Chapter 6 - Financial Underwriting: Pkanning for Personal Needs Flashcards
Estate Planning
Traditionally focused on the distribution of the estate after death, however currently it is a lifelong process dealing with the acquisition of wealth and estate maintenance as well as the deliver of estate assets upon death to beneficiaries.
Advantages of a well planned estate
- Maximized wealth
- Efficient use of estate capital
- Tax Savings
- Appropriate asset ownership
- Assurance that estate property will be distributed according to decedent’s wishes
6 Adequate estate liquidity.
Federal Estate Taxation - US
Usually only applied to large estates - only wealthiest 2%.
Arguments for estate tax
- Assists in the redistribution of wealth from the rich to the poor via government programs, providing assistance and opportunities not normally available to the economically deprived.
- The tax provides meaningful financial support for American democratic institutions of government and national programs
- The tax encourages support for charitable gifting strategy for reducing the taxable estate.
Arguments against the estate tax
- The tax disproportionately affects society’s most successful and productive citizens. It also penalizes business entrepreneurs looking to safeguard their life’s work and pas it intact to their heirs.
- Money and financial resources removed form the general economy via the estate tax cause a loss of jobs
- Tax-supports government institutions are generally less effective at promoting economic prosperity than a free-market economy.
Under the new estate tax rules
Amount an individual can be excluded from estate taxes, inclusive of gifts given during their lifetime is $5.45M for 2013 and increase for inflation to $5.34M in 2014. The top federal tax rate increased to 40% and remains in same in 2014.
Valuing the Taxable Estate
Net worth is often used as the basis from which to estimate whether an individual is subject to the estate tax. However estate tax is computer on the taxable estate, which is an amount determined by subtracting certain allowable deductions from the gross estate.
Gross Estate
The value of all property interests, real or personal, tangible or intangible, of an individual on the date of death to the extent of his or her interest in the property. Most property is valued at FMV.
Fair Market Value (FMV)
The price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.
Exceptions to FMV
Real property (land and permanent attachments) may not always have a ready market from which to estimate FMV. Under these circumstances, real property can be valued at the high of the highest price available or its salvage value (the disposal value of property at the end of its useful life).
Some real properties are s/t a special use valuation
Which is designed to value the property according to its current use, not its potential value if used for other purposes.
(i.e., farm is valued lower than a mall - if the land is perfect place for a mall, but there was no intention for this, then the valuation would be for that of a farm as intended).
Other special valuation situations (4)
- Publicly traded stock and corporate bonds are valued on the date of death or an alternate valuation date.
- US government bonds are valued at the date of death redemption price.
- Closely help corporation stock not s/t special use valuation is valued according to either the adjusted book value method or the capitalization of adjusted earnings method.
- Life insurance proceeds set aside for the benefit of the decedent’s estate or proceeds from policies owned by the decedent are taxed as part of the estate (many techniques exists to remove life insurance benefits from the taxable estate.
The adjusted Gross Estate
From the gross estate certain allowable deductions are made to arrive at the adjusted gross estate. These include:
- Allowable debts (such as mortgages)
- Funeral expenses
- Medical expenses
- Administrative expenses
- Losses during estate admin (such as the decline in value of an asset while the estate was being settled).
Marital and Charitable Deductions
These are subtracted from the adjusted gross estate to arrive at the taxable estate.
Property that is passing to the spouse of the decedent can be deducted completely from the adjusted gross estate.
These usually result in a survivor joint life insurance to offset he impact of the estate tax due at the second death.
Prudent use of the marital deduction depends on a numbers of factors including (5):
- the value of the property rights, known as the power of appointment. This is a property right reserved by the property donor that allows the donor to control who receives the property or benefits from the property.
- Partial interests in property, in which a property is owner or controlled by two or more individuals.
- Charitable remainder trusts, in which a beneficiary receives the income form the property but the charity gets the property itself upon the death of the .
- Guaranteed annuity interests, in which the charity gets income for a specific term, then the property passes to a beneficiary.
- Split gifts, in which a partial gift goes to a charity and the remainder goes to a beneficiary.
Estate Growth
Life insurance is intended to cover the liabilities of a death at an uncertain date, many estate planning sales allow for the expectation of estate growth.
Challenge to underwriters for estate growth
Determining the appropriate time frame and interest rate assumptions for any given estate.
Desirable estate growth projections should
- strive to adopt a reasonable rate of return commensurate with the average return on assets in the estate over time.
- Reflect the type of investment that make up the estate - conservative investments, such as bank certificates of deposit have a lower potential investment return than stocks or new business ventures.
- Adjust to the age of the estate owner - older individuals with fewer productive economic years require a shorter growth period.
- Assume that at least some investment income will be consumed by the estate owner and will not be complete reinvested - Retired individuals, or those with unusual medical expenses for themselves or family members can consume most or all of their available investment income; thus, estate growth for the elderly or those in ill-health can be minimal.
Estate Taxation - Canada
No estate tax.
Canada Income Tax Act provides that a deceased taxpayer is consider to have “sold” all capital property at fair market value immediately before death. Therefore gains will be handled on income tax return.
A capital gain will be incurred in situations where the FMV exceeds owner’s adjusted cost basis of the property (basically the original cost of the property). 50% will be included in the deceased’s estate terminal income tax return.
Otherwise capital gains exemption up to $750,000.
Capital property - Canada (2 categories)
- Depreciable capital property, the value of which declines over time, such as buildings, furniture, and machinery.
- Non-depreciable capital property, such as land, stock, and mutual funds.
Recaptured depreciation
If a property is actually worth more than its depreciated value, some or all of the depreciation can be added back to the value of the property through tax provisions.
Cottage cost - $60K, Depreciated value of $30K, but FMV of $70K. Pay tax on $40K.
Three separate jurisdictional premises of which can trigger the imposition of estate tax
- US Citizenship
- Residency or Domicile
- The situs or location of estate assets
Citizenship
IRS states that a tax is hereby imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the US. Citizens of the US are taxed on the value of their estate assets worldwide, regardless of where those assets are located.
Definition of a citizen includes
- All native-born citizens, and children born in the US to non-US parents.
- All naturalized citizens
- All citizens living abroad
- All individuals who have multiple citizenship status
- Former citizens and expatriates.
Residency or Domicile
A resident decedent is a decedent who, at the time of his death, had his domicile in the US. A person acquires a domicile by living there, for even a brief period of time, with no definite intention of later removing therefrom. Residence without the intention to remain indefinitely will not constitute domicile, no will intention to change domicile effect such a change unless accompanied by actual removal.
Residency and domicile is proven by 2 factors
- Physician presence
2. Intention to remain in the country
Situs of Estate Assets
The value of the gross estate of every decedent non-resident noncitizen of the US shall be that part of his gross estate which at the time of his death is situated in the US.
This means that assets owned in the US by foreign decedents are s/t estate tax, even if the decedent has never visited the US and has no residence in the country.
Rules that govern the imposition of the estate tax on foreigners including:
- The estate tax exclusion amount for non-resident aliens if $60K. Estate tax is due when a non-resident alien’s estate transfers US situs assets above $60K.
- The charitable deduction applied, but only to US charities.
- There is no martial deduction if the spouse is no a US citizen. However, if the spouse becomes a US citizen before the estate tax return is file, the deduction can be applied.
- Foreign death tax credit can be applied again the US estate tax.
Estate tax treaties exist between countries to help secure risk of double taxation on the same estate assets.
Income with Respect of a Decedent (IRD)
Is the income the decedent earned but did not receive before his or her death. Examples:
- Uncollected salaries, wages, bonuses, commissions, vacation pay, and sick pay.
- Interest/dividends accrued but unpaid
- Uncollected lottery winnings
- Assets held in deferred compensation benefits such as qualified pension plans, profit sharing plans, SEP, Keogh, and IRAs.
- Outstanding stock dividends still owed to the decedent.
- Accounts receivable of a cash basis sole proprietor
- Rents/royalties accrued but not paid
- Unreceived gain from the sale of property.
