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Additional Charitable Remainder Trust Considerations

We previously provided an overview of Charitable Remainder Trusts (“CRTs”) and suggested that now might be a good time to employ this strategy to avoid immediate capital gains taxes on appreciated or concentrated marketable securities positions. That overview has sparked a number of inquiries about this strategy. We followed the introduction with an article specifying who can and should be involved in the creation of a CRT. In this article, we look at specific questions about flexibility in choosing ultimate charitable beneficiaries, limits on how much of the charitable income tax deduction can be taken in a given tax year, what types of trust assets should be considered for contribution to a CRT, and what types should be avoided.

Choice of Charitable Beneficiaries

Using a CRT appeals to those who truly care about philanthropy, and who wish in some measure to give back to society a portion of their success. It is important that they have the utmost flexibility in choosing those charities that will eventually benefit from the assets held in the CRT.

One of the methods used for flexibility in choosing charities is to draft the CRT so that the trustmaker may change the charitable beneficiaries at any time. This right can be exercised during life or can be exercised in a trustmaker’s will or trust. In fact, this right to change charitable beneficiaries can be given to other income beneficiaries such as the trustmaker’s spouse or children. With this type of drafting, if a trustmaker’s charitable objectives change or if the charity is no longer able to meet the trustmaker’s needs, then a new charity or charities can be named.

There are certain requirements that must be met by a charity before it can be a “qualified” charity for purposes of a CRT. A charity must be qualified in order to ensure that the CRT’s benefits will be realized and that the assets will not be included in the trustmaker’s estate. Charitable beneficiaries can include public charities and operating and non-operating private foundations (often referred to as non-public charities). The only repercussion of naming non-public charities as the charitable beneficiary of a CRT is that the amount of the current charitable income tax deduction drops substantially regardless of the kind of property that is being contributed to the CRT. All charities that are named in a CRT must be qualified charities as defined in the Internal Revenue Code.

CRT trustmakers can name as many or as few charitable beneficiaries as they choose. There are a number of different methods that are used to name charitable beneficiaries. For example, a trustmaker could allocate a fixed percentage to a number of charities, such as: 40 percent to the Red Cross, 25 percent to the Boy Scouts, 25 percent to the Girl Scouts, and 10 percent to the American Legion. In another example, a trustmaker could name all or a portion to the trustmaker’s own charitable foundation or a donor advised fund, such as: 100 percent to the John and Sarah Doe Charitable Foundation, or 50 percent to the Sam and Betty Smith Foundation and 50 percent to the Fidelity Charitable Fund with advice given by the trustmaker’s children. Finally, trustmakers may leave all or part of the CRT assets to their local Community Foundation or to a National Foundation, such as: 100 percent to the National Foundation for Philanthropy, or 50 percent to the Community Foundation for Anne Arundel County and 50 percent to the National Heart Foundation.

Annual Limits on CRT Charitable Income Tax Deductions

A federal judge once said, “Trying to understand the various exempt organization provisions of the Internal Revenue Code is as difficult as capturing a drop of mercury under your thumb.” Because of the inordinate complexity of the Internal Revenue Code, it is impossible to succinctly give you an overview of this area of the law in this article. However, you should know these basics:

  • Gifts of long term capital gain property are deductible up to 30 percent of the trustmaker’s contribution base (i.e., his or her adjusted gross income computed without regard to the charitable deduction and any net operating loss carryback) if given to public charities, but only up to 20 percent if given to certain private foundations.
  • While cash gifts can normally be deducted up to 50 percent of the trustmaker’s contribution base if given directly to public charities, this increase limitation is not available for contributions to CRTs. For a gift of cash to a CRT, the most that can be deducted in any one year is 30% of the contributor’s contribution base.
  • If these limitations prevent a taxpayer from deducting the predicted value that will ultimately pass to charity from his CRT in the year of contribution, any deduction generated by making gifts to a CRT can be carried forward for an additional 5 years.
  • A Charitable Remainder Annuity Trust will not qualify for an income tax deduction if the probability exceeds 5 percent that the trust assets will be exhausted prior to passing to charity. (This restriction does not apply to Charitable Remainder Unitrusts.)

I find that the decision whether or not to proceed with CRT planning is not generally based on the amount of the charitable income tax deduction. It does not play a major role in most people’s decision-making process, possibly because the capital gain issue is of much greater concern. As in all planning, the motivation of each person differs, and it is the task of your advisors to make sure your planning fits these motives.

CRT Contributable Trust Assets

Using cash is the easiest method to fund a CRT. There are no initial capital gains tax savings when cash is given to a CRT, but the charitable deduction that can be taken is a maximum of 30 percent of taxpayer’s “contribution base.” If these limits keep the trustmaker from deducting the entire amount that is predicted to go to charity, he or she may carryover the unused amount of the deduction for up to five additional years.

The second easiest assets to give to a CRT are publicly traded securities. Because these securities are traded publicly, they are easy to value and can be readily sold. Charitable deductions can also be taken for CRT gifts of marketable securities up to a maximum of 30% of the contributor’s contribution base with any unused charitable deduction amount subject to carryover for up to five years.

CRTs can accommodate gifts of assets which are difficult to value as long as there is an independent trustee. These hard-to-value assets include:

  • Real estate
  • Closely-held stock
  • Tangible personal property

CRTs are generally not designed to accommodate gifts of:

  • Assets encumbered with debts (such as real property subject to a mortgage or deed of trust)
  • Business inventory
  • Limited partnership and limited liability company interests
  • Real estate investment trust interests
  • Options to acquire or sell securities
  • Installment obligations

Contributions of these types of assets could invalidate the trust or create significant income tax problems and should be avoided in almost every situation.

The Irrevocability of a CRT and the Gifts to it

A CRT is irrevocable; its essential terms cannot be changed. As a result, great care should be taken to make sure that every CRT document provides the exact instructions of its trustmakers and the precise handling of the innumerable contingencies that might arise in the future. It is imperative that these trusts be carefully designed and written by experts.

Just as the trust documents are irrevocable, the gifts that are made to them are also irrevocable. They are not conditional and cannot be taken back.

Additional gifts cannot be made to Charitable Remainder Annuity Trusts, but additional gifts can be made to any type of charitable remainder unitrust. Note, however, that, if circumstances change and a new CRT is desired, the provisions of the new CRT do not have to be the same as the original one. It may be a good idea to make a series of CRTs, especially if you believe that interest rates will be increasing over a long period ahead.

As you can gather from our discussions about the details of CRTs, they are powerful strategies if implemented by those who know what they are doing. They should only be created with the help of an experienced tax planner and trust attorney. If you think that a CRT might be a solution for your situation, I would be honored if you contacted me for assistance with this strategy.

© Richard Wright 2019

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Federal Gift Tax Considerations

Keeping Away The Holiday Grinch:
Federal Gift Tax Considerations

Each year, the approaching Holidays spark questions about the federal gift tax and its applicability to year-end gifts.  We all quite naturally want to make gifts in this season so that we can watch our loved ones enjoy them.  For those who can afford to do so, this also becomes an opportunity to transfer wealth that may otherwise be taxed in the future for income or estate tax purposes.  Typically, a question I often get from clients is “please remind me again how much am I allowed to give…?  The simple but unresponsive answer to the question is that a person may give away whatever he or she wants.  Aside from proscriptions against defrauding creditors, there is no law restricting how much one may give away.  It is the costs of making the gifts that in reality define the situation.  Among those costs, as this article will explain, are the potential ramifications of the federal gift tax.

Gift Tax Considerations for Donors

The federal gift tax is a levy that the federal government collects from donors for the privilege of making gifts, i.e., transfers of property and other valuable interests without receiving value (“consideration”) in return.  Besides raising revenue, its purposes are to underpin the federal estate tax (i.e., the federal governments levy on decedents for the privilege of passing wealth after death) and the federal income tax.  Because of the federal gift tax, taxpayers may not defeat the estate tax by giving away their assets before they die.  At the same time, the gift tax theoretically prevents high bracket income taxpayers from giving away income-producing assets to lower bracket taxpayers to force the income taxation on such income at the recipient’s lower brackets (before the income recipient returns the property and/or its income to the donor).  The federal gift tax does not prohibit taxpayers from making gifts of any size.  It merely means that if one makes a taxable gift that is not otherwise exempt, as discussed below, the federal government may impose a 40% excise tax on the value of the gift transferred.  If applicable, that tax becomes a cost that the donor needs to consider in making the gift.

Maryland does not have a comparable state gift tax, but transfers of a material part of a decedent’s property within two years before death and lifetime transfers by a decedent “in contemplation of death” may be subject to Maryland inheritance tax after the donor’s death.  Recall however that transfers made to spouses, lineal descendants, parents, grandparents, siblings, and qualified charities are in any case exempt from Maryland inheritance tax.

Lifetime Exemptions from Gift Taxation

Fortunately, Congress has decided that the gift tax should only apply to relatively wealthy people.  Like the federal estate tax and until January 1, 2026, federal gift tax is not currently imposed on an individual’s first $11.18 million in otherwise taxable transfers during his or her lifetime.  The Internal Revenue Service has recently announced that, with inflation, this amount will be $11.4 million starting in 2019.  Thus, while lifetime gifts reduce the amount of transfers that can be made estate tax-free after death, married individuals will have a total of some $22.8 million dollars after the end of 2018 that will be exempt from federal transfer taxes on gifts or post-mortem transfers.  And with “Portability”, surviving spouses may use whatever exemption goes unused by a first decedent spouse after his or her death if an estate tax return is filed for that spouse.

Unfortunately, current law provides that on January 1, 2026, these exemptions will be decreased by half.  For 2026 and beyond, the Internal Revenue Code will limit gift and estate tax-free transfers to a total of $5.7 million (plus an adjustment for future inflation), or a total of some $11.4 million for married couples.  Even if this reduction stands, the $5.7 million future exemption amount means that most individuals can make very substantial tax-free gifts if they choose to do so.

Gift Tax Deductions and Annual Exclusions

In addition to the lifetime exemptions from federal gift tax, the Internal Revenue Code also provides for deductions for the value of gifts made to spouses and charities.  Because of these deductions, transfers between spouses and contributions to charity do not generally reduce the taxpayers’ lifetime exemptions.  (For example, if a taxpayer makes a $20,000 transfer to his spouse, the net value of the gift becomes the $20,000 transferred minus a $20,000 marital deduction, or a net taxable gift of $0.)

Additional annual “exclusions” from gift tax are also available that are designed to allow smaller gifts without reducing the taxpayer’s available lifetime exemption.  In essence, these are the lifetime gifts (such as Holiday, anniversary and birthday gifts) with which the IRS does not wish to be bothered.  The federal government is actually pretty generous with these annual exclusions.  Every taxpayer may annually give any number of individuals up to a total of $15,000 each without such gifts reducing his or her lifetime gift and estate taxation exemption.  Moreover, spouses may combine their $15,000 annual exclusions so that one spouse may use all of this $30,000 combined exclusion.  (Such “split” gifts do, however, require the spouses to file a federal gift tax return for the year in question to alert the IRS that both are consenting to this combination, and the consent will apply to all gifts made by either during the year.)

The “wrinkle” for annual exclusion gifts is that they are limited to only those gifts the recipient can immediately enjoy.  Examples of these are gifts of cash or marketable securities made outright to a gift recipient and most ordinary Holiday, birthday, engagement, and wedding gifts.  These eligible annual exclusion gifts are known as “gifts of present value” as opposed to “future value gifts” that cannot be fully enjoyed until some future time.  Examples of future value gifts are transfers made to trusts for beneficiaries and gifts that don’t take effect until a future event.  Only gifts of present value are eligible for inclusion in a donor’s annual gift tax exclusion.  For future value gifts, the donor’s lifetime exemption must be applied to prevent gift taxation.

Annual Gift Tax Returns

For most individuals, the real problem with making gifts of future interests or gifts of present value in excess of the annual gift tax exclusions is the requirement that an annual Form 709 United States Gift Tax Return must be filed for years in which such gifts occur.  For most, the size of the lifetime exemptions is enough to prevent actual gift taxation, but the return is still required so that the federal government (and the donor) can track where the taxpayer stands with regard to his or her remaining exemption.  Like federal income tax returns, these Forms 709 are due by April 15th of the year following the taxable year and are somewhat arcane and difficult to prepare.  The cost of worrying about, preparing, and documenting these returns thus becomes the real cost of making gifts that are not covered by available annual exclusions. If all gifts made are present value gifts totaling less than $15,000 for each recipient, returns are not required.

In this context, what most people mean when they ask how much they are “allowed” to give is “how much may I give to family members and friends without complications like having to file a gift tax return?”  From that limited perspective the answer becomes (for 2018) up to $15,000 per person in total annual gifts (including Holiday and birthday presents) if such gifts may be immediately used and enjoyed by the recipients.

The Internal Revenue Service’s End of 2018 Gift to Wealthy Taxpayers

This description of Holiday gift taxation would not be complete without noting the Internal Revenue Service’s November 26th “gift” to the wealthy.  From the above description, you will note that a taxpayer may make a total of up to $11.4 million in lifetime exempt gifts before January 1, 2026, and spouses may make such nontaxable gifts before then totaling some $22.8 million.  What happens if an individual uses all of his $11.4 million lifetime exemption (or any part in excess of $5.7 million) before 2026 when the exemption is scheduled to be halved?  Prior to the IRS’ gift, a very real worry existed that the excess gifts over $5.7 million would be taxed for estate tax purposes when the donor dies because lifetime taxable gifts are added (“clawed back”) into a decedent’s taxable estate for estate tax purposes.  Worry not!  On November 26th, the Internal Revenue Service announced proposed regulations that will, in essence, increase the lifetime estate and gift tax exemption after 2025 by the value of the gifts given tax-free before 2026 in excess of the post-2025 exemption.  As a result, if these proposed regulations are finalized, the added exemption for the pre-2026 tax-free gifts will be locked in forever.  And to that, I say Merry Christmas!

On this happy note, we sincerely wish you and your loved ones a Joyful Holiday Season and a safe and healthy New Year.

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2018 Estate and Trust Tax Planning

Inflation Adjustments and Initial Observations on the 2017 Tax Act’s Impacts:

In late October, the Internal Revenue Service issued its inflation-adjusted exemptions, exclusions and tax brackets to be used for 2018 federal tax returns. See generally, Internal Revenue Notice 2017-178 and Revenue Procedure 2017-58 issued on October 19, 2017. In the estates and trusts area, the principal adjustments are as follows:

  • An individual’s federal estate, gift, and generation-skipping tax exemptions are increased after December 31, 2017 to $5,600,000. Thus, for decedents dying after December 31st with a gross estate (i.e., a taxable estate at death plus prior adjusted taxable gifts) of less than $5,600,000, there will be no federal estate tax due and no federal estate tax return is required to be filed. In addition, individuals may cumulatively make up to $5,600,000 in taxable lifetime gifts before any federal gift tax is imposed.
  • After years of remaining fixed at $14,000 per year, the federal gift tax exclusion will increase to $15,000. As a result, for calendar year 2018, individuals may make gifts that can be enjoyed immediately totaling $15,000 or less to any number of individuals without those gifts counting as lifetime taxable gifts (and without those gifts requiring the use of the $5,600,000 gift tax exemption mentioned above).
  • Finally, for trusts receiving and retaining taxable income, the federal income tax brackets have changed such that trusts do not reach the 39.6% marginal rate until they have taxable income in excess of $12,700. (Please recall that trusts get “distributable net income” deductions for amounts distributed to trust beneficiaries so that this maximum marginal rate will only be imposed on retained ordinary income above that amount. In turn, the beneficiaries receiving this distributable net income will pay tax on the income received at their personal marginal rates.) Note that the new bracket amount does not affect the Maryland income tax paid by the trust at Maryland rates on top of the federal tax.

Despite the IRS’s October pronouncement, a real question exists as to whether any of these limits will apply in 2018. As I write this article, House of Representatives and Senate conferees in Congress have agreed upon a final version for a bill entitled H.R. 1, “the Tax Cuts and Jobs Act of 2017” (referred to below as “the TCJA”). This “Conference Committee” version of the TCJA will now come before both houses of Congress for separate votes of approval. If, as expected, this Conference Committee report is approved by the House and Senate, the Conference Committee version of the TCJA will become law and generally apply with respect to tax years commencing after December 31, 2017. The Conference Committee approved version of the TCJA will substantially change the applicable 2018 estate and generation-skipping transfer tax exemption numbers already announced by the IRS and will change the income tax brackets for trusts:

  • The Conference Committee version of the TCJA will double the basic federal estate, gift, and generation-skipping tax exemptions from $5,000,000 to $10,000,000. With inflation adjustments back to 2010, the actual exemptions per individual will increase to approximately $11,200,000, and a married couple will be able to shelter over $22,000,000 for their post-mortem beneficiaries before having to worry about paying federal estate tax.
    On January 1, 2019, the Maryland estate tax exemption is scheduled to become “recoupled” with the federal exemption. As of now, were the TCJA to pass with the doubled estate tax exemption, that doubled estate tax exemption will apply for Maryland estate tax purposes as well. Time will tell how Maryland reacts to this substantial decrease in tax revenue.
  • The original House of Representatives’ version of H.R. 1 would have repealed the federal estate and generation-skipping transfer taxes entirely as of January 1, 2025. This repeal, however, is not included in the Conference Committee’s approved final version of the TCJA, and for now such repeal is no longer on the agenda.
    Since neither the House nor the Senate versions of the TCJA (nor the Conference Committee report) repeal or change the federal gift tax exclusion amount, it appears that the federal gift tax exclusion will in fact increase to $15,000 for 2018 and succeeding years (until inflation again requires an adjustment in a $1,000 increment).
  • Under the Conference Committee version of the TCJA, the brackets for trust taxable income will be changed as follows:
    • Retained trust income up to $2,550 would be taxed at 10% (a rate below the current 15% tax on such income);
    • From $2,550 to $9,150, retained trust income would be taxed at 24% (a rate also below that mandated by current law);
    • From $9,150 to $12,500, retained trust income would be taxed at 35% (a rate higher than that mandated by current law); and
    • Above $12,500, retained trust income would be taxed at the maximum 37% (a rate that is 2.6% less than that mandated by current law).

    Thus, under the Conference Committee’s version of the TCJA, the maximum bracket for federal income tax on retained trust income will apply at an amount slightly below that projected by the IRS in October, but the rate itself would be 2.6% lower.

  • Because estates and trusts are generally subject to the same rules for calculating taxable income as individuals and because the TCJA suspends most individual itemized deductions until December 31, 2025, estates and trusts will be subject to the same TCJA provisions as individuals with respect to the loss or limitation of itemized income tax deductions (e.g., a $10,000 limit on the deductibility of state and local property and income taxes, limits on the deductibility of home mortgage interest, and loss of the deduction for preparation of tax returns). In particular, trusts and estates will no longer be able to claim as deductions expenses that previously were allowable if they exceeded 2% of taxpayer’s adjusted gross income. However, trusts and estates will now be eligible for a new complicated deduction for certain “qualified business income” received for the taxable year with respect to pass-through business entities.
  • Since individual beneficiaries will not be able to make itemized deductions for these pass-throughs (at least until after December 31, 2025), residuary beneficiaries of estates and trusts will no longer be eligible to benefit from unused excess deductions for estate and trust administration expenses after termination of an estate or trust.
  • The TCJA does not change the “stepped-up” basis provisions of current law with respect to capital gains on inherited assets. As such, beneficiaries will continue to inherit capital assets with the date of death fair market value of the assets as their respective bases for capital gains purposes and without the potential of realizing income taxation on pre-mortem appreciation (or losses) in value.

To learn about how The Wright Firm can help you make adjustments to your estate planning, please contact us at (410) 224-7800, or shines@thewrightfirm.net.

All of this will make wonderful fun for the IRS’s tax return designers over the Holidays. Here’s hoping that your Holidays are merrier than theirs and that we all have a Happy New Year.

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Saving State Income Taxes with Moveable Trusts

We recently reviewed and extolled the benefits of Inheritance Trusts in three blog posts on this website. Two of the principal benefits of such trusts are to provide creditor and divorce protection for beneficiaries on accumulated trust income and to immunize such accumulated trust income and capital gains from future estate taxation.

Inheritance Trusts can be created for beneficiaries using either wills or revocable trusts. One of the underappreciated benefits of revocable trust estate planning is the potential revocable trusts allow for saving future state income taxes on accumulated Inheritance Trust income. In this post, we discuss moveable trusts and how Inheritance Trusts created under revocable trust planning can reduce or avoid state income taxation on accumulated trust income.

Moveable Trusts

Trusts are moveable in three aspects: They are moveable with regard to the state law that controls the construction and interpretation of trust provisions. They are moveable as to the law governing how the trust is required to be administered. They are also, and separately, moveable with regard to the jurisdictions to which they are required to pay taxes.

Construction and Interpretation of Trust Provisions

In general, a trust settlor (“Trustmaker”) is free to select what state law governs the meaning and effect of the terms of his or her trust. The jurisdiction selected need not have any other connection to the trust, and the Trustmaker is free to select the governing law regardless of where the trust property may be physically located, whether it consists of real or personal property, and whether the trust was created by will or during the Trustmaker’s lifetime. The only limitations to this freedom of choice is that a court of equity will be reluctant to give effect to trust action based on the law of a state that is contrary to the declared public policy of the state in which the court sits.

If a Trustmaker fails to designate the law that is to control his or her trust, the meaning and effect of a trust’s terms are determined by the law of the jurisdiction having the most significant relationship to the matter at issue. In this situation, a court would consider such factors as the place of the trust’s creation, the actual physical location of trust property, and the residence of the Trustmaker, the trustee, or the trust’s beneficiaries.

If a Trustmaker has expressly chosen the state law intended to govern his or her trust, that choice may be changed in the future by the trustee or the trust beneficiaries. Trustmakers realize that information about one state’s laws may not be readily available to future trustees and/or beneficiaries, so most trusts include provisions specifying precisely how such changes in governing law may occur. Even absent such express authorization, Maryland trustees and beneficiaries (and those of many other states) can change the originally designated governing law by court action to modify the otherwise express terms of the trust by a showing that the modification is not inconsistent with a material purpose of the trust.

Where a Trustmaker has failed to designate the law that is to control his or her trust, the circumstances of the trust may also force a change in the governing state law. The location of the trust’s principal place of administration, assets, or the residence of the trustee or the trust’s beneficiaries may change, and thereby change the jurisdiction having the most significant relationship to a given matter at issue. Finally, the Maryland Trust Act specifies a procedure by which a trustee may change the principal place of a trust’s administration with acquiescence of qualified beneficiaries. (Following this procedure is not mandatory if, as is often the case, the Trustmaker has provided an easier alternative for the trustee or a “trust protector” to change the trust’s principal place of administration.)

Trust Administration

Usually, the law of the principal place where the trust is administered will govern administrative matters, and the law of the place of trust creation will govern a trust’s dispositive provisions. Since the cardinal rule of trust administration is to give effect to the intent of the Trustmaker, the Trustmaker can influence the governing law of trust administration and disposition by stating his or her intent in this regard. However, with regard to administration and disposition, a connection (or “nexus”) is required between the jurisdiction of choice and the activities of the trust itself. For example, if a Trustmaker chooses Maryland law to govern administration and disposition, something must occur in Maryland to connect the State to the trust, e.g., ownership of land in Maryland, carrying on a Maryland business, trustee residence or location in Maryland, or the occurrence of actual trust investment and/or accounting activities in Maryland. Here again, this choice of applicable law can be changed either by a change in trust circumstances or, so long as a connection exists with the new jurisdiction, by a formal change of the trust’s designated principal place of administration.

Trust State Income Taxation

With regard to what state can tax the income of a trust, the focus shifts from what the Trustmaker wanted (after all, what Trustmaker actually wishes for state income taxation?!) to whether a state has a sufficient connection to the trust and its income to allow it to tax that trust income. For example, regardless of a trust’s principal place of administration, Maryland (and most other states that have a state income tax) taxes a fiduciary who “is required to file a federal income tax return” and who receives “income . . . derived from a business, occupation, profession, or trade carried on in Maryland”. Absent a direct investment in a Maryland business enterprise or income derived in Maryland from “a business, occupation, profession, or trade”, however, the question becomes: what makes a trust sufficiently connected to the state to allow Maryland to tax its undistributed income?

Maryland answers this question by declaring that it has a sufficient connection to the trustee to tax non-Maryland source trust income if the “fiduciary” is a resident of Maryland. For purposes of Maryland income tax, that means the state can tax the income of “a fiduciary . .  . of a trust if:

  1. the trust was created, or consists of property transferred, by the will of a decedent who was domiciled in the State on the date of the decedent’s death;
  2. the creator or grantor of the trust is a current resident of the State; or
  3. the trust is principally administered in the State.”

In the case of an Inheritance Trust, the trust does not occur unless and until the Trustmaker dies, so the creator of grantor of the trust can no longer be a current resident of Maryland. Thus, whether or not the income of the trust can be taxed by Maryland comes down to whether “the trust was created, or consists of property transferred, by the will of a decedent who was domiciled in the State on the date of the decedent’s death” and whether “the trust is principally administered in the State”. The benefit of revocable trust estate planning is that Inheritance Trusts are not created by the will of a Maryland decedent. With regard to the income taxation of non-Maryland source income of an Inheritance Trust created under a revocable trust, the question thus comes down to where the trust is principally administered.

Moving the Inheritance Trust’s Principal Place of Administration

As noted above, a trust’s principal place of administration can be changed either under the terms prescribed by the Trustmaker in the trust instrument or by complying with Maryland’s statutory procedure. Often, such a change need only require notice to the trust’s qualified beneficiaries specifying:

(i)     The name of the jurisdiction to which the principal place of administration is to be transferred;

(ii)    the address and telephone number at the new location at which the trustee can be contacted;

(iii)   An explanation of the reasons for the proposed transfer;

(iv)   The date on which the proposed transfer is anticipated to occur; and

(v)    the date, not less than 60 days after the giving of the notice, by which the qualified beneficiary must notify the trustee of an objection to the proposed transfer.

If no qualified beneficiary objects to the change, the trustee then merely goes ahead with the change. Where previously authorized by the Trustmaker, even this notice and objection procedure may not be required because the notice procedure specified above is not mandatory if the Trustmaker deems otherwise.

Over the lifetime of a trust, such a change in principal place of administration can have a substantial financial impact, especially if an Inheritance Trust has a trustee who resides in Florida or another state that does not have a state income tax or whose income tax is lower than Maryland’s relatively expensive rates. Even where this may not be the case, it may be possible to add a co-trustee who “resides” in such a state and to whom the administration of the trust may be delegated. In the case of a corporate trustee located in such a state, the immunity from state income tax may offset the cost of paying a commission to the nonresident trustee.

As such, creating an Inheritance Trust under a revocable trust (rather than a will) plus the moveability of the trust can give rise to significant potential savings in future state income taxes on accumulated Inheritance Trust income.

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Becoming A Personal Representative: Begin With The End In Mind

 

A Personal Representative is the individual who is appointed to carry out all of the duties of collecting a decedent’s assets, paying the decedent’s outstanding obligations, and distributing the remaining property to the decedent’s legatees or heirs.

When you become a Personal Representative, it’s important to begin with an understanding of what will be required during the course of the administration. Within nine months of appointment, and at least every six months thereafter until the administration is completed, the Personal Representative must submit for review and approval by the supervising county Orphans’ Court an accounting describing all receipts of the Estate and any purchase, sale, transfer, compromise, disbursement, or distribution of the Estate’s assets. Any of these transactions are subject to examination by the Court’s staff. With this in mind, a Personal Representative will want to follow appropriate procedures to keep track of this information while setting up and managing the Estate.

 

LETTERS OF ADMINISTRATION CERTIFICATE

When new Personal Representative is appointed, he or she is given multiple copies of a certificate known as “Letters of Administration” that proves his or her appointment. Financial institutions are very careful when dealing with surrogates for their depositors, so a Personal Representative will need to prove that he or she is entitled to deal with the decedent’s assets. The Personal Representative therefore needs to always be prepared to supply a Letter of Administration certificate when collecting the decedent’s financial assets or when opening a new account.

THE ESTATE’S TAXPAYER IDENTIFICATION NUMBER

One of the first steps in our process for a new Personal Representative is to obtain a new taxpayer identification number (or “TIN”) for the Estate. When a decedent dies, his Estate becomes a new taxpayer for federal and state income tax purposes. The federal income tax rates applicable to estates and trusts differ markedly from those applicable to living individuals. The decedent’s Social Security Number is therefore no longer available as an identifier for the income earned on the property belonging to the decedent before death since that income will no longer be taxed to the decedent as an individual. Because financial institutions are required to report this income to the IRS and applicable state tax authorities, they will not change the ownership of the decedent’s funds or open any new account for the Personal Representative without first receiving and verifying the Estate’s new TIN. Consequently this TIN and the Letters of Administration will both be required for the Personal Representative to begin his or her financial duties.

DEPOSITS INTO THE ESTATE BANK ACCOUNT

If you are a new Personal Representative, you will want to begin by gaining access and closing out any individual accounts held by the decedent. Once closed, deposit the funds along with any cash and checks belonging to the decedent into a separate Estate account (usually a checking account) in your name as Personal Representative with all income on the account being taxed to the Estate’s new TIN. Keeping an Estate account separate from your personal account is both a fundamental Personal Representative duty and a primary means of obtaining and keeping information needed for the Estate account.

Knowing that you will be required to account for all Estate financial transactions, be sure to keep written records of all checks received and deposited by making photocopies or scanning and storing images of the checks as digital files. Because bank statements only list the total amount of a deposit (and not the separate deposited items), one very good idea is to list on each deposit slip exactly what checks were included in that deposit or to staple the deposit slip to copies of those checks. Keep this backup information and a list of all checks and cash received with the amount, the payer, and the reason for the payment of the funds in question. That way, this information will be readily accessible when it comes time to prepare the required Estate account. Not having such information will lead to needless expense down the road if it needs to be reconstructed.

PAYING ESTATE EXPENSES

Make sure also that you have copies of all checks written or a complete check register for all Estate expenditures. If your bank will supply copies of checks written, make sure you sign up for this service for the Estate checking account. Accounts dedicated to an Estate cannot be used for your personal expenses or for Personal Representative compensation or attorney’s fees without a court order. Also, while telephone and cable TV and internet bills initially received by the Estate can be deducted as Estate accrued liabilities, they will generally not be allowed afterwards at accounting time, so be sure to cancel the services as soon as they are no longer necessary for the administration of the Estate.

MAKE THE ESTATE ACCOUNT AN ONGOING EXERCISE

Make sure that you supply copies of your records to your attorney no less than every two months. At The Wright Firm, we ask our clients monthly to deliver or mail us their bank statements with copies of their canceled checks written to date. As soon as we know what comprises the Estate assets, we start and maintain the accounting of the activities they perform as Personal Representative throughout the administration process to ensure that we get all the details we will need and that all expected rules and procedures are accurately followed. It’s much easier to keep the account contemporaneously than to have to reconstruct activities after their details are forgotten. If we start early with a good understanding of the financial transactions involved and with assembling the proof of those transactions that we may need at the end of the process, preparation of the final required accounting at the process’ end is much easier and less expensive.

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Maryland Trust Act Developments and Applications

Richard T. Wright will be a featured speaker and panelist on “Maryland Trust Act Developments and Applications” at the Maryland Bar Association’s Advanced Tax Institute on November 15, 2016. Learn more about the Maryland State Bar Association’s 2016 Advanced Tax Institute at ati.webflow.io.

As a member and former chair of the Estates and Trust Law Section of the Maryland Bar Association, Mr. Wright was instrumental in helping to write and then shepherd the Maryland Trust Act through both houses of the Maryland Legislature. This significant piece of legislation codified and updated Maryland trust law and coordinated many of its provisions with the nationally recognized Uniform Trust Code. In addition, Mr. Wright was the principal author of Subtitle 5 of the Maryland Trust Code dealing with “Creditor’s Claims; Spendthrift and Discretionary Trusts”. Along with his colleagues on the Advanced Tax Institute panel, Mr. Wright has focused on the developments and applications of the Maryland Trust Act and has shared this knowledge with Maryland attorneys and other financial professionals in many speaking engagements throughout the state since the Act became law. In addition, Mr. Wright has written a number of articles explaining pertinent aspects of the Maryland Trust Act and the effects of the most recent changes. See, for example, two articles titled The Maryland Trust Act and The Uncertain Duration of the Post-Mortem Rights of Creditors of a Revocable Trust Settlor.

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Don’t Get Overwhelmed With Your Estate & Trust Responsibilities

Are you a Trustee or Trust Beneficiary with financial responsibilities that seem a little overwhelming? You may have realized there are several legal obligations, processes and actions in taking on the role of a Trustee or Personal Representative. Here at the Wright Firm, we have years of experience in providing these services and want to help you achieve peace of mind in knowing that everything is taken care of from start to finish. With our Estate & Trust Administration services, we guide you through pertinent procedures such as probate, the process by which a Court and the county Register of Wills oversee a Personal Representative’s administration and distribution of an estate in accordance with the decedent’s will and the law. The Wright Firm provides counseling and services to keep you on track and make sure all of your duties are tended to thoroughly and properly.

Whether you have recently acquired these responsibilities or have been handling them for years, we will help you with all of your needs and concerns. Our Estate & Trust Administration services include guidance and advice with probate obligations, counseling and implementation for the administration of trusts, filing estate and gift tax returns, and the preparation of fiduciary income tax.

Give us a call at (410) 224-7800 to set up a consultation.