Taxes

Yesterday, the Supreme Court overturned Section 3 of the Defense of Marriage Act provision barring same-sex married couples from federal benefits.  Now the issue is kicked to the state politicians, and the high court’s ruling doesn’t touch the issue of having state’s recognize same-sex marriages performed outside their borders.

Pennsylvania’s definition of marriage goes back to 1996, and it defines marriage as between a man and a woman.  This is to say that Pennsylvania doesn’t recognize same-sex marriages, even if they take place outside state borders.  So what does this mean in terms of estate planning for same-sex couples?

Well, estate planning is done on a state-by-state basis because the laws vary by state.  For example, the probate process in Pennsylvania is quick and painless, however in Florida you want to avoid probate at all costs.  The tax-inheritance laws are different, too.  In Pennsylvania, the rate for inheritance tax between married couples is 0%, so a $1,000,000.00 estate transferred between a husband and wife would have a $0 tax.  The rate of inheritance tax between unrelated persons is 15%, leaving a same-sex couple, married in a different state,f to pay a tax of $150,000.

Additionally, some federal agencies base their recognition on the rules where marriages are officiated, but others rely on the rules of the state where the couple lives. Since Pennsylvania doesn’t recognize same-sex marriages, neither will the Social Security Administration or the IRS, and benefits won’t be extended to Pennsylvania residents.

Right now this is where Pennsylvania stands, although with the changing public opinion you should be sure to keep an eye out on the state politicians.  We could have a flurry of same-sex marriage legislation coming our way.

While most older adults live on fixed income, they generally find that their property taxes or rent keeps increasing.  Fortunately, Pennsylvania has a program that can help offset these expenses.  The Pennsylvania Department of Revenue's Property Tax/Rent Rebate Program aims to help reduce the expenses that those living on fixed incomes cannot afford.  Those who are 65 years of age or older, as well as widows/widowers age 50 or older and disabled individuals 18 and older, may qualify for a property tax rebate, but only if they earn up to $35,000 a year.  Please note that this amount is excluding half of their Social Security income.  Renters are able to receive a rebate check if they earn up to $15,000 a year, again excluding half of their Social Security income.

The deadline to apply to this program is June 30, as checks will be issued beginning July 1.  If you need an application, you should call the Revenue Department at 1-888-222-9190 or go to www.revenue.state.pa.us.  Applications can be downloaded at this website.  If you need help completing the application, please call the Lancaster County Office of Aging at 717-299-7979.

As a part of Congress's tax compromise to avoid falling down the fiscal cliff, the exemption amount for estate taxes will remain the same as it has been for the past two years.  The American Taxpayer Relief Act, passed in the House by a vote of 257 to 167, permanently sets the estate tax exemption at $5 million for an individual (adjusted to $5.12 million due to inflation) and $10 million for a couple (adjusted to $10.24 million).  With new inflation amounts, the exemption is expected to rise to about $5.2 million.

The gift tax and generation-skipping transfer tax exemptions will remain the same as last year as well.  They will be adjusted for inflation as the estate tax exemption was.

Congress, however, did make one change to the prior rules, by increasing the maximum tax rate by 5 percentage points.  This raises it to 40 percent.  Tax rates of 37, 39 and 40 percent will apply, depending on the value of the estate.

This bill and it's provisions would take effect January 1, 2013.  However, until President Obama signs it, the estate tax has technically reverted to its 2011 level of 55 percent and the estate tax exemption level has dropped to $1 million.  Still, President Obama has promised to sign the bill, and should be doing so quickly.

In the news, there has been a lot of talk about the impending "fiscal cliff," and if Congress and the administration can't strike a deal, starting tomorrow, January 1, there will be spending cuts and tax increases because of this cliff.  These changes have the potential to greatly impact many families, especially in terms of estate planning.

In the new year, the federal estate tax and gift tax exemptions will drop from their current level of $5.12 million to $1 million.  This means that if your estate values over $1 million, only the first million dollars will be exempt from tax, leaving the rest subject to tax rates that will also be increasing.  In 2012, the maximum tax rate was 35 percent; under current law it will be raised to 55%.  Tax rates have not been that high since 2001, and the exemption level was last at $1 million in 2003.

These two changes will all of a sudden cause quite a few people to worry about estate planning who weren't worried before.  Families with estates under $1 million can still relax, and those with estates valuing over $5.12 have likely already structured their wills to protect from estate taxes.  However, estates totaling between $1 million and $5.12 million are probably not ready for these changes.

There are several different techniques available to get out of the direct line of fire of the new estate tax laws.  Establishing trusts and using different insurance methods are two, but there are many others available.  The best plan of action would be to seek counsel from an estate planning attorney who knows all the available options and can establish the plan most suited for your needs.  While it's not too late to take action, moving quickly will best protect your family and the legacy you leave behind in the new year.

Unfortunately, most action taken now will likely prove to be unnecessary in the future, but how soon in the future is unknown.  Exemptions and tax rates have changed 9 times since the start of the century, and because most congressmen have estates larger than $1 million and will want to protect themselves from the high rates, it is likely that the exemption amount will raise to around $3 million.  However, the specifics of these changes and how soon they will come into effect are unknown at this time, and with so much uncertainty surrounding them, it is best to take action and protect your family as soon as possible.

While perusing the internet recently, I came across an article on Forbes by Deborah L. Jacobs.  At a recent online conference for estate planning advisors, she noted the questions these advisors had.  Most of these questions had to do with inherited IRAs and 529 college savings accounts.  Since some of the advisors didn't know the answers and because some are tricky, we thought it'd be in the best interest of our clients if we shared some information on them.

Inherited IRAs

The person who inherits your IRA, like other assets, isn't necessarily the person you named in your will.  Your beneficiary designations on all accounts take precedence over wishes stated in a will.  So what happens if there's no beneficiary on file?  The heir is determined by the IRA custodian's policy.  Usually the IRA is first awarded to a living spouse, then to the estate, so if you want to pass on your IRA directly to your kids, you need a beneficiary form.  To give your heirs maximum flexibility, name both primary and alternate beneficiaries.

If you've inherited an IRA, do nothing until you know what rules apply.  For example, if you are not the spouse and have inherited an IRA, you must begin taking distributions by December 31 of the year after inheriting.  Also, unless you are the spouse, you must retitle the IRA to include the original owner's name.  And once you've inherited an IRA, make sure to designate beneficiaries.

An advisor asked if you can write on the beneficiary form "according to the terms of my will."  While this will most likely be accepted by the custodian, there's no guarantee that there won't be complications.  By writing this, you have to verify that the custodian has the will on file and that they have the latest version of the will.  Still, they may not accept the designation this way, so your best bet is still to name a beneficiary.

529 Plans

A 529 Plan is an education savings plan designed to help families set aside funds for future college costs.  As long as the plan satisfies a few basic requirements, federal tax law provides special benefits to the plan participant.  This can include gift and estate tax benefits.  You can give anyone $13,000 annually without eating into your exemption from gift or estate tax.  When it comes to 529s, however, you can deposit as much as $65,000 (or $130,000 for a couple) and treat it as five years' worth of gifts.  Once in the 520, the money can grow tax free.

One advisor said he heard that if the grandparent is the owner of a 529 plan, distributions are considered income to the child and jeopardize their financial aid eligibility.  He is correct with this.  If a grandparent makes a distribution from a 529 to pay tuition, that amount counts as income and must be reported on the following year's FAFSA (Free Application for Federal Student Aid).  A student is expected to apply 50% of all income above a certain limit to education, so if a grandparent with good intentions pays the first year's tuition, he might exhaust the 529 and endanger the student's aid eligibility.  In such a case, the 529 would be best spent paying senior year tuition.

Unfortunately, it gets more complicated.  About 250 of the most expensive private colleges use a different form to award aid.  This form requires the student to report all 529 savings accounts that name him as a beneficiary and that are not owned by his parents.  These accounts can have a huge impact on aid eligibility.  You might be able to mitigate the impact on aid by transferring the account ownership to the student's parent a year before the student applies for college.  However, this raises another question: could the transfer of ownership be a taxable gift to the parent?  While the IRS hasn't ruled on this specific issue, the answer is probably not, but still be cautious.

To read the original article, click here.

On July 2, Governor Tom Corbett signed a piece of legislation that exempts farmers from inheritance tax.  This law, effective for all deaths after June 30, 2012, allows farmers to pass down their farms to their heirs without having to worry about the farm paying taxes after death.  These taxes (4.5% for children of the decedent, and 12% for siblings) left a large burden for those inheriting them, because although farmers are rich in land, they are often time poor in cash.  In order to pay the taxes, they would have to sell their farmland, causing farms to shrink in size and productivity as the family line grew longer.

When signing the bill, Corbett said that this tax has forced many families "to sell their legacy, their land and their way of life."  Now, as long as the farm is a working farm, it can be passed to immediate family members without having to pay inheritance tax.  In the past, farmers all knew of friends that had to dissolve the farm to pay inheritance tax.  Now, the nearly 63,000 farming families in Pennsylvania will be able to pass along the land and the business.

Cutting this tax is obviously cutting a source of revenue for state operation, making the budget a bit tighter.  However, agriculture is the top industry in the state, so this law could be healthier for the future of Pennsylvania.  The 8 million acres of farmland in Pennsylvania generates almost $6 billion in sales each year, and by protecting the land through eliminating inheritance tax, Pennsylvania can protect this industry.