Call us on

Tax Issues Affected by Estate Planning

  Sanjiv Gupta CPA  Published 
Tax Issues Affected by Estate Planning

It is wrongly judged that estate planning is free from income tax compliance. The truth is that when a client is filing for an income tax return, the individual has to plan meticulously on how to itemize properties so that tax expense can be curbed to some extent. Careful practitioners try to balance both factors: estate arrangement techniques and tax compliance. Following are some important points that a practitioner should keep in mind while planning estate arrangements for a client:


Family Loan:


One of the most popular wealth management methods is to transfer property rights/ loan out cash to family members. For instance, it’s easier for a son/daughter to pay back “intra-family loan” at minimum interest (under IRC sec. 7872) than to clear home loan debts, taken from a bank or a private creditor.


Also, the family sentiment which helps heirs put up with financial problems is one reason which makes an intra-family loan more popular. To go by the proceeding, an intra-family loan agreement document is drafted. It acts as a promissory memorandum. The practitioner, it is advised should keep a copy of this document.


The creditor charges a minimum interest from the benefactor who, as per rules and terms penned in the loan agreement, is required to pay back the debt amount. Most of the agreements are time-bound and the tax returns are filed in the name of the lender. In case the interest amount falls within a tax-return deductible slab, it must be shown by the borrower.

Also, the income and the interest payment terms should be in sync as per the loan agreement doc. The borrower should not skip payments; otherwise, the whole purpose of revenue management becomes futile.


Compensation Issues:


S corporation return deals with reasonable compensation possibilities which can help save payroll taxes.  Under Sec. 1402(a) shareholders can apply for compensation by filing personal Form 1040. However, there are many key issues that might affect estate planning for the client.


Unreasonable high compensation demand implies that a client is still interested to derive profit from a business partnership, gifts, and family property handovers. Gifting stocks or shares to heirs is one of the most judicious ways of doing justice to estate planning. However, if the parent lender continues to extract interest amounts over a prolonged period then IRS can debate on and preside over the matter.


The tricky part is that if the creditor is sanctioning gifts to GRATS (grantor retained annuity trust) that is trying to gain an absurdly low compensation then it could unveil the ‘real’ estate-arrangement plans and put at stake all possibilities to save payroll taxes.


Therefore a practitioner must be alert not to stress much on compensation; rather they must understand how the process works and how it must be approached at.


Grantor Trusts


Grantor trusts, a very popular technique for asset protection and estate planning, must be included in the trust provisions when a client transfers his assets to an irrevocable trust. The ubiquitous revocable living trust is a common grantor trust used to segregate gift assets from inherited assets. Mostly used in determining equal share in divorce proceedings, living trusts are often used to avoid probate.


The Beneficiary Defective Irrevocable Trust (BDIT) caters to the child alone and not the parent because if the trust is established by the child’s parent or any other benefactor for that matter it includes an annual demand called the Crummy power for the child/ benefactor which makes the child its rightful trust. BDIT should be handled with precision different from the traditional ones. Again all those assets’ immunity stands jeopardized under revocable living trusts if assets received as gifts or inheritance by the client are used to paying income tax.


Insurance Transfer for Value Rules


If an insurance transfer is not subjected to IRC Sec.101(a)(2), its proceeds then are income tax-free. Transfer for value rules is triggered only if it takes place between a corporation and a shareholder and not between two partners in a partnership. Following this life insurance transfers that appear on any return must be investigated to avoid transfer for value rules.


Disregarded LLCs


In order to bring down the administrative expenses of a business partnership, clients often prefer utilizing ‘single-member ignored Limited Liability companies’. The only disadvantage of this policy is that if a lawsuit is filed against the client then the executive organ of the government can investigate all personal accounts of the client. Filing a Schedule C, on the other hand, much guards income information of an individual.  


Schedule B: Titles To Assets


In 2010 the IRS sanctioned the “asset portability” tax act. This provision allows the surviving spouse to ignore estate tax payment in a de-coupled state. However, this provision is only limited to state tax exemption policies and does not work at the federal level.  The practitioners on the other hand, more often follow the traditional technique of paying a subsidy to trust in the name of the deceased. But it seems that there are many loop-holes in the asset portability act which the IRS needs to address.


Non-retirement asset division, balancing property distribution, etc should be carefully planned by the practitioner so as to avoid complications while preparing Schedule B concerning Titles to Assets.