GTH Estate Planning Blog

Lars is putting about $30,000 a year into his retirement plan at the CPA firm. Actually it isn't just Lars's; it's earned income therefore his and Kyra's community property. His account has grown to about a million and a half. This would have seemed like a great amount when Lars started work. Now it's not even their largest asset; they have more than that in real estate, thanks mostly to the smarts and generosity of his childless Uncle Nils.

Some of the retirement plan is Roth, meaning Lars doesn't get to deduct that portion going into the plan, but it isn't taxable when it comes out. His account is invested in stocks, bonds, and REITs. The plan permits Lars and the other participants to direct their own allocations. Lars likes watching the numbers and has an especially good feeling about this holding generally. Why?

Another thing that strikes Lars as he prepares and reflects on his 2012 personal income tax return, is the amount of self-employment tax. He pays this because, as a partner in a CPA firm, he gets a share of the partnership's net income rather than a salary, so there is no Social Security tax deducted from his draws (paychecks). For him the SE tax is about $20,000 for the year, roughly half the amount of income tax he's paying.

At 55, Lars is ten years or so away from drawing Social Security, and has been paying SE tax for a long time. He has not factored Social Security income into his retirement planning, although as the time gets closer and the system remains in place he becomes a little more confident he'll actually receive some. But it doesn't seem like a great bargain, paying today's equivalent of a $20,000 a year for decades in hopes of his and Kyra's getting $30,000-plus for -- well, maybe decades, maybe it isn't so bad.

Seeing the reduced tax on his capital gains and dividends, Lars feels confirmed in favoring stocks over bonds. There is part of his portfolio that doesn't show up in his income tax return, though, at least not yet: his retirement plan.

Some of it actually never will: the Roth portion. Lars's firm has a 401(k) plan, and he has some of his account in Roth status, meaning he pays the tax on the income as it goes in, but neither the future income and gain on these contributions, nor the distributions when they come out, will be taxed. Lars likes this idea.

Even the non-Roth portion of the retirement plan that will be taxed when it comes out, gets tax-free growth in the meantime. This takes away one of Lars's reasons for not liking bonds, the taxation of interest income at ordinary rates.

Lars is a professional tax preparer. Actually at this advanced stage of his career as a CPA, he is much more reviewer than preparer; the less senior accountants in his office do the return assembly. He has a couple of peculiarities in the way he does his own return. First, he extends it so he can go over it with some deliberation. Tax season is a crush every year.

And Lars does his return by hand, at least initially. This is so he can see how the income and tax ingredients really go together. After he's done that, he does indeed run it through their software and, since the results are always at least a little different, he learns something from that too.

One thing he notices this year is the tax calculation on dividends and capital gains. These have a maximum rate of 15%, about half that on ordinary income like earned income and interest. The policy reasons for this benefit, Lars recalls, are to soften the double taxation of dividends (taxed both at the corporate and the shareholder level, theoretically at least), and to encourage people to invest. Invest in equities, at least. Not bonds.

Sondra was helping Uncle Rudolph with his finances, so he put quite a bit of his money in an account in both of their names. He made them joint tenants of the account with right of survivorship, meaning that if one of them died, the other would get all the money. The evidence indicated this was what he intended. Rudolph got cancer and started to fail. Sondra was aware that there were other helpers and it seemed there was a risk one of them would write checks for Rudolph or otherwise access his money. So Sondra took $113,900 out of the joint account to protect it.

Then Rudolph died and other niece Edwina became his executor. Edwina sued Sondra for taking Rudolph's money without authorization.

The trial court ruled for Sondra, determining that Rudolph made a gift to Sondra when he established the joint account. So she was justified in withdrawing funds while he was still living. Any remaining balance in the account passed to her upon his death under Revised Code of Washington 30.22.100(3): "Funds belonging to a deceased depositor which remain on deposit in a joint account with right of survivorship belong to the surviving depositors unless there is clear and convincing evidence of a contrary intent at the time the account was created."

Alfred and Sarah named their kids, or at least two of them, Don and Dawn. These homophonic siblings ended up opposing each other in Court. After dad died, Dawn got a Durable Power of Attorney to act for Sarah, and put a bunch of mom's money in an account with Edward Jones titled in their two names as joint tenants with right of survivorship. Dawn made some gifts and loans to friends from this fund, but when mom died there was still more than $400,000 in the account. Dawn took it by right of survivorship, and put it in her own account at the same broker.

When mom died, brother Don was Trustee of her Living Trust that served in effect as her Will (see our earlier blogs on Living Trusts). Apparently most of the trust was to go to charity, but despite a lessened self-interest Don went to Court to challenge Dawn's taking the Edward Jones account by survivorship, claiming that as mom's property it should be part of her trust instead.

Widow Maria died and left her modest home to handyman Terry and his wife. Her Will also made gifts to two nuns and her church, with the bulk of her roughly $700,000 estate going to two cousins of her late husband. Rose, one of those cousins, was named as Personal Representative (executor).

There was a question, though, whether Maria's Will controlled her whole estate. She had in her last weeks established a joint bank account with Terry, and put some $234,000 into it. The law is that this joint account, having been set up with right of survivorship (JTWROS), passed automatically to Terry, apart from Maria's Will, unless Rose could show "by clear and convincing evidence" that Maria intended otherwise (Revised Code of Washington 30.22.100).

Instead of taking the funds by survivorship and forcing Rose to sue him, Terry gave the funds to the estate and then sued to get them back, on the same statute creating the presumption in his favor. He won in the trial court, but the estate appealed.

The diversified trust portfolio of our friend Lars gained $66,500 during 2012, on its initial investment of $500,000. He is expecting 2013 to be a flat year. The precious metals mix of rich uncle Nils advanced less, to $538,250 but he feels his gold, half his holdings, will be up 15% in the coming year. They meet for dinner at Guy.

Well, not so good for the old man so far. Gold is down almost 5%, and silver nearly 7%. Platinum and especially palladium are up, but the weighted average is minus 2% for the first quarter. Nils suspects he won't be choosing the drink this time.

In its 2012 decision In Re Estate of Kazmark, the Washington Court of Appeals resolved the question whether Earle Sr. was bound by agreement with his predeceased spouse Barbara, to keep his Will in place that benefited her family as well as his.

Barbara's son Shane first had to rebut Earle Jr.'s assertion that Earle Sr. and Barbara's Community Property Agreement superseded their Wills and any agreement under which the Wills were made. The Community Property Agreement did override the Wills in a sense. It was used upon Barbara's death to transfer the whole estate to Earle Sr. without the necessity of probating or otherwise using Barbara's Will at all. But the Court didn't have much trouble refusing Earle Jr. on this one. The Community Property Agreement was entirely consistent with the Wills, accomplishing more easily what Barbara's Will would have done upon her death. Because it only supported the work of the 2005 Wills, the Community Property didn't supersede or otherwise negate them or any agreement they represented.

When Earle Sr. died in July of 2009, Earle Jr. sought to probate the nine-day-old Will that left the residue of his father's estate to him. Earle Sr. had become wealthy by most people's standards, by marrying Barbara in 1985 and then surviving her in 2009. This turn of events was not pleasing to Barbara's son Shane, who would have received half the estate under her 2005 Will had Barbara had survived Earle Sr.

Earle Sr. had actually done a Will just like Barbara's in 2005. It and a Community Property Agreement gave all to the surviving spouse, and then, after both of their lifetimes, half to his family and half to Shane. Then a flurry of events in 2009 threatened Shane's share. Barbara died and Earle Sr. got all her estate. Then he changed his Will to favor Earle Jr. and cut Shane out. This is a risk in any case where each spouse has his or her own children, and the estate plan puts all in the hands of whichever spouse survives.

Lars has seen a lot in his three decades as a CPA. One thing he's learned is that in taxes, investments, and estate planning, the most dangerous clients aren't the ones who need a lot of guidance, but rather the ones who don't need any. The ones who know it all. It tends to run in certain occupations.

Take the subject of tax-saving gifts, for instance. There are a lot of untruths and one big favorable set of truths, more so now with the new law. Here are some of the assertions he hears:

"I can only give $10,000 a year." This is the annual gift tax exclusion (actually $14,000 now), the amount one person can give any other person each year without using any lifetime gift tax exemption. But it's not really the limit. One still doesn't pay any tax as one uses the lifetime exemption (now $5,250,000 for each giver).

"OK, but I don't want to use my lifetime exemption. I want to save it for my estate." Well, it would save it not to make gifts, but once you have given away those stocks or that real estate, all future income and appreciation on the gift occurs out of your taxable estate. So it pays to use it as one can afford to.

Our CPA friend Lars and his rich Uncle Nils are having one of their regular dinners at the oddly named restaurant Guy. Nils has heard that the State of Washington's legislature, desperate for funds, is talking about doubling the already-high estate tax rate for its residents. He's thinking about moving.

Nils has been on the internet and describes some of his findings to Lars. A minority of states impose an estate tax. Washington's tax starts at 10% on estates over $2 million, and goes up to 19% for larger amounts. It's one of the highest in the nation.

Nils knows a couple of guys who have already declared other states their home now. Some states are better than others. California has an income tax that significantly undermines the benefit of moving, unless one manages to do it just before one dies. Nevada is better, with neither an income tax nor an estate tax, but few people seem to be talking about moving there.

Lars is a tax guy. This has been a good skill for him. He likes it, kind of a math-like career foundation that makes him useful, earns him a good living, and has forced him (he recognizes) to develop people skills in order for things to go well. He's gotten more interested in estate planning and estate taxes in recent years, but income taxes have been his bread and butter for most of his career.

What Congress did at the beginning of January is an interesting combination of income taxes and estate planning stuff. It's mostly good for those who are wealthy or want to get there. There is still a favorable tax rate for capital gains (generally a maximum of 20%, compared with 39.6% on ordinary income), and the lower rate was also maintained for qualifying dividends. Of course there is policy justification for taxing dividends at lower rates; theoretically at least the corporation's income has already been taxed. But it's still a good deal for those who have stocks, like Lars. His portfolio will grow a little faster over time as a result.

Our friend Lars and his wife Kyra have a Living Trust with a bypass trust arrangement. This means that the share of the first spouse to die, is to be held in trust for the lifetime benefit of the surviving spouse. One of the benefits of this trust is that it would preserve the estate tax exemption of the first estate. There is a new conventional wisdom that bypass trusts aren't needed now that we have portability, by which the surviving spouse inherits the unused portion of the deceased spouse's exemption whether there is a trust or not.

Lars isn't buying this new thinking. If his estate goes outright to Kyra, she inherits his now $5,250,000 unused exemption to add to her own, but can lose it if she remarries. So a possible result is preserving no exemption of the first estate. If instead a $5,250,000 trust is established and grows in value to $10,000,000 during the surviving spouse's lifetime, the first estate gets that much exemption.

Our CPA friend Lars is on one of his crunchy early Sunday walks on the rocky beach. It's light by 7 now. Kyra is sleeping in. Lars can't, or at least would rather walk and think.

CPAs do more income tax work than estate work, but as he and his clients have matured and become more wealthy, he's taken a special interest in gift and estate taxes, and other aspects of estate planning. This morning he's trying to psych out the meaning of the recent Federal tax law changes for him and his practice.

One thing that has happened, at least in Lars's State of Washington, is that state estate taxes have become more important. The main reason is pretty obvious: the State exemption (in Washington) is $2 million per estate; the Federal is now $5,250,000. For a married couple those numbers are doubled, if there is proper planning. At these levels, Lars's rich Uncle Nils still has to worry about the Federal estate tax, but he's in a small minority. Lars and many of his clients fall between $4 million and $10 million, where only the State estate tax is a concern.