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Tips to avoid an income tax and estate planning time bomb

During a review of their finances for the New Year, many well-meaning parents may unknowing plant a tax bomb for their children in their estate plan. Attorney H...
During a review of their finances for the New Year, many well-meaning parents may unknowing plant a tax bomb for their children in their estate plan.
Attorney Henry Weatherby
joined FOX 61 Good Day Connecticut to explain how timing is everything to reap the most from an inheritance and offers tips for general beginning of the year tax planning.

Simply stated, the tax levied on the sale of an asset can be drastically different depending on how the asset became the heir property.

For example, parents may deed a residence to a child while they are alive to avoid protect it from long term care costs or to avoid probate.

Since the child did not pay the parents the fair market value of the residence, then the parents have made a gift to the child. Depending on the value of the gift, a gift tax return may be required.

Here’s an example of what we see many families doing:

the parents own a home that they paid $50,000 for, but it’s worth $200,000;

because of concerns about long-term care costs the put the home in the children’s names, this creates a reportable gift of $200,000;

when the children sell the property, and less assume that they sell it for the $200,000, then they will owe income tax on $150,000.

Of course more the property is worth at the time of its sale the greater the gain in the larger the tax bill will be.

If instead the parents had used a revocable trust to own the home then the residence would be passed on after death and the child would not owe any income tax so long as the property was sold for what it was worth as of the date of death ($200,000 sales price - $200,000 stepped up basis = $0 gain). This is true no matter what the property is worth at the time of the parents passing.

Basically, the parents have unknowingly created an income tax bill for their children by gifting property during their lifetimes instead of allowing the children to inherit the property after death.

We routinely do planning for our clients that solves both the long-term care problem and the avoidance of probate without creating the income tax problem that so many people encounter needlessly.

It doesn’t matter how old you are. If you don’t already have an estate plan, get it done. Start with a will, power of attorney, healthcare power of attorney, living will. To do the best job for yourself and your loved ones you may also need to do additional planning as it applies to your situation.

Make tax-free gifts. Under current federal law, you can give up to $14,000 to as many people as you wish each year without a requirement to file a gift tax return. (But keep in mind that the Medicaid laws don’t care about this federal income tax rule.) Making these annual exclusion gifts is a great way to reduce the size of your estate (and potentially save estate taxes) over time. Charitable gifts are unlimited. So are gifts for tuition and medical expenses, if you give directly to the institution.

Review/update beneficiary designations. This is especially important if your beneficiary has died, is a minor or if you are divorced.

Review/update your insurance. Check the amount of your life insurance coverage and make sure it meets your family’s current needs.

Consider getting one of the several forms of long-term care insurance to help pay for the costs of long-term care (and preserve your assets for your spouse and children) in the event you and/or your spouse should need it due to illness or injury.

At the minimum, everyone over the age of 18 needs:

  • A Power of Attorney for Heath Care, which gives another person legal authority to make health care decisions for you if you are unable to make them for yourself.
  • A living will for end of live decisions when you are terminal or in a persistent vegetative state (think Terri Schiavo’s situation) because you are unable to make them for yourself.
  • HIPPA Authorizations, which give written consent for doctors to discuss your medical situation with others, including family members. In addition, a Revocable Living Trust is preferable over a Will at incapacity because it can prevent the court from controlling your assets.
  • Review/update guardian for minor kids. It is quite likely that the person you name as guardian for your children when they are small will not be the best choice as they get older. If you haven’t named a guardian who is able and willing to serve and something happens to you, the court will decide who will raise your kids.

It is so important to work with a firm that has a proven system of keeping an estate plan up to date with all of the changes in the law, the client’s finances and health, as well as changes in the health and finances of family members.

Most importantly, the real reasons to do estate planning are to take care of ourselves and our families the way that we want to.

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