Wealth Management

Installment Sales: A Viable Option for Transferring Assets

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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

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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

Life Insurance for More Than Just Cash Flow

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Many people think of life insurance as a product for family protection. The life of one or two breadwinners is insured; in case of an untimely death, the insurance payout can help with raising children and maintaining the current lifestyle.

Once the children are able to live independently and a surviving spouse is financially secure, insurance coverage may be dropped. Such a strategy uses life insurance as a hedge against the risk of lost income when that cash flow is vital.

This type of planning is often necessary. That said, life insurance may serve other purposes, including some that are not readily apparent.

Final Expenses

When someone dies, funeral and burial expenses can be daunting. In addition, the decedent’s debts might need to be paid off, perhaps including substantial end-of-life medical bills. Many insurers offer policies specifically for these and other post-death obligations, with death benefits commonly ranging from $10,000 to $50,000.

The beneficiary, typically a surviving spouse or child, can receive a cash inflow in a relatively short time. Generally, this payout won’t be subject to income tax. The result might be less stress for beneficiaries during a difficult time and a reduced need to make immediate financial decisions in order to raise funds.

Investment Support

This year’s stock market volatility has worried some investors, who may be tempted to turn to safer holdings, which have little or no long-term growth potential. Prudent use of life insurance might help to allay such fears.

Example 1: Jill Miller has $600,000 in her investment portfolio, where she has a sizable allocation to stocks. She is concerned that an economic downturn could drop her portfolio value to $500,000, $400,000, or less. Therefore, Jill buys a $250,000 policy on her life.

Now Jill knows that her children, the policy beneficiaries, will receive that $250,000 at her death, income-tax-free, in addition to any other assets she’ll pass down. This gives her the confidence to continue holding stocks, which might deliver substantial gains for Jill and her children.

Balancing Acts

Life insurance also can help to treat heirs equally, if that is someone’s intention, but circumstances create challenges.

Example 2: Charles Phillips, a widower, owns a successful business in which his older daughter Diane has become a key executive. Charles would like to leave the company to Diane, but that would exclude his younger daughter Eve, who has other interests.

Therefore, Charles buys a large insurance policy on his life, payable to Eve. This assured death benefit for Eve will help Charles structure his estate plan so that both of his daughters will be treated fairly. There is a potential downside to consider if Charles is wealthy enough to have an estate that is subject to the federal estate tax ($11.18 million in 2018). In this case, a large insurance policy will swell his gross estate, leading to a greater estate tax liability.

Life insurance may be especially helpful when one or both spouses has children from a previous marriage.

Example 3: Jim Devlin’s estate plan calls for most of his assets to be left in trust for his second wife, Robin. At Robin’s death, the trust assets will pass to Jim’s children from his first marriage. Robin is younger than Jim, so it could be many years before his children receive a meaningful inheritance.

Again, life insurance can provide an answer. If Jim insures his life and names his children as beneficiaries, his children may get an ample amount without having a long wait.

Proceed Carefully

The life insurance marketplace ranges from straightforward term policies to so-called permanent policies (forms of variable, universal, or whole life) that have investment accounts with cash value. In some cases, policyholders can tap the cash value for tax-free funds while they’re alive.

Our team can help explain the tax aspects of a policy you’re considering, but you should exercise caution when evaluating any possible purchase of life insurance. Give us a call to find out what you’ll be paying and what you’ll be receiving in return.

Additional Resources

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

529 Plans for Elementary and Secondary Education

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For many years, 529 college savings plans have offered a tax-favored way to save for higher education. These plans, officially qualified tuition programs, are named for the IRC section that provides their advantages.

In brief, 529 plans are funded with after-tax dollars. In college savings plans, account owners choose from a menu of investments, and any earnings are untaxed. Distributions are also tax-free if they do not exceed the qualifying educational expenses of the account beneficiary: payments of tuition, fees, supplies, and certain housing expenses for the account beneficiary’s study at an eligible educational institution. Before 2018, eligible educational institutions included only post-secondary institutions.

Youth Movement

Under the new tax law, the benefits mentioned previously (tax-free investment earnings, potentially tax-free distributions) remain as they were. The difference is that for tax years beginning after December 31, 2017, 529 plans are no longer limited to higher education at a post-secondary institution. Now they can be used for elementary and secondary education, as well. That includes learning in public, private, and religious schools.

There is one key caveat: Tax-free distributions for elementary and secondary education are capped at $10,000 per student per year. As before, there is no annual limit on qualified distributions from 529 plans for higher education.

Eligible Schools

  • For qualified tuition program tax benefits, an eligible educational institution now can be either an elementary, a secondary, or a post-secondary school.
  • Among post-secondary schools, eligible schools are generally any accredited public, nonprofit, or privately owned profit-making college, university, vocational school, or other post-secondary educational institution.
  • A post-secondary school also must be eligible to participate in a student aid program administered by the U.S. Department of Education.
  • Eligible elementary and secondary schools include any public, private, or religious school that provides elementary or secondary education (Kindergarten through grade 12 classes).

Example 1: Bill and Claire Dawson open a 529 account for their newborn son Noah. Over the years, they invest thousands of dollars there. When Noah is age 10, in the fifth grade, he goes to a private school where the tuition is $15,000. The Dawsons take $10,000 from Noah’s 529 account to pay part of his tuition with a tax-free distribution. A larger distribution could lead to an income tax obligation and possibly an additional 10% tax on the amount of the taxable distribution.

Sooner Than Later 

For families like the Dawsons, using 529 money for pre-college costs might not be an ideal strategy. The earlier money is withdrawn, the less time there will be for compounding earnings. Extending untaxed investment buildup, which eventually may come out as a tax-free distribution, is a prime benefit of 529 plans.

Even so, the new law can prove beneficial in some situations. When cash is short and private school costs are high, a $10,000 tax-free distribution from a 529 plan may be welcome. If students are now attending an expensive high school but are expected to attend an inexpensive college, it may make sense to use the $10,000 529 distribution each year.

Moreover, even though the new 529 provision applies to federal tax, substantial benefits might come from state taxes. Nearly every state offers a 529 plan, and most of them provide state income tax credits or state tax deductions to residents who invest in the home state’s plan. (Some states have tax benefits for investing in any 529 plan.)

So far, states have differed on how they’ll treat 529 plan distributions for K-12 distributions. Assuming your state goes along with the new federal law, using $10,000 a year for pre-college costs may become especially attractive.

Example 2: Suppose Ted and Sarah Raymond live in a state that offers a 10% tax credit for 529 contributions. They invest $10,000 in their state’s plan this year, getting a $1,000 credit against state tax. Then, they use that $10,000 to pay part of their daughter Gina’s private high school tuition. With the $1,000 state tax saving, the Raymonds effectively reduce Gina’s school cost by $1,000 by streaming their cash through their state’s 529 plan.

Additional Resources

Our team can inform you of your state’s tax treatment of 529 contributions and how the state is dealing with the new rules on 529 distributions. Give us a call.

Don’t Neglect Estate Planning.

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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.