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Estate Planning for Millennials and the “Middle Class” | Business Succession Planning Under the Tax Cut and Jobs Act

March 27, 2018

Estate Planning for Millennials and the “Middle” Class

by Ambria Armstrong

With all the changes in the new tax laws, some people may be hesitant to move forward with an estate plan. It is important, however, to keep in mind that most clients will not be subject to the federal estate tax and therefore the changes to the federal estate tax laws do not impact planning. Estate planning is still important for a multitude of reasons, including:

  1. Pennsylvania Inheritance Tax

Unlike the federal estate tax, in Pennsylvania everyone is subject to state inheritance tax. The tax rates are currently at 0% for spouses, 4.5% for children, 12% for siblings, and 15% for everyone else. There are still techniques to minimize the Pennsylvania inheritance taxes paid by those who inherit from you. For example, life insurance is not subject to Pennsylvania inheritance tax. In addition, real estate located outside of Pennsylvania is not subject to the tax and in certain cases agricultural use property is exempt from the tax.

  1. Children

Providing for your children is one of the most important pieces of estate planning. Even if you do not think you have much to give them, you may have more than you think – for example, many employers offer life insurance as an employee benefit. Also, term life insurance is relatively inexpensive if you are younger and healthier.

There are two primary options to provide for minor children: a custodian account or a trust.  For a custodian account, you designate a custodian to manage the account for the benefit of your child (or children). A custodial account is not as flexible as a trust but offers many of the same features. A custodial account can last until the child is twenty-five years of age.  A trust is more flexible than a custodial account but requires more effort to administer. For example, a trust can last as long as you want. The trustee has discretion to distribute funds to benefit your child.  You can specify certain events, such as buying a house, buying a car, getting married, or starting a business, at which your trustee is encouraged to make distributions from the trust for your child. You can also authorize your trustee to permit your children and their guardians to live in your current house (rather than selling the house) and to pay for the expenses of the house from the trust.

If you or your spouse has children from a prior relationship, there are often unintended consequences of dying intestate (meaning without a will). In these situations, it is important to make absolutely clear who is to be provided for and how much of your estate should go to each child. Often the intestate laws of Pennsylvania, in these situations especially, do not accurately carry out your wishes.

  1. Unmarried Couples 

For those of you who are not married but wish to provide for your significant other, you must have an estate plan for those wishes to be carried out. Pennsylvania intestacy laws provide for your estate to pass entirely to relatives, so even if you are living together, your significant other will not receive anything unless you are married. Also keep in mind that anything passing to a non-relative will be taxed at the 15% Pennsylvania inheritance tax rate. Any jointly titled assets will have 50% of its value attributed to each of you, which can result in tax owed on half of the funds in your joint bank account, for example.  In these situations, life insurance can be especially beneficial since it is exempt from inheritance tax.

  1. Business Owners

Small business owners who have not yet reached the federal estate tax exemption should still think about who you would want to take over your business if you were to die.  Normally, a successor is identified in a “buy-sell” agreement or similar contractual arrangement. Alternatively, your business can be transferred at death under the terms of your Last Will and Testament. It is important to plan for the orderly disposition of your business so that you do not lose the value that was created during your lifetime.

  1. Powers of Attorney

In addition to a Last Will and Testament, you should have a healthcare power of attorney and a financial power of attorney.

Your healthcare power of attorney designates one or more people to make medical decisions for you if you are incapacitated. In addition, your health care agent is authorized to receive HIPAA protected information (this is especially important if you are single). A health care power of attorney also sets for your wishes regarding end-of-life medical care.

Your financial power of attorney allows someone to act on your behalf for any financial matters. This could include anything from writing checks for you if you are out of town, to applying for government benefits for you, to dealing with real estate transactions on your behalf. You may also need to use this power of attorney if you are out of the country, for example.

Every person’s situation is unique, so your estate plan should be crafted to address your goals, family circumstances, and assets. But, having an estate plan is the first step in ensuring that your wishes are carried out and that taxes are avoided to the extent possible.

Business Succession Planning Under the Tax Cuts and Jobs Act

by Vance Antonacci

The Tax Cuts and Jobs Act (the “Act”) was signed into law on December 20, 2017, with an effective date of January 1, 2018. The Act doubled the exemption amounts for taxpayers for estate, gift, and generation skipping transfer taxes. The exemption amounts are now $11,200,000 per person and $22,400,000 per married couple. The exemption amounts will increase each year based on inflation. The increased exemption amounts under the Act, however, will only exist through December 31, 2025. Unless the law is amended, the increased exemption amounts will “sunset” on January 1, 2026 to their pre-2018 levels (adjusted for inflation). The Act did not amend the tax rate for estate, gift, and generation skipping transfer taxes, which remain at 40%.

For clients who are business owners, the Act may or may not impact the execution of the succession plan for the family business. In general, succession planning should be framed more by planning to achieve long term success for the business than by tax avoidance. For example, the importance of developing next generation leaders is not impacted by the tax laws. However, the Act does present unprecedented opportunities for planning. Some considerations for clients:

  • Clearly, the increased exemption amount allows for more significant lifetime gifting of business interests. For those clients engaged in gifting of business interests, you may want to consider a more significant gift or gifts in the next few years.
  • Although not directly related to succession planning, clients should consult with their accountants to confirm whether the structure of the business and the compensation paid to its owners is optimized under new section 199A of the Code (the new section that provides an income tax deduction for “pass through” businesses).
  • For clients who have trusts that own business interests, consideration should be given whether to restructure the trusts to ensure an income tax basis step up upon the death of a beneficiary. Trusts are generally designed so that the assets of the trust are not included in the beneficiary’s taxable estate (to avoid estate tax). However, trust assets do not get an increase in cost basis when the beneficiary dies. If the beneficiary will not be subject to estate tax, it may make sense to trade the Pennsylvania inheritance tax at the rate of 4.5% for children to avoid the capital gains tax on built-in gains.
  • For clients with grantor trusts, consideration should be given to substituting high cost basis assets with low cost basis assets.
  • With respect to life insurance, clients should review their life insurance portfolio to ensure that the amount of life insurance backing buy-sell obligations is adequate. Likewise, clients should review life insurance policies to make sure the amount of coverage is adequate, that the policy is performing as illustrated, and to evaluate whether an exchange of policy is warranted. In the case of Irrevocable Trusts, it may be possible to reduce the death benefit in exchange for lower (or no) premiums (a lower death benefit may not be needed as much now for estate tax planning and the lower death benefit could provide stability to the policy).

Another consideration for clients is that the Act may be amended or revoked. The Act likely would be amended or repealed if President Trump is not reelected and the Democratic Party gains control of the House and the Senate. Some clients may want to consider taking advantage of the increased exemption amounts by making current gifts to family members or trusts or implementing a gifting strategy for so long as the increased exemption amounts remain available.

Every estate plan and estate planning client is unique, so the Act will impact each client differently.  Some clients, for example, will want to retain income producing assets while gifting non-income producing assets. Some clients may want to unwind trusts while other clients may want to continue trusts for tax planning or asset protection reasons.

We recommend a periodic review of any estate plan because the law and the client’s circumstances and planning goals change. If you have any questions about how the Act will affect you, your family, or your estate plan, please contact a member of the McNees Estate Planning Practice Group.

© 2018 McNees Wallace & Nurick LLC
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