Posts Tagged ‘estate planning’

How to Develop Your Occupational Living Will

Bev working with a staff CPA, Jeff Dorn.

As children we dream. We dream unfettered. We dream of traveling to the stars; we dream of life as a policeman, fireman or even a doctor. Some fall in love with numbers and can’t think of anything else. We dream of great discoveries as scientists or helping people reach their dreams and goals financially.

Then we grow up.

Society tells us we must prepare for retirement as soon as possible. The financial services industry breathes and dies by our willingness to buy into their story.

The news feeds are filled with stories of people who started early, saved hard and retired early. As someone living inside said community I notice a pattern. A large majority of people who take a knee at an early age—any age, in fact—go through a predictable pattern. Travel dreams are realized. Some want to golf or fish. After a while golfing or fishing all day becomes the job. Travel turns into a drag. Living on the road looks far more appealing from the outside.

Experiencing new destinations is what people really want. The actual traveling is sheer pain. I’ve never heard anyone say she can’t wait to be sealed inside an aluminum tube with her 260 closest friends for several hours.

Even with travel dreams alive, it is as common as weeds in a garden for people to pick up a side gig (some call it a side hustle) after the gloss of retirement wears off.

Then, there are people who find their calling early and live their side gig from day one. We call these people entrepreneurs or business owners.

Never Ending Story

Whether you find your calling early or after you retire from a “traditional” career, life is best when you discover what provides you the greatest joy. Once you find the activity you enjoy most you begin to build a life and habits around said activity.

Starting a business or side gig requires planning. The one issue rarely addressed is the exit plan. As I look down the barrel of my fast approaching 54th birthday I have to ask serious questions about my tax practice. What if I were injured or got sick? Either event could destroy what I spent a lifetime building.

As we age and accumulate wealth we quickly discover the need for a living will. I propose a significant percentage of people also need to consider an occupational living will.

Vision of the Future

Of all the employees I ever had, Bev is the only one still asked about every tax season. Bev hasn’t worked for me in seven years!

Bev was my first employee. Her skills and work ethic assured my efforts to build a firm were successful. Bev wasn’t the fastest, but she was consistent. And for the record, fast isn’t always better in taxes and accounting.

When I let Bev go it broke my heart. I wrestled with the decision a long time. Her abilities were more than adequate, but bitter Wisconsin winters were taking their toll. Cold air took her breath away. There were times Bev would need several minutes to catch her breath walking from the car to the office door. Her health was more important than a few more years of service.

Bev still comes to the office every tax season to get her return done. It’s a continuing fringe benefit for a rockstar employee. It’s always a good day when Bev walks in the door.

But there was another reason I asked Bev to retire.

Lost Step

When winter turns nasty and the hours long Bev felt the effects. She lost a step as tax season wore on. If the weather added to the stress I could chart the increase in errors.

I review virtually every return in my office. Some get a minor once-over and other returns get a proctology exam. Bev started to lose a step in her 60s when the workload increased and weather added stress. If only I found the fountain of youth to keep Bev at her post.

Dementia is an insidious disease. It approaches gradually. People around you may notice, but we have self-defense mechanism to delude ourselves. We are the last to know our quality is no longer up to par.

Bev is still mentally sound. Stress and health were the real deciding factors.

Lifetime of Love

I was lucky. I found the work I enjoy early in life. As a business owner I can choose my hours and workload within reason. This is a lifelong occupation. If I were to sell my practice I’d probably be doing taxes and consulting on the side within months. (Either that or Mrs. Accountant would hit me with a rolling pin as I started to bounce off walls.)

As much as I love my work I must accept the day may come when I’m no longer proficient at it. Worse, a car accident or cancer could end my ability to serve my clients. In the past the issue wasn’t as acute. The returns I handled back then were more traditional. Now I manage accounts from around the nation, all with advanced issues. Finding qualified staff has been a challenge. Dementia in unwelcome.

I’m not alone in this. The Washington Post had an excellent article dealing with these issues and it’s where I got the idea for this post.

The more you love your calling the less likely you want to retire from it. Unfortunately, the day comes when we no longer serve our clients adequately. That is where an action plan set into place well in advance can protect you, your family and your clients.

Occupational Living Will

Your facts and circumstances will determine the necessary steps in your occupational living will. Below are steps I’ve taken over the last several years in preparation for my demise.

  • Create a business bible. Around the time Bev took the long walk I had a come to Jesus moment. I knew the day would come when my body couldn’t cash the checks my mind was writing. Every member of my office team was a part of building the office bible. Every task was outlined step-by-step. Should any employee be on vacation, quit, retire or become incapacitated, there was a guide for each process our company performs. We discovered the office bible is an excellent tool when we get in a bind and it gets regular use. It is also a part of the training process for new employees.
  • Create redundancy. Certain people handle certain tasks. In a small office it is hard to have several people working on every project. While it is natural for one person to handle most issues around certain tasks, it is wise to train staff to have at least a working knowledge of other tasks. The increased payroll expenses should be minimal.
  • Create a succession plan of ownership. This is hard for business owners. In my office if I’m ever unable to perform my duties I would lose the right to vote my shares. In effect I would lose control of my company to someone already in place and able to make the decisions necessary to keep clients serviced and the company alive.
  • Train and train some more. It is almost impossible to over-train your team. Cross train so more than one person is competent in all areas of practice.
  • Keep your family informed. Planning for dementia, accident or other disease is not the highlight of the day. Still, keep a copy of the office bible available to family members with additional information on operating the business. Remember, your family will be under serious stress if something happens to you. Provide a guide to make it as easy as possible for your loved ones in your time of incapacity. Be sure to inform family of pass codes and where the money is, including working capital, online savings accounts and lines of credit.

Here are considerations I’ve had a difficult time handling, yet MUST be addressed.

  • Find your replacement. It is so easy for me to fall into the trap of I’m so good at what I do nobody can measure up. That’s ego, not intelligence speaking. Once upon a time I had a much larger staff. As my practice transformed into serving fewer clients at a higher level it grew harder to find experienced tax professionals to compliment my talents. My primary goal this year is to find my replacement. Instead of sending me out to pasture I can have more free time during tax season and a seasoned pro to compliment my tax skills. A true win/win situation.
  • Work with peer/competitors. At first blush this one sounds stupid. But think about it. You already work with other professionals and businesses in your field. Start a dialog to build bridges for unforeseen personal events. It could lead to a sale or merger of your business. Or, it could compliment both businesses, reducing stress and increasing profits for all.

Estate planning is often put off to the detriment of family. In business it is even more important to plan ahead. Having trusted friends and family in place to guide you through an illness or dementia might be uncomfortable, but it is necessary if you care about your clients, employees, friends and family.

There are alternatives to retiring. Your workload can shift, be reduced or more focused. When you love your work as much as much as I do it is hard to plan for the day it will be reduced or completely out of your life.

But it is still the right thing to do.

Living with a NIMCRUT

Recently I discussed my net worth and how I went from a poor farm boy to an eight figure net worth. To keep the discussion moving I glossed over a few issues, most notably some of the vehicles I use to invest and protect my net worth from taxation. My sole mention of using trust instruments to protect net worth and save taxes caused several requests to hit my email inbox. People wanted to know more about trusts and how they can be used to super-charge net worth, provide guaranteed income, reduce taxes and protect against lawsuits stealing your hard earned money.

To which I mentally replied, “Is that all?”

A tax discussion on trusts turns into hard core tax planning quickly. Discussing all trusts is beyond the scope of a simple blog post and even beyond the scope of an entire blog. Too many variables are involved. What we can do in a single blog post is cover one trust topic enough to help you decide if it is right for you and get you to the right people to facilitate the process.

Today we will discuss an animal called the net income makeup charitable remainder unitrust, or NIMCRUT. It sounds like a derogatory name you would call someone in the heat of battle. Instead, the NIMCRUT, or even her sister the CRUT, is the perfect tool to get a massive tax break now, avoid paying capital gains on highly appreciated assets, help the charity of your choice and get a nice income stream—some of which might be tax free—for your entire life or a set number of years. Sound like fun? Then read on.

The Problem

Highly appreciated assets face a large capital gains tax rate, currently topping out at 20% for federal, plus more in many states. To make matters worse, the alternative minimum tax is calculated using a 22 ½% capital gains rate.

Moving money from a long-term, highly appreciated asset to a higher income producing asset requires a serious tax haircut. The reason for the transfer of investments frequently revolves around income. The old asset has appreciated several fold, but has a low or no current income distribution. To access your net worth requires sale of a portion of or the entire asset, triggering a taxable event.

Basics of a NIMCRUT

A NIMCRUT is really a charitable remainder trust with a unique income makeup feature.

Once a NIMCRUT is established, assets are transferred into the trust. The trust sells the asset/s and since it is a charitable trust pays no tax on the gain. You personally did not sell the asset so you also pay no tax on the gain, nor is there anything to report on your personal tax return.

Because you donated to a charitable trust (a qualified nonprofit organization (the beneficiary) gets the remainder at some point in the future) you also get a tax deduction on your personal tax return. The tax deduction has to be discounted for the present value of the future gift. In the old days we used tables provided by the IRS to calculate our deduction; today we have handy online calculators linked at the end of this post.

Example: A 53 year old donating $1 million of stock to a NIMCRUT with a basis of $100,000 would avoid paying capital gains tax on $900,000, plus get a current tax deduction on Schedule A (subject to limitations) of $239,894. Any unused charitable deduction is carried forward up to five years.

The tax avoided and the additional deduction is a great start. BUT, you also get an income stream from the trust. Remember, this is not a straight forward donation to a charity. The charity gets the remainder at some point in the future. You choose how much income per year you want before the charity takes possession of the gift. The Tax Code requires at least a 5% rate with higher amounts allowed (up to 50%). A common rate is 7% and is used for our example above.

You also choose the term, either life or up to 20 years. The longer the term the lower the tax deduction on Schedule A.

CRUT or NIMCRUT

There is a difference between the two. Generally, a NIMCRUT only pays you from income, excluding capital gains. A CRUT can dip into the corpus to fund payments. The NIM part of a NIMCRUT means you can catch up, if you will, the missed portion of past payments.

Since many investments do not throw off a 7% income available for distribution, two investments rise to the surface: real estate and annuities. The rent is available to distribute to the annuitant (you).

An annuity inside the NIMCRUT can control the flow of funds. Income must be distributed up to the rate listed in the trust document. Previously missed payments are “made up” in years when the income supports the payment.

Since tax is due on all or most distributions, your personal tax situation might require more control over when you get paid and hence pay tax. The annuity inside the NIMCRUT can delay paying out; therefore, no income is available for distribution. When you need the money you can take your distribution by having the annuity pay out income to the NIMCRUT. (Special thanks to Putnam Investments for presenting the annuity strategy at a H.D. Vest Financial Services conference during the mid 1990s.)

Assessing the Benefits

Let’s add up all the benefits of a NIMCRUT before disclosing a few negatives.

First, you avoid capital gains on a highly appreciated asset. Most taxpayers will avoid 15% to 20% long-term capital gains tax with a NIMCRUT, plus state capital gains taxes. In our example, $900,000 of avoided LTCG adds to a $180,000 tax reduction at the 20% LTCG rate.

Next, you get a present value charitable deduction on Schedule A subject to normal limitations for the future charitable contribution. Our example shows a $239,894 deduction.

Assuming a 7% rate and no increases in value of the NIMCRUT investments, you will receive 140% of the original investment over 20 years. If the investments inside the NIMCRUT increase, your payment will too. Our example should generate $1.4 million over 20 years.

Normally you are the trustee so you determine the investments inside the NIMCRUT.

You control in a limited fashion when and how much you get paid. Most income from a CRUT or NIMCRUT is taxable. A portion of a CRUT might be exempt.

At the end of the term your named charity receives the remainder.

To keep the kiddos happy you can purchase a single premium term life insurance policy for the amount of the charitable gift with the tax savings from avoiding the LTCG tax. This is done with an irrevocable life insurance trust (ILIT).

If you die while the NIMCRUT is in effect the remainder goes to the charity, is added to your estate, but your estate takes an equal amount as a charitable deduction.

In sum, you avoid LTCG taxes on unrealized asset appreciation, get a deduction up front, receive income over your lifetime (single or joint) or a set number of years up to twenty, support your preferred charitable causes and give the kiddos a healthy legacy to boot.

Drawbacks

Every strategy has pros and cons. A NIMCRUT is irrevocable. This means you can’t later change your mind. Well, you can change your mind, but there is nothing you can do about it. You must plan in advance for a NIMCRUT. The issues and process is complex and set in stone once in effect.

There are annual reporting requirements. At minimum a Form 5227 is required. Sometimes a Form 1041 or other tax forms are required. Few tax professionals are versed or experienced in preparing complex trust tax returns. You will need to find one who is.

You must have an attorney to draft the trust documents. No shortcuts here. An experienced estate attorney will smooth the process and inform you of issues pertinent to you while avoiding IRS scrutiny.

Large investments are required and large unrealized LTCG increase the tax benefits of the NIMCRUT. Realistically, anything less than $100,000 of asset value or $50,000 of unrealized gain to transfer to the NIMCRUT is inadvisable. $1 million of highly appreciated assets and greater put into a NIMCRUT yield excellent advantages to many high net worth taxpayers.

A CRUT usually allows corpus to be used to pay the annuitant, but yields fewer tax benefits. A NIMCRUT must have income from which to pay the annuitant (you). Many NIMCRUTs exclude capital gains from income in the trust documents.

The Next Step

It’s not all roses when planning a trust. Trusts are nor for everyone. They are powerful estate planning tools to carry out your wishes and serve your needs. It takes time and there are legal fees.

I intentionally left out a massive amount of information to keep to this post’s story line brief. Additional research is required even before you contact your estate attorney.

Here is an interesting article on NIMCRUTs you might find valuable.

Here is a NIMCRUT calculator. You can play with the numbers to get an idea of the tax benefits available. The same site has excellent calculators for a variety of CRUTs and CRATs as well.

You can read a bit more from the IRS on the issues discussed.

Finding a qualified attorney is an issue for many readers. Here is an article by a company that helps people set up charitable trusts. (Not an affiliate.)

Finally, if you want to read extensively before committing to a discussion with an attorney, here is a good book on the subject from Amazon.