Estate Planning – Estate Planning

Will the Secure Act Affect Your Retirement Plan

A Late 2019 tax change will have a major impact on retirement planning!

On December 20, 2019, President Trump signed the Setting Every Community Up for Retirement Enhancement Act of 2019, better known as the “SECURE Act.” Although it passed the House in July, the SECURE Act only recently passed through the Senate on December 19, as part of an end-of-year appropriations act. The SECURE Act implements quite a few technical changes which will affect retirement planning in general. However, some of the most significant changes will have a direct and very substantial impact on estate planning.

In previous years, a plan participant (i.e. the individual who initially established and funded the IRA) could pass unused IRA assets to a so-called “stretch-IRA” for the benefit of a designated beneficiary (i.e. a person inheriting IRA funds on the participant’s death). The purpose of a stretch IRA was to extend the tax-deferral of the IRA. This would allow the minimum required distributions to be stretched out over many years, thereby increasing the overall tax benefit of the account. Often, participants would establish stretch-IRAs for their young grandchildren, hoping that the minimum required distributions would be based on each grandchild’s age. This would allow more assets to retain tax-deferred status longer and thereby decrease the overall tax burden. For large IRAs, this decreased tax burden could be very significant.

The SECURE Act eliminates the stretch-IRA for participants dying after 2019. Under the new rules, inherited IRA assets must be distributed within 10 years of the participant’s death. A few exceptions to this rule apply, for example, where the beneficiary is a surviving spouse, a minor, or a child (but not a grandchild) that is disabled. But the new 10-year distributions rule will apply in most other circumstances.

Obviously, the loss of the stretch-IRA is important for tax planning purposes, but its significance goes even deeper. For example, when planning for a stretch-IRA, a participant is likely to have established one or more trusts in his or her estate plan. This type of planning would be particularly important where minors (like grandchildren) were expected to be the designated beneficiaries of the IRA. Often, these trusts directed that no distributions were to be made from the trusts except for the required minimum distributions which would have been required under then-applicable law. The expectation was that the IRA would be depleted incrementally over years. This would give the beneficiary limited access to the IRA assets with marginal tax impact triggered by each distribution. Under the new law, however, the required distribution comes at the end of the 10-year period. Not only does this prevent the beneficiary from enjoying the extended use of the IRA assets, but the lump-sum distribution can have a seriously detrimental tax impact on the beneficiary.

Estate planning around retirement assets has always been complicated. The SECURE Act will actually make that planning a little bit easier moving forward (albeit at the cost of losing a pervious tax benefit). However, for clients whose planning was carefully tailored to the old regime, significant changes may be needed to avoid a major tax trap.

If you’d like to discuss how your estate plan might be impacted by the SECURE Act, please contact our office to set up a consultation.

Christian Kelso | Farrow-Gillespie & Heath LLP | Dallas, TX

Christian S. Kelso, Esq. is a partner at Farrow-Gillespie Heath Witter LLP. He draws on both personal and professional experience when counseling clients on issues related to estate planning, wealth preservation and transfer, probate, tax, and transactional corporate law. He earned a J.D. and LL.M. in taxation from SMU Dedman School of Law.

Do You Need a Revocable Trust?

in Estate Planning/by Amanda Brenner

Not everyone knows what a revocable trust is or whether they need one. This article discusses the general characteristics of a revocable trust, some of the benefits a revocable trust offers, and other considerations that are relevant to this estate planning vehicle.

What is a Revocable Trust?

A trust is a relationship between three people:

Settlor. Also called a grantor, a settlor is the person who creates the trust. The settlor generally also contributes most or all of the property to the trust. A revocable trust can be amended or revoked by the settlor during his or her lifetime.

Trustee. The trustee is the person who manages the trust assets as directed by the settlor. The trustee holds legal title to the assets of the trust but does so only for the benefit of the beneficiary.

Beneficiary. The beneficiary is the person who benefits from the trust.

All of these positions may be held by more than one person, and a person may hold more than one of these positions. A single person may not be the sole grantor, trustee, and beneficiary, but this is not a problem because trusts almost always have remainder beneficiaries who get to enjoy the trust property when the initial beneficiary dies. Thus, in a typical married couple scenario, the couple will be grantors of their revocable trust, serve as its initial co-trustees, and are the trusts primary beneficiaries through both of their lifetimes, after which their children will become the primary beneficiaries.

Why You Need a Revocable Trust

Even with a modest estate, there are significant benefits to including a revocable trust in your estate plan. These benefits include:

Probate Avoidance. Probate is the legal process in which, upon your death, your assets are collected, your debts are paid, and any remaining property is distributed to your heirs. Assets in a trust are not subject to probate because they pass according to the terms of your trust, so to the extent it is funded before you die, a trust will help your family avoid probate.

Dealing with Incapacity. A revocable trust can be beneficial if loss of capacity is a concern. Should you become incapacitated, a successor trustee may step in and manage your assets for you without the need for more extreme and costly measures, such as a guardianship. A guardianship can be costly, intrusive, and involve significant court oversight.

Privacy. A revocable trust can also offer privacy. When a Will is probated, it is accessible to the public as part of the court record. A revocable trust does not need to be filed in the court records, and will reduce the public exposure of your affairs.

Ancillary Probate Avoidance. If you own property outside of Texas, another state may exercise probate jurisdiction over it and force you to go through a second, ancillary probate. By transferring your out-of-state assets into a revocable trust, you can avoid this costly and burdensome consequence.

Protection Against Contests. Revocable living trusts are generally harder to contest than Wills, offering some protection against disgruntled persons who consider themselves to be heirs.

Other Considerations Regarding a Revocable Trust

There are several other things to consider when designing an estate plan with a revocable trust. For example, you will need to consider which assets you want to contribute to the trust. Most assets can be transferred to a trust without issue, but retirement accounts and Texas homestead property may be problematic. Sometimes, it might make most sense to transfer assets to the trust upon your death via a beneficiary designation or similar instrument. You will also need to consider who should be your trustee. Even if you want to be the trustee initially, you need to think about who should succeed you if you are unable to manage it yourself. In some instances, a friend or family member may be appropriate, but in others, it may be best to name a bank or trust company to be your corporate trustee. Finally, as with any estate plan, you should consider what will happen to your assets when you die. Will they go to family members, other individuals, or perhaps to charities? Will they go to those remainder beneficiaries outright or in trust? All of these are things you will need to discuss with a competent attorney.

Attorney Amanda Brenner’s primary practice areas are estate planning, business formations, and nonprofit organizations. Ms. Brenner graduated from University of Pittsburgh School of Law in 2015.

Legal Documents for Your College Checklist

in Estate Planning/by Amanda Brenner

While shopping for extra-long twin sheets and plush mattress pads for your soon-to-be college freshman, consider adding these items to your checklist:

Financial Power of Attorney (POA)
Medical Power of Attorney (MPOA)
Health Insurance Portability & Accountability Act (HIPAA) Authorization

You are probably wondering why your barely-an-adult child needs these documents. Most high school grads have already turned or are about to turn eighteen. When a child turns eighteen, he or she becomes a legal adult. The law considers adult children capable of making their own decisions and permits them full legal privacy. Your rights as legal guardian have ended.

This new legal independence can create hurdles for you and your ability to provide assistance to your adult child. For example, imagine if your child needs medical attention but the doctor refuses to speak to you about your child’s condition because of HIPAA concerns. With a HIPAA authorization, the doctor is allowed to inform you of your child’s condition. Furthermore, what if there are immediate medical decisions that need to be made, but your child is unconscious? If you are the appointed agent under a Medical Power of Attorney, you are able to make those critical and important medical decisions. These documents can be a part of the ultimate care package for your newly-minted young adult.

Financial Power of Attorney

The first document to add to your college student’s shopping cart is the financial power of attorney (“POA”). In a POA, the principal (your child) appoints an agent (you) to make financial and related decisions or actions on behalf of him or her in the event of need. For example, the POA gives you the authority to continue signing for your child for banking and tax purposes.

Medical Power of Attorney

An MPOA appoints an agent to make medical related decisions on behalf of or for the principal.

HIPAA Authorization

A HIPAA authorization permits doctors and healthcare providers to share health information with a list of individuals authorized by the principal. Otherwise, HIPAA law generally prohibits medical personnel from discussing your adult child’s health information with you.

Customization Options

Each document can be customized to fit your child’s needs. The powers and decisions given to an agent under the POA and MPOA can be as broad or as limited as the principal specifies. For example, the power to handle tax matters can be granted under the POA while the power to handle digital assets and the content of electronic communications can be withheld. Under the HIPAA authorization, the information authorized to be provided to individuals can be as limited as the principal prefers. Each one of these documents can be drafted to be effective only for a certain period of time, such as for the four years of your child’s college career.

There are countless scenarios in which these documents can be of great help during your child’s journey through adulthood. Without these documents, you may be denied the ability to help your child and be forced to get court approval when time is of the essence. The estate planning attorneys at Farrow-Gillespie Heath Witter LLP can help you check these important documents off your to-do list at an affordable fixed fee. Please contact us for further information.

Attorney Amanda Brenner’s primary practice areas are estate planning, business formations, and nonprofit organizations. Ms. Brenner graduated from University of Pittsburgh School of Law in 2015.

Those Pesky Trusts! A Brief Primer on Terminating Unwanted Trusts

in Estate Planning/by Spencer Turner

Estate planning attorneys often wax poetic about the multitude of advantages found in a simple trust instrument. They’re not wrong. A well-crafted trust is an excellent vehicle for addressing a client’s concerns under a variety of different circumstances. Clients may place assets in a trust for tax benefits, creditor and divorce protection, planning for incapacity, family dynamics and a host of other reasons.

Yet no trust exists without a level of complexity and sophistication. Every trust has a trustee who must fulfill strict fiduciary duties and carefully manage the trust assets for the beneficiaries. The terms for distributing property from the trust may involve difficult calculations or restrictive standards that are not easily met. In some cases, a trust instrument’s vague provisions may leave both the trustee and beneficiaries confused as to how to proceed with the trust administration. Eventually, these complexities may become overly burdensome. Life circumstances may also render the trust’s intended benefits and purpose unnecessary.

Whatever the reason, trustees and beneficiaries often find themselves stuck with a trust that no longer meets their needs. But many of these trusts are or have become irrevocable and cannot be unilaterally terminated. Trustees and beneficiaries should not despair, however. Texas law has recognized several different ways to modify or ultimately terminate those pesky trusts.

A. Uneconomical Trusts

The Texas Trust Code enables a trustee to terminate a trust whose assets are valued less than $50,000. The trustee must consider the purpose of the trust and the nature of the assets, and ultimately determine that the value of the assets is insufficient to match the costs of continued administration. A common example of this occurs when a trust established under the provisions of a deceased person’s will receives only minimal funding from the deceased’s estate. The amount held in trust often does not justify the time, effort, and cost in administering the trust.

B. Combining Separate Trusts

Typically, the Texas Trust Code does not allow the outright termination of a trust without petitioning a court of proper jurisdiction for approval. But its provisions do allow for combining two or more separate trusts into a single trust without a judicial proceeding. This is only permissible where the combination would not impair the rights of any beneficiary or prevent the trustee from carrying out the purposes of either trust. Again, this is a great tool for consolidating trusts established under a deceased person’s will.“

C. “Decanting”

Another alternative to judicial termination of a trust, “decanting,” is the distribution of trust assets from one trust to a new trust that may have slightly different terms. The helpfulness of this provision of the Texas Trust Code largely depends on how much discretion the original trust grants the trustee. An attorney will need to carefully evaluate the level of variance the new trust may have under the circumstances.

D. Judicial Termination

A trustee or beneficiary may petition a court of proper jurisdiction to order the termination or modification of a trust. However, the grounds to do so are limited and specifically outlined in the Texas Trust Code. Petitioners should not expect a quick and easy process; terminating a trust in a court of law requires careful preparation, evidence, and a willing judge.

E. Termination by Agreement

Texas case law has recognized that in certain instances the settlor, trustee, and beneficiaries of an irrevocable trust may collectively agree to terminate the trust. This is a great tool if all parties are agreeable. But it does have its drawbacks. If the settlor is dead, then no agreement may be reached. Furthermore, an incapacitated beneficiary may not enter the agreement, further halting any opportunity to proceed under this method.

Trusts are excellent vehicles to achieve any number of tax, asset protection, or family dynamics-related objectives. At some point, these irrevocable trusts may become burdensome and unnecessary. An attorney may use the methods mentioned above to terminate or modify those pesky trusts.

Spencer Turner is an associate attorney at Farrow-Gillespie Heath Witter LLP. Since obtaining his license to practice law in 2016, Mr. Turner primarily has focused his legal efforts in the trust and estates arena. He has been featured as a speaker on various aspects of the probate process at several seminars hosted by the National Business Institute. Spencer graduated from Baylor University School of Law.

The Effects of Divorce on Wills and Estate Plans in Texas

in Estate Planning/by Elaine Price

Here is a guide to the legal effects of divorce on Wills, Trust instruments, and financial accounts in Texas.

Wills and Divorce in Texas. When a person’s marriage is dissolved by divorce, the former spouse cannot receive any payments, benefits or inherit property from that person’s will unless it expressly states otherwise. Not only is the former spouse not allowed to take any benefits or serve in a fiduciary role with regard to the estate, but neither can a relative of the former spouse do so, unless the relative is also a relative of the testator.

Trust Instruments and Divorce in Texas. A person can create a trust through provisions in a will. However, if that person’s marriage is dissolved by divorce, Texas law will operate as if the former spouse has disclaimed his or her interest in the trust. The divorce cancels the former spouse’s right to receive any property from the trust, to act as trustee, or to be appointed in any other fiduciary capacity. However, this rule applies only to trusts created in a will, and not to trusts created during one’s lifetime.

Divorce on P.O.D. and Multiple-party accounts. If a deceased individual has established a “pay on death”, multiple-party account, or any other beneficiary designation during a marriage that ends in divorce, the beneficiary designation of the former spouse, as well as of relatives of the former spouse who are not a relative of the decedent, are no longer effective.

Exceptions to the Rule. Some exceptions to the general rules occur under the following circumstances:

The Court’s divorce decree so orders.
Express terms in a trust instrument grant rights regardless of divorce.
An express provision of a pre-nup or post-nup relates to the division of the marriage estate.
The decedent reaffirms the survivorship agreement in writing.
There are express provisions in joint trust documents.
The former spouse is re-designated as the P.O.D. payee or beneficiary after a divorce.

This article brushes the surface of the many estate planning issues that can occur after a divorce in Texas. Be sure to review your estate planning documents yearly and seek the counsel of an attorney when there has been a major life event, such as marriage, birth, death, changes in investment accounts, property changes, or divorce.

Elaine Price practices in the areas of probate, heirship, and guardianship proceedings. Ms. Price is a graduate of the Thurgood Marshall School of Law and holds a Bachelor of Arts in political science from Prarie View A&M. Elaine was formerly with the law office of Rhonda Hunter.

Upjohn Clause: A Trap for the Unwary Trustee

in Estate Planning/by Christian S. Kelso

Featured image: Bethany and Preston Kelso. Photo used with subjects’ permission.

Many trust instruments prohibit trustees from relieving themselves of a legal duty under applicable law. Such language, which is sometimes referred to as an “Upjohn” clause after the case of Upjohn v. U.S. (30 A.F.T.R. 2d. 72-5918 (W.D. Mich 1972)), is most often, intended to prohibit a trustee from using trust assets to pay for anything which he or she is obligated to provide to his or her child as a matter of law and regardless of the trust.

Section 151.001 of the Texas Family Code imposes a legal obligation on parents to support their minor children. This includes the duty to provide a child with clothing, food, shelter, education, and medical and dental care.

The prohibitive language of an Upjohn clause typically comes into play in one of two scenarios: Either a grandparent has established a trust for the benefit of a minor grandchild and named the intervening child as trustee, or a spouse has established a trust for the benefit of a minor child and named the other spouse as trustee. In either case, the trustee is the parent of the beneficiary and owes the beneficiary a legal duty of support because the beneficiary is a minor. Although there are other circumstances where an Upjohn clause might apply (for example in the context of a marriage or guardianship), corporate and unrelated trustees generally do not need to concern themselves with this particular legal landmine.

The legal obligations prohibition is primarily meant to prevent inclusion of the entire trust corpus in a trustee’s estate under Treas. Reg. § 20.2041-1(c)(1), which treats the power to relieve a support obligation as a general power of appointment. Importantly, the trustee does not have to actually discharge an obligation. The mere power to do so is enough to cause inclusion. This is why some affirmative mechanism is needed to deny the trustee such power in the first place.

Legal support prohibitions are often contained in the boilerplate of a trust instrument which individual trustees are unlikely to bother reading and less likely to understand. Litigators who specialize in trust administration issues know to look for these clauses and point out violations. If a trustee makes even a small distribution in violation of an Upjohn clause, he or she has violated his or her fiduciary duty and may be subject to severe reprimand. This underscores the point that trustees, and in particular individual trustees, should maintain a close relationship with their attorneys and other professional advisors.

Although the distributions prohibited by an Upjohn clause are narrow in scope, there is very little legal precedent for determining exactly what is prohibited and what is not, so the best course of action is to proceed conservatively and with an abundance of caution.

In the absence of legal precedent to the contrary, more conservative guidelines are advisable. Thus, where an Upjohn clause applies, the following expenditures are best avoided:

Rent or any similar payments
Home improvements or decor
Homeowners or renters’ insurance
Basic utilities for the home
Property taxes
Clothing
Health insurance
Non-elective healthcare
General dentistry
Dentures
Optometry
Prescription glasses
Food

On the other hand, there are a number of expenses which do not fall within support obligation, so trust assets may be properly expendable on the following:

Cell phones
Pets
TV, cable, or satellite service
Internet service
Personal accessories
Automobiles
Auto insurance
Private school education
Extracurricular activities
Trips and vacations
Elective health care
Orthodontics

If you would like to discuss the particular language in your trust instrument, or the circumstances in which it operates, please contact one of our trust attorneys for guidance.

Christian S. Kelso, Esq. is a Senior Associate at Farrow-Gillespie Heath Witter, LLP. He draws on both personal and professional experience when counseling clients on issues related to estate planning, wealth preservation and transfer, probate, tax, and transactional corporate law. He earned a J.D. and LL.M. in taxation from SMU Dedman School of Law.

Capacity to sign

in Estate Planning/by Christian S. Kelso

Different legal actions require different levels of mental capacity to be valid. For example, the level of mental capacity required to sign a will, referred to as “testamentary capacity,” is lower than the level of capacity required to sign a contract, called “contractual capacity.” The various standards are discussed below.

Capacity to Sign a Will – Testamentary Capacity

To have testamentary capacity, the will signer must satisfy five requirements. First, the signer must understand the business in which they are engaged. Second, the signer must understand the effects of making a will. Third, the signer must understand the general nature and extent of their own property. Fourth, the signer must know to whom their property should pass or is likely to pass. And fifth, the signer must be able to collect all of this information in their mind at once and understand the how it all connects. They also must not suffer from an “insane delusion” that affects the will, nor be under undue influence from an outside party.

A person signing a will may do so during a lucid interval (sometimes also known as a “moment of clarity”), which is a time of mental capacity that is both preceded and followed by periods of mental incapacity. As long as the signing occurs during this lucid interval, the person has capacity to execute the document at issue.

Testamentary capacity must be proven only if the will is challenged by someone during the probate process. The party seeking to uphold the will (the will proponent) is the party who must prove that the testator did, in fact, have capacity at the time of the will signing. To guard against claims to the contrary, the estate planning attorney should be certain that the testator has capacity at signing, and should not allow someone with questionable capacity to execute a will.

Capacity for Other Legal Arrangements

In contrast to testamentary capacity, the standard for legally signing other documents is generally higher.

Contractual Capacity

Contractual capacity is the mental capacity required to validly execute a contract. Contractual capacity requires that the contracting person appreciates the effects of the act of signing the contract, and understands the nature and consequences of signing the contract as well as the business that they are conducting.

Power of Attorney

Although not entirely clear under Texas law, proper execution of a power of attorney probably requires contractual capacity. The reason is that the POA is valid during the signer’s lifetime and can have a profound effect on business and financial transactions.

Donative Capacity

Donative capacity, or the capacity to make a gift, is an elusive concept in Texas, but other states require something that appears to be higher than contractual capacity. Common requirements are that the donor of the gift must understand the nature and purpose of the gift, the kind and amount of property given, who is a reasonable recipient of the gift, and the effect the gift will have on the donor. Some states go so far as to require that the donor understand that the gift is irrevocable and that it will reduce the donor’s own assets.

Health Care Decisions

The capacity required to make health care decisions is more than mere mental capacity. Patients must give “informed consent” to all health care procedures, which requires that the patient be competent and that the consent be given voluntarily. The consent is informed when the health care provider gives the patient the information the patient needs to make the right choice.

The Effect of a Lack of Capacity

If a person does not meet the requisite mental capacity requirements when he or she enters into a legal arrangement, the arrangement and its supporting documents are generally void and unenforceable. Third parties can challenge these documents if they believed the person lacked capacity when the documents were signed. For a will, that means bringing a contest during the probate process.

FBAR deadline is April 18

in Asset & Investment Protection, Estate Planning/by Liza Farrow-Gillespie

The annual due date for filing Reports of Foreign Bank and Financial Accounts (FBAR) for foreign financial accounts has been changed from June 30 of each year to April 15. This date change was mandated by the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Public Law 114-41 (the Act). Section 2006(b)(11) of the Act changes the FBAR due date to April 15 to coincide with the federal income tax filing season.

All United States citizens and permanent residents who own or have signing authority over financial accounts valued in the aggregate at more than $10,000 and located outside the United States must file the annual FBAR report. Penalties for failing to do so include criminal prosecution and forfeiture of up to 100% of the funds in the foreign account(s).

Extensions

The maximum extension for filing the FBAR is six months, to October 15. Filers who fail to meet the FBAR annual due date of April 15 will receive an automatic extension to October 15 each year. Accordingly, specific requests for this extension are not required.

Deadline for 2017

Because of the Washington D.C. holiday that falls in 2017 on April 15, the due date for FBAR filings for foreign financial accounts maintained during calendar year 2016 is April 18, 2017, corresponding to the federal income tax deadline.

For more information, contact Liza Farrow-Gillespie or Christian Kelso.

Digital asset planning

in Asset & Investment Protection, Estate Planning/by Catherine Parsley

As technology advances over time, the average person owns more and more digital assets. The definition of digital assets is very broad and includes intangible assets ranging from online accounts, such as bank accounts, email accounts, and social media, to digital files stored on a computer or in the cloud. Traditional estate planning tools have been useful in dealing with comparable non-digital assets, such as by allowing a person’s fiduciary to deal with a bank in person. However, the efficacy of traditional estate planning tools on digital assets is still unclear.

Digital Assets Under Federal Law

While most issues of property disposition are handled by state laws, digital assets are usually controlled at the federal level because of their interstate nature. Original guidance was offered by the Electronic Communications Privacy Act of 1986 (ECPA)’s Stored Communications Act (SCA). The SCA allows digital asset providers to deny access to anyone, but includes a now-abused “lawful consent” exception. The exception is not applied uniformly between states and is therefore unclear and unhelpful.

Digital Assets Under Texas State Law

More recently, twenty-three states have passed the Revised Uniform Fiduciary Access to Digital Assets Act (RUFADAA) in some form, which provides specific guidance on how to distribute digital assets upon death. RUFADAA allows a person’s fiduciary, such as an agent or executor, access to online accounts if the person explicitly grants the power in an estate planning document or through a service provider’s own procedures. RUFADAA also allows the fiduciary to determine how to distribute and manage the assets after the person’s death. RUFADAA was filed in the Texas Legislature on February 21, 2017 for consideration during the 85th Regular Session.

In states that have not passed RUFADAA, planning for the disposition of digital assets remains unclear. Most digital assets will be governed by the user’s licensing agreements, which vary over time and between assets. More certainty will likely arise as these assets become more prevalent.

Estate Planning for Digital Assets

Whether or not the Texas legislature adopts RUFADAA, special considerations for digital assets should be included in every estate plan. The attorneys at Farrow-Gillespie & Heath, LLP understand the issues digital assets present and are prepared to help clients address them in a way that is appropriate for each client’s particular situation.

About the Author

Catherine Parsley is currently (March 2017) an intern at Farrow-Gillespie Heath Witter, LLP. Ms. Parsley is a law student at SMU Dedman School of Law in Dallas, Texas, where she is a staff editor of the SMU Law Review. Catherine served as a judicial extern for Chief Justice Nathan L. Hecht, of the Supreme Court of Texas. She holds a B.S. in communications studies, cum laude, from the University of Texas at Austin.

It’s time to make your 663(b) trust and estate distributions!

in Asset & Investment Protection, Estate Planning/by Christian S. Kelso

Contact Christian Kelso to guide you through the estate planning process.

Trusts and estates often pay more tax than individuals in like circumstances. This is not because they are taxed at higher rates, but rather because the same rates applicable to individuals are “compressed,” meaning that each marginal rate increase happens at a lower level of income than it does for individuals. For example, the highest rate of income tax for both trusts and individuals for 2016 was 39.6%, but whereas this rate only applies to income over $415,050 for single individual filers, for trusts and estates, this rate applies to all income over $12,400. Other tax burdens, such as the 3.8% Net Investment Income Tax (a/k/a the “Obamacare Tax”) and higher rates of capital gains tax follow suit along similar lines. Obviously, these add up to a significant potential tax burden.

Fortunately, there is a way to mitigate this tax burden. Trusts and estates may take a deduction for “distributable net income,” which is generally the amount of income that is distributed from the trust to a beneficiary. When this happens, the income is effectively shifted from the trust to the beneficiary, who simply adds it to their personal return and pays at whatever rate is applicable to them (including the distributed trust income, of course).

Since large amounts of unnecessary tax can be avoided by shifting income to beneficiaries in this manner, it is common practice for trustees to make distributions for this purpose, assuming, of course, that such distributions are permissible and proper under the terms of the trust. But there is a problem: How does the trustee know how much income to distribute from a given trust before the close of a given tax year? Unfortunately, it is impossible, to know exactly how much income a trust has until after the tax year has closed, at which point, it’s too late to distribute all the income.

Enter IRC §663(b). Under this special provision, a trust or estate may elect to treat any distribution made within the first 65 days of a given tax year as having been made on December 31 of the previous year. In other words, the trustee gets 65 days after the actual close of the year to calculate how much income should have been distributed and then actually make that distribution. The trustee then makes an election on the trust or estate’s income tax return (Form 1041) and voila, the problem is solved!

Although §663(b) distributions may provide a significant benefit, the can also represent a significant danger to trustees. On the one hand, any distribution from a trust should only be made if and to the extent it is proper under the terms of the trust. Even if such a distribution is permissible, it may not be in the best interests of a given beneficiary, as taxes are only one of many considerations. On the other hand, a §663(b) distributions can save a significant amount of tax, so failing to make such a distribution, if permitted, could subject a trustee to liability for waste.

Making the right decision requires careful analysis. The fiduciary attorneys at Farrow-Gillespie Heath Witter, LLP are well-versed with the applicable law and have the practical experience to understand the nuanced process that is involved with make the right decision. If we can help you with this, please don’t hesitate to call.

The trust and estate planning attorneys at Farrow-Gillespie Heath Witter LLP, located in downtown Dallas, serve all of your trust and estate planning needs, including:

Estate planning for small estates
Estate planning for large, taxable estates
Trust review and modification
Trust and estate administration
Trust litigation
Will contests
Probate
Heirship proceedings
Guardianships

The SECURE Act: Will it Affect Your Retirement Plan?