Planning for the Spendthrift Child

Let's Talk about......Planning for the Spendthrift Child
By: Alan Orlowsky

One of the main reasons our clients get involved in estate planning is to provide loved ones with protection from claims of future creditors, and “predators” such as divorcing spouses or lawsuits. If you leave your property to your child as an outright distribution, the property will not be protected from these things, but by using well-designed trusts, many protections are available. However, in some families, protection of assets from outside forces is not as important as protection from the child who is receiving the inheritance!

 

What is a parent to do when they want to treat children equally, but are afraid that one of the children will waste their inheritance within weeks or months of inheriting it? There is a longstanding concept in trust law known as “spendthrift” protection. These are provisions which provide that the Trustee will have sole control to make distributions from the trust without interference from others. The spendthrift clause prevents a third party (creditor or “predator”) from being able to compel the Trustee to make distributions of trust property.

Under the spendthrift rules of most states, a person is free to leave assets in trust for another person, with specific language in the trust specifying who, besides a trust beneficiary, can have access to the trust assets. If the trust includes a “spendthrift” clause that specifically states that trust income and principal is not to be available for payment to a trust beneficiary’s creditors, then as a general rule the trust would be immune from attack by a beneficiary’s creditor. This sweeping protection would apply regardless of the amount or nature of a beneficiary’s liabilities, and would include protection of the trust assets if the child were to go through a divorce.

However, the extent of protection offered by a trust with a spendthrift clause will depend upon state law. Under some states, certain creditors are still allowed access to a trust. This could include a beneficiary’s obligations for alimony or child support, or payments to creditors who have provided certain “necessities of life” to the beneficiary.

For even stronger protection, your trust can be very specific on how and for what purposes funds are to be distributed. For example, you might specify that distributions will be made to your child on the condition that your child remains gainfully employed or, if unemployed, that your child is demonstrating steady progress toward becoming gainfully employed. You can also establish guidelines in your trust that provide that trust funds are to be used for funding non-luxury items, such as a used but safe car for transportation, and only if the beneficiary is able to pay for the ongoing maintenance and insurance of the car.

You can use very conservative distribution guidelines that allow the Trustee to make distributions solely based on demonstrated need. When combined with incentive provisions that allow the Trustee to pay for expenses that enhance a beneficiary’s career, such as funding further education, a child’s dependency over trust funds can be controlled.

If you have questions about this post or about a particular legal situation, visit out website www.orlowskywilson.com or please contact Alan Orlowsky by calling 847-325-5559.

Estate and Tax Planning for 2014

Let's Talk about Estate and Tax Planning for 2014
By: Alan Orlowsky

The United States tax code and regulations are absurdly complicated. In 1939, the entire tax law was contained in 504 pages. The current tax law is nearly 74,000 pages in length! There is no professional advisory and no employee of the IRS or the U.S. government that knows the entire code.

The most recent changes in the tax law are detailed in the American Taxpayer Relief Act of 2012 (ATRA) which was signed into law on January 2, 2013. Here are some key provisions that will impact estate planning for 2014.

Estate Tax, Gift Tax, and Generation-Skipping Transfer Tax Laws

1. The federal estate tax, gift tax, and generation-skipping transfer tax exemptions have been indexed for inflation. The exemption amount was $5.25 million in 2013 and increases to $5.34 million for 2014.

2. The maximum estate, gift, and generation-skipping transfer tax rate increased from 35% in 2012 to 40% in 2013. It remains at 40% for 2014.

3. The annual gift tax exclusion for 2014 remains at $14,000 ($28,000 for married couples). That is the amount that may be gifted to any individual without gift taxes, and without using any of your lifetime exemption.

4. Prior to 2010 married couples could use both of their individual estate tax exemptions by using what was known popularly as “A/B Trusts” in their estate planning. The Tax Reform Act of 2010 made the tax exemptions for married couples “portable” through 2012. That means that the surviving spouse could apply the unused portion of their deceased spouse’s exemption, along with their own exemption, to reduce estate taxes on the 2nd spouse’s death. ATRA made this “portability” permanent for 2013 and beyond (as much as any tax law can be deemed permanent). In other words, in 2014 a married couple can pass $10.68 million to their heirs without special planning. To take advantage of this opportunity, the surviving spouse must file IRS Form 706 after the first death, and elect to use the deceased spouse’s exemption.

5. NOTE that “portability” applies only to the federal estate tax, not to the generation-skipping transfer tax, or to state inheritance tax laws (with the exception of Hawaii who has made the state estate tax exemption portable between married couples). Careful planning is still required to take full advantage of existing tax laws.

Income and Capital Gains Taxes

1. The highest marginal income tax rate increased to 39.6% for 2013 for those above the taxable income thresholds. The thresholds are adjusted each year for inflation. The top rate applies to single filers with taxable incomes over $406,750 for 2014 and to married joint filers with taxable incomes over $457,600. These threshold amounts will continue to be adjusted annually.

2. Using the same threshold amounts, the long term capital gains tax rate for 2014 is 20% for those in the highest marginal tax bracket; 25% on Depreciation recapture; and 28% on Collectibles and qualified small business stock after exclusion.

3. There is a 3.8% Medicare tax on net investment income for single filers whose “modified adjusted gross income” exceeds $200,000 or married joint filers who exceed $250,000 for 2014. This effectively results in a maximum capital gains rate of 23.8%.

4. For 2014, itemized deductions are reduced or phased out for single filers with incomes over $254,200 and married filing jointly over $305,050.

5. The Alternative Minimum Tax (AMT) was “permanently” indexed for inflation. For 2014, both single taxpayers and those who are married filing jointly, there is a 26% rate on AMT taxable income under $182,500 and 28% over $182,500. The threshold amounts are cut in half (under and over $91,250) for married filing separately.

Medicare and FICA Social Security Taxes

1. The employee portion of Social Security (FICA) taxes increased back to 6.2% during 2013. (The 2% reduction was temporary, and was allowed to expire.) For self-employed individuals, the rate reverted from 10.4% to 12.4% and remains there for 2014.

2. For single filers who earn $200,000 and married joint filers who earn $250,000 there was an additional 0.9% Medicare tax for 2013. That rate continues for 2014.

3. The FICA wage base for 2013 was $113,700 and is $117,000 for 2014 with the annual adjustment for inflation.

4. A 3.8% Medicare tax was added to capital gains taxes in 2013 for single filers whose “modified adjusted gross income” exceeded $200,000 or married joint filers who exceeded $250,000. Those thresholds remain the same for 2014.

If you have questions about this post or about a particular legal situation, please contact Alan Orlowsky by calling 847-325-5559 or visit our website at: www.orlowskywilson.com