From the passage of the long-expected SECURE Act to the establishment of paid leave for federal workers, we have recently seen some significant developments in estate planning and business law. To ensure that you stay abreast of these legal changes, we’ve highlighted four noteworthy developments and analyzed how they may impact your estate planning and business law practice.
Senate Passes SECURE Act
The SECURE Act, which makes important changes to the law applicable to retirement accounts, was approved as part of a bipartisan appropriations bill and became effective on January 1, 2020. It eliminates the maximum age for contributions to traditional IRA accounts and increases the age for required minimum distributions from retirement accounts from 70 ½ to 72 years of age for older Americans still in the workforce. The SECURE Act’s most impactful change for estate planners is the elimination of the “stretch” option for most non-spouse beneficiaries of inherited IRAs, which previously allowed distributions to be taken over a beneficiary’s life expectancy. Under the new law, most beneficiaries are required to withdraw the entire balance of the IRA by the end of year ten after the participant’s death. There are, however, some exceptions to the new ten-year mandatory withdrawal rule for “eligible designated beneficiaries.” In addition to spouses, the participant’s minor children (until they reach the “age of majority”), disabled and chronically ill beneficiaries, and beneficiaries who are not more than ten years younger than the participant can still take distributions over their life expectancy.
Takeaways: In light of the SECURE Act, new strategies should be implemented for many estate planning clients. Planning with trusts should take into consideration the type of beneficiary and the tax consequences, and should weigh the desire for tax minimization against the need for asset protection. Additional strategies such as Roth conversions, charitable remainder trusts, distributions to charitable beneficiaries, using life insurance to pay taxes or offset amounts passing to charities, and spousal options—for example, rollovers, treatment as an inherited IRA, or disclaiming to a younger generation beneficiary—should also be considered. If you have clients who passed away within the nine months prior to the SECURE Act’s effective date, filing a timely disclaimer may allow distributions to be made over the life expectancy of a younger individual.
IRS Approves Final Anti-Clawback Regulations
Treasury Decision 9884
Treasury Decision 9884, which was made available on November 22, 2019, addresses concerns that the benefit to taxpayers of gifts made between January 1, 2018 and December 31, 2025—the period during which the gift and estate tax basic exclusion amount (BEA) is double the $5 million (adjusted for inflation) exclusion amount in place before the 2017 Tax Cuts and Jobs Act—could be “clawed back” in the calculation of their estate taxes if they die after the reversion of the BEA to the pre-reform level.
Under the Final Regulations, a special rule is adopted allowing an estate to compute its estate tax credit using the greater of the BEA applicable during a taxpayer’s lifetime or the BEA applicable on the taxpayer’s date of death, ensuring that taxpayers will not be adversely impacted if the increased BEA returns to the pre-2018 level as currently scheduled.
The Regulations also clarify that the increased BEA is a “use or lose” benefit, i.e., it is available only to the extent that a taxpayer actually uses it by making gifts during the period in which the increased BEA amount is available. For example, if Taxpayer A makes a gift of $4 million during the increased BEA period, but dies post-2025, in a year when the BEA is $6.8 million, $6.8 million is the BEA that should be used to calculate the estate tax credit.
In addition, the new Regulations make clear that if an estate elects to transfer any unused amount of a deceased spouse’s gift and estate tax exclusion (DSUE) to the surviving spouse between January 1, 2018 and December 31, 2025, the DSUE will not be reduced as a result of the reversion of the BEA to the pre-tax reform level. For example, if Spouse A dies between 2018 and 2025 at a time when the BEA was $11.4 million without making any taxable gifts and not having a taxable estate, the estate could allow surviving Spouse B to elect to use Spouse A’s $11.4 million BEA. If Spouse B never remarries and dies without making any gifts post-2025, when the BEA has reverted to $6.8 million, the credit that should be applied in calculating the estate tax is Spouse A’s used $11.4 million plus Spouse B’s BEA of $6.8 million, i.e., a total of $18.2 million.
Takeaways: High-net-worth clients can make large gifts between January 1, 2018 and December 31, 2025 without concern that they could lose the tax advantages of gifts made during the period in which the increased BEA applies if they pass away after the increased BEA sunsets. Estate planning attorneys can help clients take advantage of the increased exclusion amount by making lifetime gifts of appreciating assets to decrease their taxable estates. A number of planning strategies utilizing trusts should be considered, e.g., transfers to a spousal lifetime access trust can enable your client to take advantage of the increased BEA while retaining some of the benefits of the money by naming a trusted spouse as the trust’s beneficiary.
Charity Inherits IRA Tax Free
Private Letter Ruling 201943020
In Private Letter Ruling 201943020, released October 25, 2019, the IRS determined that assets in a decedent’s IRA could be transferred tax-free to the new IRA of the charitable organization (the taxpayer) named by the decedent as beneficiary. The charitable organization sought a private letter ruling because the custodian of the decedent’s IRA, before distributing the amounts in the decedent’s IRA, sought to require the charitable organization to create a new transfer IRA with the custodian to which the custodian could transfer assets from the decedent’s IRA directly in a trustee-to-trustee transfer.
The charitable organization requested several rulings: (1) the new IRA set up pursuant to the custodian’s request is not an IRA defined by IRC section 408; (2) the new account is a taxable trust; and (3) a distribution from the decedent’s IRA to the new account is subject to federal income tax.
First, rejecting the charitable organization’s position, the IRS held that the transfer IRA did not fail to be an IRA because it was maintained for the benefit of the charitable organization as beneficiary of the decedent, as it maintains the same legal characteristics and limitations under IRC section 408 as the original IRA after the death of the decedent. In addition, the IRS noted that there was nothing in the definition of “inherited IRA” contained in IRC section 408(d)(3)(C)(ii) to suggest that accounts that do not fall within that definition because they are held by non-individual beneficiaries cannot constitute IRAs, as non-individuals are permitted to be IRA beneficiaries under Treas. Reg. 1.408-2(b)(8) and IRC section 7701(a)(1). Further, the definition of “inherited IRA” in IRC section 408(d)(3)(C)(ii) was intended to be limited in its application and was only meant to prohibit certain individuals from performing IRA rollovers: Non-individual beneficiaries were precluded from performing rollovers by other IRC provisions, which would make the inclusion of a more explicit provision superfluous.
Second, because the IRS ruled that the new IRA account did not fail to be an IRA under IRC section 408, it is exempt from taxation under IRC section 408(e)(1), i.e., it was not a taxable trust as contended by the charitable organization.
Third, the IRS determined that a direct trustee-to-trustee transfer of assets from the original IRA to the new IRA, both of which were maintained for the benefit of the same charitable organization as the beneficiary of the decedent, did not constitute a payment or distribution includible in the charitable organization’s gross income.
Takeaways: In PLR 201943020, the IRS addressed the rules applicable to inherited IRAs when non-individual beneficiaries, such as the charitable organization at issue, are involved, clarifying that even if an IRA does not fall within the definition of an inherited IRA because the beneficiary is a non-individual, it can, nonetheless, constitute an IRA.
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Paid Leave for Government Employees
The defense appropriations bill, passed December 17th as part of the larger spending appropriations bill and signed by President Trump on December 20, 2019, provides twelve weeks of paid leave to mothers and fathers upon the birth, adoption, or fostering of children. Federal employees who have worked for the government at least one year will be eligible for paid leave beginning in October 2020. Although employees who take the leave are required to return to work for at least twelve weeks after they take advantage of the benefit, the government can waive that requirement for medical reasons.
Takeaways: The new law, which will benefit more than two million Americans, follows the lead of many large U.S. companies, the District of Columbia, and a handful of states, i.e., California, Connecticut, Massachusetts, New Jersey, New York, Oregon, Rhode Island, and Washington (some of which have not yet gone into effect), which offer varying paid parental leave programs. It is expected to increase the pressure on private companies to improve their paid family leave policies.
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