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Financial Planning

Saturday, February 28, 2015

Changing Uses for Bypass Trusts

Changing Uses for Bypass Trusts

Every year, each individual who dies in the U.S. can leave a certain amount of money to his or her heirs before facing any federal estate taxes. For example, in 2013, a person who died could leave $5.25 million to his or her heirs (or a charity) estate tax free, and everything over that amount would be taxable by the federal government. Transfers at death to a spouse are not taxable.

Therefore, if a husband died owning $8 million in assets in 2013 and passed everything to his wife, that transfer was not taxable because transfers to spouses at death are not taxable. However, if the wife died later that year owning that $8 million in assets, everything over $5.25 million (her exemption amount) would be taxable by the federal government. Couples would effectively have the use of only one exemption amount unless they did some special planning, or left a chunk of their property to someone other than their spouse.

Estate tax law provided a tool called “bypass trusts” that would allow a spouse to leave an inheritance to the surviving spouse in a special trust. That trust would be taxable and would use up the exemption amount of the first spouse to die. However, the remaining spouse would be able to use the property in that bypass trust to live on, and would also have the use of his or her exemption amount when he or she passed. This planning technique effectively allowed couples to combine their exemption amounts.

For the year 2013, each person who dies can pass $5.25 million free from federal estate taxes.  This exemption amount is adjusted for inflation every year.  In addition, spouses can combine their exemption amounts without requiring a bypass trust (making the exemptions “portable” between spouses). This change in the law appears to make bypass trusts useless, at least until Congress decides to remove the portability provision from the estate tax law.

However, bypass trusts can still be valuable in many situations, such as:

(1)  Remarriage or blended families. You may be concerned that your spouse will remarry and cut the children out of the will after you are gone. Or, you may have a blended family and you may fear that your spouse will disinherit your children in favor of his or her children after you pass. A bypass trust would allow the surviving spouse to have access to the money to live on during life, while providing that everything goes to the children at the surviving spouse’s death.

(2)  State estate taxes. Currently, 13 states and the District of Columbia have state estate taxes. If you live in one of those states, a bypass trust may be necessary to combine a couple’s exemptions from state estate tax.

(3)  Changes in the estate tax law. Estate tax laws have been in flux over the past several years. What if you did an estate plan assuming that bypass trusts were unnecessary, Congress removed the portability provision, and you neglected to update your estate plan? You could be paying thousands or even millions of dollars in taxes that you could have saved by using a bypass trust.

(4)  Protecting assets from creditors. If you leave a large inheritance outright to your spouse and children, and a creditor appears on the scene, the creditor may be able to seize all the money. Although many people think that will not happen to their family, divorces, bankruptcies, personal injury lawsuits, and hard economic times can unexpectedly result in a large monetary judgment against a family member.

Although it may appear that bypass trusts have lost their usefulness, there are still many situations in which they can be invaluable tools to help families avoid estate taxes.


Tuesday, May 13, 2014

When Can You Destroy Financial Records?

The IRS has three years from your tax return filing date to audit your return, if it suspects good faith errors. (For example, your 2013 taxes were due by April 15, 2014.  The IRS has until April 15, 2017 to audit your return for good faith errors).  

However, the IRS has six years to challenge your return if they think you have under-reported your gross income by 25% or more.  

There is no time limit if you fail to file your return, or if you have filed a fraudulent return.  You should keep your filed tax returns for at least six years.

If you have made a nondeductible contribution to an IRA or a Roth IRA, you should keep your financial records indefinitely in order to prove that you already paid tax on this money when the time comes to withdraw.  You should keep annual summaries from your retirement accounts until you retire, or until you close the account.

Bank records should be kept for at least a year, and perhaps permanently--especially if there are payments made related to your taxes, your business expenses, home improvement costs, and mortgage payments.  You should go through your bank records once a year, and shred those items that have no long-term importance.  

In terms of bills and credit card receipts, you should permanently keep receipts for large purchases, such as jewelry, appliances, antiques, etc.  There will be important if you have a future insurance claim for loss or damages.  Keep business- and tax-related expense records for at least 7 years.

Keep all records documenting the purchase price and sales price of any owned real estate.  Be sure to keep records documenting permanent improvements, such as remodeling, additions, and installations.

Paycheck stubs - one year.  Once you receive your annual W-2 from your employer, make sure the information on your pay stubs matches with the W-2.  If it does, shred the stubs.  

Consider scanning your financial records to an electronic copy (PDF) and/or storing that information "in the cloud."  There are many providers of cloud storage, including Legal Vault, which I make available to my clients at the Law Office of Joan Medeiros.





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