Could a tax-free exchange help cover LTC insurance costs?

9-1-16

No estate plan is complete without considering long-term care (LTC) expenses and how to pay for them. LTC insurance is an option, but these policies can be expensive. One solution is to use a total or partial tax-free exchange of an existing life insurance policy or annuity contract.

Reviewing the history

For many years, Internal Revenue Code Section 1035 has permitted taxpayers to exchange one life insurance policy for another, one annuity contract for another, or a life insurance policy for an annuity contract without recognizing any taxable gain.

In the late 1990s, the U.S. Tax Court approved partial tax-free exchanges. A partial exchange might involve using a portion of an annuity’s balance or a life insurance policy’s cash value to fund a new contract or policy. In order for the transaction to be tax-free, the exchange must involve a direct transfer of funds from one carrier to another.

The Pension Protection Act of 2006 expanded Sec. 1035 to include LTC policies. So now it’s possible to make a total or partial tax-free exchange of a life insurance policy or annuity contract for an LTC policy (as well as one LTC policy for another).

Funding LTC costs

Partial tax-free exchanges can work well for standalone LTC policies, which generally require annual premium payments and prohibit prepayment. A partial tax-free exchange not only provides a source of funds for LTC coverage but also offers significant tax benefits.

Ordinarily, if the value of a life insurance policy or annuity contract exceeds your basis, lifetime distributions include a combination of taxable gain and nontaxable return of basis. A partial tax-free exchange allows you to defer taxable gain and, to the extent the gain is absorbed by LTC insurance premiums, eliminate it permanently.

If you’re concerned that LTC costs might deplete your funds, thus allowing less wealth to pass to heirs, contact us. We can help you determine whether one of these strategies may be an option for you.

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Estate planning benefits of FLPs may be in danger

9-22-16

For many years, family limited partnerships (FLPs) have been a popular estate planning tool, in part due to their tax benefits. Specifically, they can allow you to transfer assets to your children (and other family members) at discounted values for gift tax purposes. The gifts may even be tax-free if you apply your lifetime exemption or annual exclusion.

However, the IRS recently proposed regulations that, if finalized, would limit the effectiveness of FLPs for reducing the taxable value of transferred interests.

FLP in action

To execute an FLP strategy, you contribute assets — such as marketable securities, real estate and private business interests — to a limited partnership. In exchange, you receive general and limited partner interests.

Over time, you gift, sell or otherwise transfer interests to family members and anyone else you wish (even charitable organizations). For gift tax purposes, the limited partner interests may be valued at a discount from the partnership’s underlying assets because limited partners can’t control the FLP’s day-to-day activities and the interests may be difficult to sell.

This can provide substantial tax savings. For example, under federal tax law, you can exclude certain gifts of up to $14,000 per recipient each year without depleting any of your lifetime gift and estate tax exemption. So, if discounts total, say, 30%, in 2016 you can gift an FLP interest that’s worth as much as $20,000 before discounts (based on the net asset value of the partnership’s assets) tax-free because the discounted fair market value doesn’t exceed the $14,000 gift tax annual exclusion.

An FLP must be established for a legitimate business purpose, such as efficient asset management and protection from creditors, to qualify for valuation discounts. Partnerships set up exclusively to minimize gift and estate taxes won’t pass IRS muster.

Time is of the essence

If you’ve been considering using an FLP, you may need to act soon to take advantage of current tax provisions in the event the rules change. Contact us to learn more about FLPs and how the proposed regs may affect them.

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Are frequent flyer miles ever taxable?

8-30-16

If you recently redeemed frequent flyer miles to treat the family to a fun summer vacation or to take your spouse on a romantic getaway, you might assume that there are no tax implications involved. And you’re probably right — but there is a chance your miles could be taxable.

Usually tax free

As a general rule, miles awarded by airlines for flying with them are considered nontaxable rebates, as are miles awarded for using a credit or debit card.

The IRS partially addressed the issue in Announcement 2002-18, where it said “Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.”

Exceptions

There are, however, some types of mile awards the IRS might view as taxable. Examples include miles awarded as a prize in a sweepstakes and miles awarded as a promotion.

For instance, in Shankar v. Commissioner, the U.S. Tax Court sided with the IRS, finding that airline miles awarded in conjunction with opening a bank account were indeed taxable. Part of the evidence of taxability was the fact that the bank had issued Forms 1099 MISC to customers who’d redeemed the rewards points to purchase airline tickets.

The value of the miles for tax purposes generally is their estimated retail value.

If you’re concerned you’ve received mile awards that could be taxable, please contact us at 952-979-1140 and we’ll help you determine your tax liability, if any.

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Giving real estate to charity is rewarding, but beware of tax traps

8-25-16

Did you know that the estate of director John Hughes donated the family’s Illinois mansion to a nonprofit hospital? After allowing another charity to use the home for a fundraising event, the hospital sold the home and used the proceeds to expand its campus.

In this instance, two organizations were able to enjoy this gift. If you’re considering donating real estate to charity, beware of these four potential tax traps:

  1. When you donate real estate to a public charity, you generally can deduct the property’s fair market value. But when you donate it to a private foundation, your deduction is limited to the lower of fair market value or your cost basis in the property.
  2. If the property is subject to a mortgage, you may recognize taxable income for all or a portion of the loan’s value. And charities might not accept mortgaged property because it may trigger unrelated business income tax. For these reasons, it’s a good idea to pay off the mortgage before you donate the property or ask the lender to accept another property as collateral for the loan.
  3. Failure to properly substantiate your donation can result in loss of the deduction and overvaluation penalties. Generally, real estate donations require a qualified appraisal. You’ll also need to complete Form 8283, Noncash Charitable Contributions, have your appraiser sign it and file it with your federal tax return. If the property is valued at more than $500,000, you’ll generally need to include the appraisal report as well.
  4. If the charity sells the property within three years, it must report the sale to the IRS. If the price is substantially less than the amount you claimed, the IRS may challenge your deduction. To avoid this result, be sure your initial appraisal is accurate and well documented.

Before taking action, consult us to ensure that you avoid these traps.

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Now’s the time to start thinking about “bunching” — miscellaneous itemized deductions, that is

8-23-16

Many expenses that may qualify as miscellaneous itemized deductions are deductible only to the extent they exceed, in aggregate, 2% of your adjusted gross income (AGI). Bunching these expenses into a single year may allow you to exceed this “floor.” So now is a good time to add up your potential deductions to date to see if bunching is a smart strategy for you this year.

Should you bunch into 2016?

If your miscellaneous itemized deductions are getting close to — or they already exceed — the 2% floor, consider incurring and paying additional expenses by Dec. 31, such as:

  • Deductible investment expenses, including advisory fees, custodial fees and publications
  • Professional fees, such as tax planning and preparation, accounting, and certain legal fees
  • Unreimbursed employee business expenses, including vehicle costs, travel, and allowable meals and entertainment.

But beware …

These expenses aren’t deductible for alternative minimum tax (AMT) purposes. So don’t bunch them into 2016 if you might be subject to the AMT this year.

Also, if your AGI exceeds the applicable threshold, certain deductions — including miscellaneous itemized deductions — are reduced by 3% of the AGI amount that exceeds the threshold (not to exceed 80% of otherwise allowable deductions). For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (married filing jointly) and $155,650 (married filing separately).

If you’d like more information on miscellaneous itemized deductions, the AMT or the itemized deduction limit, let us know.

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