2014 Private Clients Group Annual Client Update

December 2014

Overview |
Practices

Dear Clients and Friends:

The year 2014 has been, relatively speaking, a quiet one on the federal estate, gift and generation-skipping transfer (“GST”) tax front. This letter summarizes the current tax regime and some important changes and considerations in trust and estate law. Should you have questions or desire a more detailed explanation of any of the provisions of the transfer tax system or this letter, you should consult with your Cummings & Lockwood attorney.

ESTATE, GIFT AND GST TAX RATES AND EXEMPTIONS IN 2014 AND BEYOND

The amount exempt from the estate and gift taxes is $5,000,000 indexed for inflation (set at $5,340,000 for 2014 and increasing to $5,430,000 for 2015) and these taxes are now unified so that the entire exemption can be used during lifetime or, if unused during lifetime, at death. The GST exemption is also $5,000,000 indexed for inflation (set at $5,340,000 for 2014 and increasing to $5,430,000 for 2015). The federal estate, gift and GST tax rates remain at 40%.

CHANGES TO ANNUAL EXCLUSION AMOUNTS

Because of inflation indexing, some annual exclusion amounts increased as of January 1, 2014. The annual exclusion from gift tax, i.e., the amount that you can give to any number of people each calendar year without using lifetime gift exemption or incurring a gift tax, is $14,000 per donee in 2014 and will remain at that amount in 2015. The amount an individual can give to his or her non-US citizen spouse per calendar year is $145,000 in 2014 and is increasing to $147,000 in 2015.

TAX-FREE DISTRIBUTIONS FROM INDIVIDUAL RETIREMENT PLANS FOR CHARITABLE PURPOSES

As of the writing of this letter, Congress has not acted to extend the ability to make tax-free distributions from an Individual Retirement Account (“IRA”) to qualified charities. For those clients who have not yet taken their required minimum distributions for the 2014 calendar year in the hopes that Congress will again allow charitable distributions by individuals over age 70½, please remember that absent Congressional action before the end of the year, required minimum distributions must be taken by December 31, 2014 to avoid penalties.

POTENTIAL FUTURE CHANGES TO THE FEDERAL TRANSFER TAX SYSTEM

While death and taxes both remain certainties, what is not always certain is how the taxes will be imposed. It is always possible that tax laws will change. Even if the current exemption amounts and rates remain intact, there have been various legislative proposals in recent years which would limit certain gifting techniques entirely or significantly curb their effectiveness. These include:

Restricting fractional interest discounts for many transfers of non-business assets made to family members, e.g., family investments, partnerships or limited liability companies.
Requiring Grantor Retained Annuity Trusts (“GRATs”) to have a minimum term of 10 years and a remainder greater than zero.
Imposing a 90 year limit on the protection from GST tax for trusts to which GST exemption is allocated.
Severely limiting the use of “grantor trusts” that permit donors to pay the income tax on the taxable income generated by assets owned by the trust without such tax payments being treated as additional taxable gifts and without the trust assets being included in the donor’s taxable estate.

If you are considering any gifting strategies involving one or more of the above techniques, you may wish to speak with your Cummings & Lockwood attorney about these issues.

STATE TAX UPDATE AND REVIEW

Florida

Florida continues to have no state gift or estate tax.

Connecticut

Connecticut has a separate state gift tax with an exemption of only $2,000,000. This means that if a Connecticut resident makes a $5,340,000 gift to take full advantage of the federal gift exemption available in 2014, a Connecticut gift tax of $259,800 will be due on the $3,340,000 difference between the federal and Connecticut exemptions. Note, however, that this tax can be avoided if the gifted property is real property or tangible personal property not located in Connecticut.

New York

Changes to New York Estate Tax Laws

In 2014, New York made significant changes to the New York estate tax laws. As a result, New York continues to have no state gift tax and New York’s estate tax exemption will rise over the next five years from its level of $1,000,000 at the beginning of this year to match the federal level of $5,000,000 indexed for inflation in 2019. New York’s maximum estate tax rate remains at 16%. In addition, the method for imposing tax and utilizing the state exemption of a New York resident’s estate also changed in ways less favorable for many clients. The estate tax is now, essentially, a “cliff tax” such that the exemption is phased out for estates that exceed the exemption amount, and estates that are more than 105% of the exemption amount will be taxed in full as if no exemption existed. This means that any estate in excess of the current New York exemption amount ($2,062,500 now and increasing to $3,125,000 on April 1, 2015) by more than 5% will face a tax on the entire estate and not just the amount of the estate that exceeds the exemption.

While this new tax regime is more generous for those estates in excess of the prior exemption amount of $1,000,000 and under the new exemption amount, the new tax law actually increases the taxes due on estates in excess of $2,062,500 (or in excess of $3,125,000 after April 1, 2015). In addition, gifts by a New York resident between April 1, 2014 and April 1, 2019 within three years of death will be added back to the value of the estate for purposes of determining the New York estate tax due. Given the complexity and fluidity of the New York estate tax laws over the next several years, if you are a New York resident or own real property located in New York, you may wish to consult with your attorney to discuss how these changes may affect your situation and estate planning.

Changes to New York Income Taxation of Certain Trusts

Recent years have seen an increase in popularity of certain kinds of trusts, referred to as “incomplete non-grantor trusts” which are designed to reduce the grantor’s income tax liability. In brief, these trusts are designed so that the grantor still has access to the assets placed in trust, but the trust assets are subject to taxation in a state which does not impose income tax on the trust, allowing the grantor to remove the trust assets from the income tax system in his or her home state. New York has changed its income tax laws with regard to these kind of trusts. Prior to January 1, 2014, New York did not tax the income of a trust funded by a New York grantor as long as the trust did not have a New York trustee, New York source income or any assets that were physically located in New York. As of January 1, 2014, despite federal law to the contrary, New York will treat these trusts as if they were grantor trusts, that is, their income is required to be reported on the grantor’s personal New York state income tax return, even though the trust assets are not owned by the grantor any longer. This change in the law closes a perceived loophole by preventing New York residents from removing taxable income from the New York state tax system while still retaining a beneficial interest in the property generating the income. It remains to be seen if other states will follow New York in closing similar loopholes.

OTHER DEVELOPMENTS

Inherited IRAs No Longer Protected under Federal Bankruptcy Rules

In June of this year, the United States Supreme Court held in Clark v. Rameker that inherited IRAs are not “retirement funds” within the meaning of federal bankruptcy law. This means that inherited IRAs are available to satisfy any creditor claims against the beneficiary who inherits the IRA. It is not clear from the ruling if the same rules will apply to an IRA inherited by a spouse. Although certain states, including Florida, have state bankruptcy laws which will continue to protect inherited IRAs from a beneficiary’s creditors, the applicability of these laws will depend on where the beneficiary resides at the time of the bankruptcy and not where the original owner resided before death. Accordingly, many clients who are interested in creditor protection for their beneficiaries are now considering leaving retirement accounts to trusts for their beneficiaries, rather than outright. While naming a trust as a beneficiary of a retirement account may be advisable, care must be taken to be sure such a designation does not have unintended income tax or other negative consequences. Please speak with your Cummings & Lockwood attorney before naming a trust as the beneficiary of any IRA, 401(K) or other retirement account.

Planning for Diminished Capacity and Incapacity

One aspect of estate planning focuses on transfer taxes and the efficient transfer of assets during lifetime and death to intended beneficiaries. However, it is also important that planning address the most important beneficiary of one’s assets -- one’s self. Careful thought and planning should go into structuring the appropriate safeguards to assist in decision-making and asset management in the event of diminishing capacity or incapacity. Various techniques and documents can be used to put such a potential network in place so that it can be activated when and if needed. These include the use of Durable Powers of Attorney, Advanced Medical Directives and Living Wills, Prospective Designations of Guardians and/or Conservators in the event of a court determination of incapacity and the creation of Revocable Living Trusts. In most situations, a combination of all of these documents is recommended. As life expectancy and medical advances increase, the likelihood of living longer and ending one’s life with diminished ability to manage one’s own affairs also increases. You should make sure you have the appropriate measures in place to protect you and your loved ones if such a situation should develop.

Florida Enacts New LLC Statute

Limited Liability Companies (“LLCs”) have been recognized in Florida since 1982. The Florida legislature has updated the laws governing LLCs over the years, but an entirely new “overhaul” of LLC laws will become effective for all existing Florida LLCs on January 1, 2015. Based on so-called “uniform” laws that are designed to bring consistency and coherence to the rules governing LLCs across the country, the new Florida LLC law affects the design and operation of LLCs in a number of important ways. Important aspects of the new Florida LLC law include expanding the number of mandatory rules that an LLC is subject to, clarifying who may legally bind or manage an LLC, providing for the withdrawal of an owner of an LLC under certain circumstances (and allowing for penalties for an improper withdrawal) and streamlining the procedures applicable to LLCs that merge with other business entities or dissolve. If you have questions about how this will affect your Florida LLC, contact your Cummings & Lockwood attorney.

CONCLUSION

We will, as always, keep you posted of any major developments in future updates.

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In this Update, we have deliberately simplified technical aspects of the law in the interest of clear communication. Under no circumstances should you or your advisors rely solely on the contents of this Update for legal advice, nor should you reach any decisions with respect to your personal tax or estate planning without further discussion and consultation with your advisors.

In accordance with IRS Circular 230, we are required to disclose that: (i) this Update is not intended or written by us to be used, and it cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer; (ii) this Update was written to support the promotion or marketing of the transaction(s) or matter(s) addressed by such materials; and (iii) each taxpayer should seek advice on his or her particular circumstances from an independent tax advisor.