charitable organizations. If you would like to learn more about DAFs or other charitable giving alternatives, please contact a member of Pepper’s Private Clients Group.

Is Your Retirement Plan Unclaimed Property?

Under Pennsylvania law, financial institutions must report accounts held with no activity for three years to the Commonwealth and transfer the unclaimed property to the Pennsylvania Treasury. Typically, state laws treat retirement accounts (such as IRA and 401(k) accounts) differently than other types of property, so that the time period after which the property must be transferred to the state does not begin to run until after the account owner is eligible for distributions from the account.

Pennsylvania changed its unclaimed property law to treat retirement accounts in the same manner as any other type of account. Because many people do not actively manage their retirement accounts, and automatic employer contributions may not be sufficient to keep an account "active" under the rules, your retirement account may be treated as unclaimed property if you are not careful. The change in Pennsylvania law has been widely criticized, and Pennsylvania has issued guidance that suspends enforcement of the law as it considers how it might be applied. However, if you are one who pays little attention to your retirement fund accounts, in order to keep your account active, we suggest you log in online at least annually to review your account and to confirm your contact information is current.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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