Installment Sales: A Viable Option for Transferring Assets

Boston-street_LI-532x266 Installment Sales: A Viable Option for Transferring Assets
Photo: Michael Browning

Are you considering transferring real estate, a family business or other assets you expect to appreciate dramatically in the future? If so, an installment sale may be a viable option. Its benefits include the ability to freeze asset values for estate tax purposes and remove future appreciation from your taxable estate.

Giving Away vs. Selling

From an estate planning perspective, if you have a taxable estate it’s usually more advantageous to give property to your children than to sell it to them. By gifting the asset you’ll be depleting your estate and thereby reducing potential estate tax liability, whereas in a sale the proceeds generally will be included in your taxable estate.

But an installment sale may be desirable if you’ve already used up your $11.18 million (for 2018) lifetime gift tax exemption or if your cash flow needs preclude you from giving the property away outright. When you sell property at fair market value to your children or other loved ones rather than gifting it, you avoid gift taxes on the transfer and freeze the property’s value for estate tax purposes as of the sale date. All future appreciation benefits the buyer and won’t be included in your taxable estate.

Because the transaction is structured as a sale rather than a gift, your buyer must have the financial resources to buy the property. But by using an installment note, the buyer can make the payments over time. Ideally, the purchased property will generate enough income to fund these payments.

Advantages and Disadvantages

An advantage of an installment sale is that it gives you the flexibility to design a payment schedule that corresponds with the property’s cash flow, as well as with your and your buyer’s financial needs. You can arrange for the payments to increase or decrease over time, or even provide for interest-only payments with an end-of-term balloon payment of the principal.

One disadvantage of an installment sale over strategies that involve gifted property is that you’ll be subject to tax on any capital gains you recognize from the sale. Fortunately, you can spread this tax liability over the term of the installment note. As of this writing, the long-term capital gains rates are 0%, 15% or 20%, depending on the amount of your net long-term capital gains plus your ordinary income.

Also, you’ll have to charge interest on the note and pay ordinary income tax on the interest payments. IRS guidelines provide for a minimum rate of interest that must be paid on the note. On the bright side, any capital gains and ordinary income tax you pay further reduces the size of your taxable estate.

Simple Technique, Big Benefits

An installment sale is an approach worth exploring for business owners, real estate investors and others who have gathered high-value assets. It can help keep a family-owned business in the family or otherwise play an important role in your estate plan.

Bear in mind, however, that this simple technique isn’t right for everyone.

We can review your situation and help you determine whether an installment sale is a wise move for you. Contact us today, before transferring real estate.

Power of Attorney – Your Trusted Agent

qtq80-NCeHz6-1024x684 Power of Attorney – Your Trusted Agent

Most people realize the importance of a will to help direct the transfer of assets after death. During your lifetime, you also may want to have a power of attorney (POA) for convenience and asset protection.

The person who creates a POA is known as the principal. In the POA, an agent (known as the attorney-in-fact) is given the authority to act on the principal’s behalf. POAs come in different forms with different purposes.

General POA

A general or regular POA gives the agent the broad ability to act for the principal. This type might be useful when the principal will be unable to act on his or her own behalf for some reason. Someone in the military, for example, might name an agent to handle financial affairs during the principal’s overseas assignment.

Limited POA

As the name suggests, these special POAs are not open-ended. There could be a specified time period when you’re unable to act on your own behalf. Alternatively, a limited POA could be effective only for a designated purpose, such as signing a contract when you can’t be present.

Durable POA 

Regular or limited POAs may become void if the principal loses mental competence. Unfortunately, that can be the time when a POA is needed most: when assets could be squandered because of poor decisions.

Therefore, a durable POA can be extremely valuable because it remains in effect if the principal becomes incompetent. The agent can make financial decisions, such as asset management and residential transactions. If a durable POA is not in place, the relatives of an individual deemed to be incompetent might have to go to court to request that a conservator be named, which can be a time-consuming and expensive process with an uncertain outcome.

Springing POA

Some people are not comfortable creating a POA while they are still competent, yet an individual who loses mental capability cannot legally create a POA. One solution is to use a springing POA, which takes effect only in certain circumstances, such as a doctor certifying that the principal cannot make financial decisions. Note that some states may not allow springing POAs, and some attorneys are skeptical about using them because the process of getting a physician’s timely certification might be challenging.

Health Care POA

The POAs described previously empower an agent to make financial decisions. A health care POA is different because it names someone to make medical decisions if the patient cannot do so. The agent named on a financial POA could be someone trusted with money matters, whereas someone with other abilities and concerns could be appropriate for a health care POA.

Powerful Thoughts

As indicated, the agent you name on any POA should be someone you trust absolutely with your wealth or your health. Married couples are best protected if both spouses have their own POAs.

In addition, you might have to check with the financial firms holding your assets before having a POA drafted. Some companies prefer to use their own forms, so a POA drafted by your attorney might not be readily accepted. Moreover, financial institutions might be reluctant to accept a very old POA, so periodic updating can be helpful.

When creating a POA, you should make it clear that the power applies to retirement accounts such as IRAs. Your agent should have the ability to execute rollovers and designate beneficiaries, for example. An attorney who is experienced in estate planning can help you obtain a POA with the power to help you and your loved ones, if necessary.

Additional Resources

Funding Company’s Buy-Sell With Life Insurance Can Be Tricky

life-insurance-buy-sell_LI-532x266 Funding Company’s Buy-Sell With Life Insurance Can Be Tricky
Photo: Stock

Among the trigger events of a small company buy-sell agreement, death of a co-owner typically is included.

Example 1: Wendy Young and Victor Thomas both own 50% of YT Corp. They have a buy-sell, which calls for Wendy to buy Victor’s interest in YT if he dies. Similarly, Victor will buy Wendy’s interest in YT from her estate if she is the first to die.

Small company buy-sells such as the one for YT Corp. often fall into one of two categories:

  • Cross purchase. Wendy will buy Victor’s shares directly from his heirs, or vice versa.
  • Here, YT Corp. will buy the decedent’s interest. If Victor is first to die, YT will buy his shares, leaving Wendy as the sole owner.

Finding the Funds 

With either type of buy-sell, a “buy” must be made, and the decedent’s interest in the company might be extremely valuable. Therefore, life insurance often is used to provide the funds for the buyout.

Example 2: In a cross-purchase arrangement, Wendy will acquire a policy on Victor’s life, and Victor will own a policy on Wendy’s life. If Victor dies, the insurance payout will go to Wendy, generally free of income tax. Wendy can use this money to buy Victor’s interest in YT Corp. from his estate at the price set in the buy-sell.

If Victor is the survivor, the process will take place in reverse.

Pros and Cons

There are some advantages to a cross-purchase arrangement. If the shares have appreciated over the years, Wendy will get a basis step-up to current value when she buys Victor’s shares. That could reduce the tax on a future sale of all of Wendy’s shares.

On the other hand, the premiums on a large life insurance policy could be substantial. Wendy and Victor might not be willing and able to pay these costs personally. This issue could be further complicated if, say, Victor is much older than Wendy and in poor health. The premiums on a policy insuring Victor could be much higher than the premiums for a policy insuring Wendy; this disparity may have to be resolved by some financial arrangement between the owners.

In addition, not every small company has 2 co-owners. With 3 owners, each would have to own life insurance policies on 2 others, for a total of 6 policies. Four owners would need 12 policies, and so on.

Regarding Redemptions 

Some of these cross-purchase problems can be resolved by using a corporate redemption plan.

Example 3: In a redemption plan, YT Corp. needs to buy only two life insurance policies: one on Wendy and the other on Victor. If Victor dies, the death benefit goes to YT, which uses the money to redeem Victor’s shares. If Wendy dies first, YT will buy her shares.

This method addresses the problems of multiple owners, uneven premium payments, and personal outlays for premiums. On the negative side, a redemption plan places what might be valuable insurance policies in the company’s possession, subject to creditors’ claims. Adverse tax issues also may arise, including the loss of a basis step-up for the surviving co-owner or owners.

Other ways to use life insurance for buy-sells may be suggested by an experienced insurance agent. For instance, a trust might be created and funded by multiple co-owners, with an independent trustee acquiring life insurance policies on those owners’ lives. The taxation of a trusteed buy-sell might be more favorable than taxation of a redemption plan. Our office can explain the likely tax consequences of any strategy you’re considering for funding a buy-sell through life insurance.

If your company initiates a buy-sell to be funded with life insurance, make sure to keep the policies up to date. If the company’s value grows but the coverage doesn’t increase, the insurance payout could be only a fraction of the required purchase price.

 

 

Disclaimer: This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

Don’t Neglect Estate Planning.

grief_LI-532x266 Don’t Neglect Estate Planning.
Photo: Ben White

Save Heirs From An Unhappy Ending

The article, “More give in the gift tax,” mentions that the federal estate tax exemption now exceeds $11 million per person. Accordingly, few individuals or married couples will owe this tax. Nevertheless, there is more to successful wealth transfer than reducing or eliminating estate tax. Ideally, you’ll want your assets to pass to the desired recipients with a minimum of turmoil and expense.

To start, you should have a will prepared by an experienced attorney. Your will should not only name specific heirs for specific assets, but also identify an executor who will administer your estate and, if relevant, guardians who will care for any minor children.

Once your will has been prepared, don’t file it away and forget about it. Review the document periodically, especially after major life events such as births, deaths, marriages, and divorces.

In addition to a will, other efforts should be included in your estate planning.

Beneficiary Designations

Many assets will pass to a beneficiary or co-beneficiaries at your death. They include retirement accounts, annuities, and life insurance proceeds, as well as certain bank and investment accounts. The good news is that these assets usually pass without having to go through probate, which might be expensive and time consuming.

The bad news? Generally, a beneficiary designation will override what’s in a will. Keeping beneficiary designations current can be vital. Except when a legal agreement is in place, you probably won’t want assets to pass to an ex-spouse under an old beneficiary form.

Employer-sponsored defined contribution retirement plans, such as 401(k)s, may be required to pass to a surviving spouse, unless a waiver has been signed. Complying with such rules may save your heirs from an unhappy ending.

Revocable Trusts

In recent years, revocable trusts (also known as living trusts) have become popular. As the name indicates, these trusts can be undone, with trust assets reverting to the trust creator, known as the grantor. Meanwhile, the creator continues to control the assets in the trust and have access to income from such assets.

Assets transferred into such trusts can avoid going through probate at the creator’s death. As mentioned previously, retirement plans and other assets avoid probate anyway. The same is true for assets held as joint tenants with right of survivorship―such property passes to the surviving owners.

Therefore, probate avoidance applies to other types of assets if they are held in a revocable trust. To get this benefit, assets must be transferred into the trust.

Beyond probate avoidance, revocable trusts also might reduce administrative expenses by helping the trustee to identify and gain control over the assets. Additionally, a revocable trust can be valuable in case of incapacity. Control of trust assets may pass to a successor trustee or co-trustee.

Example 1: Nancy Hunter creates a revocable trust into which she transfers her bank accounts, investment accounts, and real estate. Nancy names her daughter, Judy Palmer, as successor trustee. Now, if Nancy loses the ability to manage the trust assets, Judy will take control.

Before naming someone as successor trustee, consider this question: Is this person able and willing to serve? If not, a corporate co-trustee may be the answer. The latter solution will cost money but could be less expensive than losses caused by an unqualified trustee.

Irrevocable Trusts

With irrevocable trusts, the grantor gives up control of assets transferred into the trust. Such trusts can serve many purposes, such as reducing estate tax, protecting beneficiaries who might handle money unwisely, and providing strong creditor protection. Modifying an irrevocable trust can require considerable effort and expense, if it can be done at all.

Other Components 

A thorough estate plan also might include a letter of instruction, durable power of attorney, and health care directives. The lawyer who drafts your will and any trusts you might desire can let you know what else you’ll need for a comprehensive estate plan.

This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.

More Give in the Gift Tax

girl-balloons_LI-532x266 More Give in the Gift Tax
Photo: Senjuti Kundu

The Tax Cuts and Jobs Act of 2017 increased the federal estate tax exemption to $11.18 million for 2018. That’s per person, so the combined exemption for a married couple can be as much as $22,360,000 worth of assets this year.

The same ceilings apply to the federal gift tax, which offsets the estate tax.

Example 1: Mona McAfee plans to give $20,000 to her son Luke this year. Does that mean that Mona’s estate tax exemption would be reduced to $11,160,000?

Probably not. In addition to the lifetime exemption numbers now in effect, there is also an annual gift tax exclusion. Due to an ongoing process of inflation adjustment, that exemption increased to $15,000 in 2018. Therefore, in 2018, each person can give up to $15,000 to any number of recipients without incurring gift tax consequences. That’s up from an annual $14,000 exclusion, which was in effect the previous five years.

Here, Mona’s $20,000 would be partially covered by the $15,000 exclusion, so only $5,000 will have gift tax consequences. Mona would have to report a $5,000 taxable gift on IRS Form 709. That $5,000 taxable gift will reduce her current federal estate and gift tax exemption amount to $11,175,000, assuming no other taxable gifts have been made.

As the recipient of the gift, Luke will pay no taxes.

Real-World Relevance

Most people won’t have estates close to $11 million, so this exercise might seem academic. Still, the $15,000 annual gift tax exclusion can have practical effects in many situations. It’s also worth noting that paying someone else’s medical or education bills directly won’t be included in the $15,000 allowance.

Example 2: Rhonda Cole wants to provide financial support for her son Mark’s two children, Ken and Julie. To do so, Rhonda pays tuition bills for Ken and Julie directly to their colleges. The total is $50,000. In addition, Rhonda gives them each $15,000 in 2018 and no other gifts.

Rhonda also decides to give Mark $15,000 this year and pays $5,000 worth of bills from Mark’s medical procedures directly to the health care providers. In total, Rhonda has given $100,000 to her loved ones, reducing her taxable estate by that amount. However, she hasn’t gone over the $15,000 exclusion for any recipient in 2018, so Rhonda hasn’t made any taxable gifts and will not have to file a gift tax return.

Note that the $15,000 limit presents a handy ceiling for making family gifts each year without the bother and expense of filing a gift tax return. This strategy won’t work as well if Rhonda gives Mark $50,000 so Mark can pay his children’s college bills. Then, Rhonda will have made a taxable gift of this amount and will be required to file Form 709.

Paired Planning

Other possibilities exist if a married couple holds assets jointly, perhaps in a bank or brokerage account. A gift from such an account, or a gift of other property, by one spouse can be considered to be divided equally between the two spouses, so the annual gift tax allowance effectively increases to $30,000. There are two ways to do this. The easy way would be for each spouse to write a separate check for $15,000. If this is not practical, the spouses can get the benefit of a $30,000 annual exclusion by electing “gift splitting” on Form 709.

Gift tax Notes

  • The gift tax lifetime exemption ceiling of $11.18 million for 2018 will increase with inflation, but much lower limits are scheduled after 2025. There is some uncertainty about how this reduction, if it takes effect as scheduled, will affect large taxable gifts.
  • Any future reduction in the lifetime gift tax exemption is unlikely to affect gifts that conform to annual gift tax exclusion rules.

If you have any questions about how gift tax works, please contact our office. One of our tax professionals would be glad to help. You can also complete the following form and we can contact you.

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This post originally appeared in the CPA Client Bulletin Resource Guide, © 2018 Association of International Certified Professional Accountants. Reprinted by permission.