September 26

The Basics of the “Stepped-up Basis” — a Big Loophole to Avoid Tax on Investment Gains

Even if you are not a close follower of estate planning issues, it is worth learning the basics of the most famous tax loophole in the Internal Revenue Code, known as the automatic step-up in basis at death.

After you learn the basics of the rule, remember this:  Before deciding to sell any stocks, bonds, real estate, or other investment property, always consider the consequences the sale could have on your family’s ability to use this loophole.  You don’t need to know all the ins and outs of the rule; simply seeking legal advice if you identify a potential “step-up” issue could save your family tens or hundreds of thousands of dollars.

Example

Paula, a widow, has one adult daughter. 

In 2011, Paula bought 2,000 shares of Apple stock for $100,000. 

Today, Paula’s 2,000 shares of Apple stock are worth $200,000. 

Paula has lived a long and happy life, but she has a serious medical condition and her doctors say she now has less than a year left to live.  She wants to give $200,000 from the Apple stock to her daughter.   Our goal is to get as much of that money to her daughter as possible.

Let’s look at the tax implications of two options:

1) Paula sells the stock now and gives the proceeds to her daughter, or

2) Paula holds on to the stock and passes it to her daughter at death.

Option 1 (Pay Lots of Taxes):

If Paula sells her stock today, the federal government will tax her on the gain (or appreciation) in her Apple stock.  Calculating this gain is a simple subtraction problem.  Take the value of the stock on the date of the sale ($200,000), and subtract the “basis”, which is the value of the stock on the day it was purchased ($100,000).  $200,000 sale price minus $100,000 basis equals a $100,000 gain. 

For simplicity, let’s say in Paula’s tax bracket, she owes 15% federal capital gains tax on that $100,000 gain.  15% of $100,000 is $15,000 in federal tax.  If her state tax rate is 5%, she will owe an additional $5,000 in taxes on the sale, for a total of $20,000 in taxes. 

Option 2 (Take Advantage of the “Step-Up” Loophole)

Let’s say instead of selling the Apple stock during her life, Paula keeps the stock until her death.  She then passes it on to her daughter through a will, living trust, or by naming her as a death beneficiary on her investment account.  For simplicity, let’s say the stock is worth $200,000 on the date of Paula’s death.  Paula’s daughter takes possession of the stock, and then decides to sell it right away.

The stock is worth $200,000 today but was purchased for $100,000, so using the subtraction problem from above, Paula’s daughter will still owe taxes on $100,000 in gain…right?  Wrong!

Under the Internal Revenue Code Section 1014(a), when someone receives property upon another’s death, the “basis” value of the property is calculated at the date of death, not the day the investment was purchased.  So, the IRS forgets about the fact that the property was actually purchased by Paula for $100,000, and the new basis is “stepped up” to $200,000. 

The subtraction problem becomes $200,000 sale price minus $200,000 “stepped-up basis”, which equals zero taxable gain.  15% federal tax on $0 is $0.  5% state tax on $0 is $0.  Paula’s daughter takes the property and owes no income tax.

Option 2 saves Paula’s family $20,000 in tax, money that could have been lost had she not know about the “step up” loophole!

Conclusion

One of the fundamental principles of tax is that income (gain) is subject to taxation.  The Section 1014 “step up” is a huge exception to these rules.  But it is easy to miss out on the benefit if you aren’t paying attention.  Remember, this is just a brief overview and is not individual legal advice, so make sure to consult an estate planning professional if you have property that might qualify for this loophole.

Published by the Law Office of Ian Holzhauer in Naperville, IL.  
Note:  The information above is not legal advice and is not the basis of an attorney-client relationship.  If you need assistance, you can hire an attorney to assist you with your individual legal needs. 
September 24

The Basics: Hiring an Estate Planning Attorney

The Importance a Well-Drafted Estate Plan

The benefits of a complete estate plan (and the consequences of failing to make one) are immeasurable.  For parents of minor children, a properly-drafted will ensures your children will be cared for by people you know and trust in the event of your death, not someone chosen by a judge you’ve never met.   This reason alone makes life without an estate plan unacceptable for most families with small children, mine included.

Aside from wills, other useful estate planning tools can be tailored to your needs.  If appropriate for you, a living trust can ensure your property is not tied up in probate after your death.  Failure to plan ahead will often leave your loved ones unable to quickly distribute property, instead forcing them to spend a year and considerable sums of money muddling through the court system, unable to move on after a death in the family.  A living trust and other documents can help avoid all of this.  There are numerous other well-documented benefits to a solid estate plan.

Competent legal advice for your estate plan is of enormous value.  The law governing wills draws back on centuries of English legal tradition before the existence of the United States.  Many of the rules about witnessing, signatures, and other formalities are both archaic and draconian.  However, failure to comply with these formalities often invalidates an entire will–an experienced estate planning attorney can help you avoid errors that could cost your family tens or hundreds of thousands of dollars in the future.   The following are some practical considerations about hiring an attorney:

Barriers to Hiring at Attorney

I hear people of all ages and walks of life saying, “I have been meaning to get a will/trust.  I just haven’t gotten around to it yet.”  Inertia can certainly be a factor.  And hiring an attorney to help with
your estate planning can be daunting, particularly if you have never worked with an attorney before, or don’t know anyone who could offer a reference.

I can understand the hesitation to seek out an attorney.  In over six years as a JAG in the Air Force, I formed an attorney-client relationship with well over 500 clients in matters ranging from simply updating a power of attorney, to helping terminally ill retirees with their wills, and even to serious criminal cases during my time as an Area Defense Counsel.  Most of my clients were seeing an attorney for the first time in their life.  Some of them told me they felt embarrassed to seek help at first or didn’t know what to expect from an attorney.  But after working together, I believe many of my clients felt much more at ease about their legal issues and confident in their knowledge of the process.  I feel it is crucial to find someone that makes you feel comfortable, and who empowers you to take charge of your legal affairs.

Practical Tips for Finding an Attorney that Works for You

When looking for an estate planning attorney, make sure to research your options.  If you know and feel comfortable with an attorney in your local area, call and ask for recommendations.  Even if estate planning is not the attorney’s specialty, he or she may be happy to point you in the right direction.  If you know people who have hired attorneys, ask about their experiences. 

If you don’t know any attorneys or former clients, compare the websites of some of the estate planning attorneys in your area.  Do they specialize in one or two areas of law, or are they general practitioners with many specialties?  Have they practiced in other areas before? 

Feel free to interview several attorneys before hiring one.  Ask up front if they will do a free consultation.  Pay close attention to the “bedside manner” of each attorney.  Do you comfortable asking for clarification when you don’t understand something, or do you seem to be under pressure to get out of the office quickly?  When you call the receptionist, are you treated respectfully?  Are your calls returned? 

When you interview attorneys, make sure to ask them about their philosophy.  Why do they practice law?  In my time as a JAG, I developed my own philosophy:   It is better to spend most of my time carefully listening to my clients’ concerns, and only then offering advice, than to prescribe one-size-fits-all solutions.  I find that doing this gives the client more confidence in the process, and ultimately yields a solution better suited to their needs.  There are other successful philosophies out there, but the important thing is that you find an attorney whose philosophy fits your needs.

Published by the Law Office of Ian Holzhauer in Naperville, IL.  
Note:  The information above is not legal advice and is not the basis of an attorney-client relationship.  If you need assistance, you can hire an attorney to assist you with your individual legal needs.  

September 24

Introduction and Blog Layout

This blog is intended for a wide audience, from parents of young children researching the basics of wills and living trusts, to fellow attorneys and financial professionals wishing to discuss the latest developments in trust-related case law.  As indicated in the title, my goal is to advocate for a more client-focused, personalized and less fill-in-the-blank estate planning experience.  I feel the best way to achieve this is to invite a broad spectrum of people to read and to comment.

To facilitate navigation of the blog, I will tag each post either Basic, Intermediate, or Advanced Estate Planning.  You can navigate to posts in the applicable category by clicking the tags on the right side of the screen.

Although I am licensed to practice in Illinois, and may sometimes reference my state’s law, I welcome comments from practitioners in other states.  The intent is to keep the content broad enough that it is relevant to people across the country.

I invite you to learn more about my background on the About the Author link.  You can also visit the website for my firm, the Law Office of Ian Holzhauer in Naperville, IL. 

Note:  The information above is not legal advice and is not the basis of an attorney-client relationship.  If you need assistance, you can hire an attorney to assist you with your individual legal needs. 
January 11

Caring for Special Needs Relatives with a Supplemental Needs Trust

Courtesy Kari Reine
In common usage, “special needs” often refers to conditions first recognized in childhood, such as Down Syndrome, autism, or cerebral palsy.  In estate planning, “special needs” encompasses a broader range of conditions including developmental disabilities, but also age-related conditions, physical disabilities, mental illness, diseases, and any other conditions that could qualify a family member for current or future government benefits.  It is absolutely crucial that people who have special needs family members obtain an estate plan tailored to their unique needs.  Below is an example of how a failure to plan for special needs children could be disastrous for a family’s financial future (and how better planning could have prevented the situation):

Example

Jonathan and Carrie live in Lisle, IL, with their eighteen year-old son, Braden, who has autism.  Braden just graduated from high school, a major accomplishment in his life.  However, his condition requires him to be constantly supervised, and he needs expensive weekly occupational therapy.  He will never be able to have a job.
Jonathan and Carrie have provided a loving environment for Braden, and he is happy and doing well.  His aunts and uncles (who live in Hinsdale and Downers Grove) frequently visit and help care for him.
Jonathan and Carrie are both data analysts at a corporation in Naperville.  They have accumulated $200,000 each in their 401(k) plans, and have $100,000 in other savings.  They worry about what will happen to Braden when they die.  They have foregone taking vacations, purchasing a larger house, and always purchased clothing at thrift stores, all to save enough so that Braden will have a comfortable life.
However, with Jonathan and Carrie’s busy careers, they do not take the time to fully research the complexities of estate planning for disabled family members.  Instead, they simply name Braden as the death beneficiary on their 401(k) plans, and sign a simple will transferring their remaining $100,000 to him. 
Jonathan and Carrie (correctly) assume a guardian will be appointed to hold Braden’s property for his benefit after his death.  However, they incorrectly assume that this guardianship will solve the problems with transferring money to Braden.
Jonathan and Carrie die suddenly in a car accident, leaving Braden dependent on his extended family.  Soon after the tragedy, the extended family begins to realize what an enormous mistake Jonathan and Carrie made.
Braden’s condition had previously qualified him for Supplemental Security Income (SSI) and Medicaid.  However, with an inheritance from his parents, Braden now exceeds the asset limits for these programs.  He will now be forced to pay out-of-pocket for his expenses until he becomes impoverished, and can then obtain the benefits he once had.  Given the severity of his condition and his need for constant care, his $500,000 inheritance will quickly be depleted.
Once his inheritance is gone and he is again on Medicaid and SSI, his uncles and aunts will constantly have to purchase goods and services for him to maintain his comfort and standard of living.

A Better Plan

Braden’s parents spent their working careers saving to provide him a comfortable life after they passed away.  The last thing they would have wanted would be for him to lose medical and SSI benefits as a result of their plan, and to become a burden on their family. 
Had Braden’s parents consulted a reputable attorney who specialized in estate planning, they likely would have decided to set up a supplemental needs trust for Braden. 
Here is an example of how Jonathan and Carrie’s estate plan could have been structured:  During Jonathan and Carrie’s lives, their 401(k) accounts would stay titled in their names, with a designation that after both of their deaths, the money go into their supplemental needs trust.   Their $100,000 in savings could be retitled into a living trust, with instructions that the money would be transferred into the supplemental needs trust after the death of the second parent.  During their lives, Jonathan and Carrie would both have full access to the money in their living trust.  It is only after their deaths that the benefits of the trust would kick in.
After both parents die, all of Jonathan and Carrie’s money would flow into the supplemental needs trust.  Once the supplemental needs trust is funded, the money will be held for Braden’s benefit by a third party (a trustee). 
The trustee purchases services or items to help Braden feel comfortable.  This could be food, housing, clothing, books, movies, or even travel tickets to visit family.  However, the trust funds could not be used for medical services that would otherwise be covered by government benefits. 
Because the trustee, not Braden, decides when money is to be spent on Braden (he has full discretion), and Braden does not own the money, the Government does not consider the assets to be Braden’s.  Therefore, he qualifies for Medicaid and SSI, but still benefits from the quality of life for which his parents had worked so hard to save.  Further, Braden is not a financial burden on his extended family because his parents planned ahead for him with a well-drafted supplemental needs trust. 

Administering the Trust

The trustee of the supplemental needs trust needs to be careful to follow the instructions in the trust.  The trust money does not directly belong to Braden, and if the trustee begins to treat it that way (for example, by writing a $20,000 check directly to Braden’s bank account), the trustee may disqualify Braden for benefits.  If the trustee is unsure about how to properly do his job, he should seek help from a qualified wills, trusts, and estates attorney.
Another option is for the trustee to contact a nonprofit agency, like Life’s Plan in Braden’s hometown of Lisle, that specializes in special needs trust management.  Agencies like this can even take smaller trust funds and consolidate them into a pooled trust, to reduce administrative expenses for running the trust.

Conclusion

Families show their love to special needs relatives in amazing ways, often through a lifetime of dedicated service, patience, and kindness.  Many families also make great sacrifices to save money to help their disabled loved ones maintain a good quality of life, even after the deaths of the non-disabled family members.  Supplemental needs trusts can help secure a family’s goal to care for a disabled family member into the future.
Published by Ian Holzhauer, Esq. of Nagle Obarski PC in Naperville, IL.  
Note:  The information above is not legal advice and is not the basis of an attorney-client relationship.  If you need assistance, you can hire an attorney to assist you with your individual legal needs.  
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