The Silent Generation and Baby Boomers are incredibly fortunate generations—and so might be their heirs. Cerulli’s U.S. High-Net-Worth and Ultra-High-Net-Worth Markets 2021 report predicts these generations will transfer $72.6 trillion in assets to heirs and $11.9 trillion to charities through 2045.
That’s a lot of money, and it presents a unique opportunity for Gen Xers and Millennials to secure their financial futures. But it’s important to remember that this wealth won’t just magically appear. It will take planning and communication between the generations to transfer it smoothly.
Managing expectations is one of the biggest challenges heirs face when inheriting wealth from their parents or grandparents. Many Gen Xers and Millennials believe they will inherit a large sum of money, but this may not be the case.
Older generations are living longer and may spend a large percentage of their estate before it can be passed on. Others might give away too much money now and need financial support from their adult children later.
The first step in any estate planning discussion is getting honest about what heirs hope to receive and what the older generation can afford to give.
Older generations can find it difficult to talk about their death. They may feel like they are losing control over their life and finances. Or they may be afraid that their heirs won’t be able to handle the responsibility of inheriting wealth.
However, it’s essential for members of different generations to have open communication about estate planning. That way, everyone is on the same page when the time comes to hand over the reins.
Involving a third party—a CPA, financial advisor, or attorney—in these conversations can help. These professionals do more than ensure the estate planning documents are in order and help navigate tax issues. They can also help facilitate difficult conversations between family members and negotiate any conflicts that might arise during the process. By working with these professionals, families can avoid costly legal disputes and ensure that their wealth is transferred seamlessly from one generation to the next.
Even if the younger generation has a good idea of how much they’ll inherit, there may be some surprises. For example, they may inherit assets that must be managed carefully, such as a business or real estate. Or they may be expected to take over their parent or grandparents’ philanthropic activities.
Members of the younger generation who were kept in the dark about these decisions often struggle to live up to expectations.
If you plan on leaving a legacy for your heirs, start educating them about your intentions. Make sure they understand the role you expect them to play in managing and using the wealth you leave behind.
Every estate plan is unique, but with a long runway and proper planning, most estate tax is avoidable. The key is to start right away—as soon as it’s clear that are assets you want to transfer.
Some simple strategies you can start implementing now include:
When transferring wealth from one generation to the next, specific strategies will vary depending on whether you own a business, have philanthropic inclinations, and who your heirs are. However, what doesn’t change from one estate plan to the next is the need for communication.
For any generational wealth transfer to be successful, heirs need to understand why the wealth is being transferred, how it will be managed, and their role in the process.
Failure to communicate effectively can lead to many problems, including family feuds and lost money. So, families need to have open discussions about generational wealth transfer early on—before any decisions are made. Managing expectations and having honest conversations can help your family avoid misunderstandings and ensure the transition goes as smoothly as possible.
If you have money invested in the stock market, you’re well aware of potential volatility. Needless to say, this volatility can affect your net worth, thus affecting your lifestyle. Something you might not think about is the potential effect on your estate tax liability. Specifically, if the value of stocks or other assets drops precipitously soon after your death, estate tax could be owed on value that has disappeared. One strategy to ease estate tax liability in this situation is for the estate’s executor to elect to use an alternate valuation date.
Typically, assets owned by the deceased are included in his or her taxable estate based on their value on the date of death. For instance, if an individual owned stocks valued at $1 million on the day when he or she died, the stocks would be included in the estate at a value of $1 million.
Despite today’s favorable rules that allow a federal gift and estate tax exemption of $12.06 million, a small percentage of families still must contend with the federal estate tax. However, the tax law provides some relief to estates that are negatively affected by fluctuating market conditions. Instead of using the value of assets on the date of death for estate tax purposes, the executor may elect an “alternate valuation” date of six months after the date of death. This election could effectively lower a federal estate tax bill.
The election is permissible only if the total value of the gross estate is lower on the alternate valuation date than it was on the date of death. Of course, the election generally wouldn’t be made otherwise. If assets are sold after death, the date of the disposition controls. The value doesn’t automatically revert to the date of death.
Furthermore, the ensuing estate tax must be lower by using the alternate valuation date than it would have been using the date-of-death valuation. This would also seem to be obvious, but that’s not necessarily true for estates passing under the unlimited marital deduction or for other times when the estate tax equals zero on the date of death.
Note that the election to use the alternate valuation date generally must be made with the estate tax return. There is, however, a provision that allows for a late-filed election.
The alternate valuation date election can save estate tax, but there’s one potential drawback: The election must be made for the entire estate. In other words, the executor can’t cherry-pick stocks to be valued six months after the date of death and retain the original valuation date for other stocks or assets. It’s all or nothing.
This could be a key consideration if an estate has, for example, sizable real estate holdings in addition to securities. If the real estate has been appreciating in value, making the election may not be the best approach. The executor must conduct a thorough inventory and accounting of the value of all assets.
If your estate includes assets that can fluctuate in value, such as stocks, be sure your executor knows about the option of choosing an alternate valuation date. This option allows flexibility to reduce the chances of estate tax liability. Contact your estate planning advisor for additional information.
How much can you and your employees contribute to your 401(k)s next year — or other retirement plans? In Notice 2022-55, the IRS recently announced cost-of-living adjustments that apply to the dollar limitations for pensions, as well as other qualified retirement plans for 2023. The amounts increased more than they have in recent years due to inflation.
The 2023 contribution limit for employees who participate in 401(k) plans will increase to $22,500 (up from $20,500 in 2022). This contribution amount also applies to 403(b) plans, most 457 plans and the federal government’s Thrift Savings Plan.
The catch-up contribution limit for employees age 50 and over who participate in 401(k) plans and the other plans mentioned above will increase to $7,500 (up from $6,500 in 2022). Therefore, participants in 401(k) plans (and the others listed above) who are 50 and older can contribute up to $30,000 in 2023.
The limitation for defined contribution plans, including a Simplified Employee Pension (SEP) plan, will increase from $61,000 to $66,000. To participate in a SEP, an eligible employee must receive at least a certain amount of compensation for the year. That amount will increase in 2023 to $750 (from $650 for 2022).
Deferrals to a SIMPLE plan will increase to $15,500 in 2023 (up from $14,000 in 2022). The catch-up contribution limit for employees age 50 and over who participate in SIMPLE plans will increase to $3,500 in 2023, up from $3,000.
The IRS also announced that in 2023:
The 2023 limit on annual contributions to an individual IRA will increase to $6,500 (up from $6,000 for 2022). The IRA catch-up contribution limit for individuals age 50 and older isn’t subject to an annual cost-of-living adjustment and will remain $1,000.
Current high inflation rates will make it easier for you and your employees to save much more in your retirement plans in 2023. The contribution amounts will be a great deal higher next year than they’ve been in recent years. Contact us if you have questions about your tax-advantaged retirement plan or if you want to explore other retirement plan options.
What makes Roth IRAs so appealing? Primarily, it’s the ability to withdraw money from them tax-free. But to enjoy this benefit, there are a few rules you must follow, including the widely misunderstood five-year rule.
To understand the five-year rule, you first need to understand the three types of funds that may be withdrawn from a Roth IRA:
Contributed principal. This is your after-tax contributions to the account.
Converted principal. This consists of funds that had been in a traditional IRA but that you converted to a Roth IRA (paying tax on the conversion).
Earnings. This includes the (untaxed) returns generated from the contributed or converted principal.
Generally, you can withdraw contributed principal at any time without taxes or early withdrawal penalties, regardless of your age or how long the funds have been held in the Roth IRA. But to avoid taxes and penalties on withdrawals of earnings, you must meet two requirements:
The withdrawal must not be made before you turn 59½, die, become disabled or qualify for an exception to early withdrawal penalties (such as withdrawals for qualified first-time homebuyer expenses), and
You must satisfy the five-year rule.
Withdrawals of converted principal aren’t taxable because you were taxed at the time of the conversion. But they’re subject to early withdrawal penalties if you fail to satisfy the five-year rule.
As the name suggests, the five-year rule requires you to satisfy a five-year holding period before you can withdraw Roth IRA earnings tax-free or converted principal penalty-free. But the rule works differently depending on the type of funds you’re withdrawing.
If you’re withdrawing earnings, the five-year period begins on January 1 of the tax year for which you made your first contribution to any Roth IRA. For example, if you opened your first Roth IRA on April 1, 2018, and treated your initial contribution as one for the 2017 tax year, then the five-year period started on January 1, 2017. That means you were able to withdraw earnings from any Roth IRA tax- and penalty-free beginning on January 1, 2022 (assuming you were at least 59½ or otherwise exempt from early withdrawal penalties).
Note: If you’re not subject to early withdrawal penalties (because, for example, you’re 59½ or older), failure to satisfy the five-year rule won’t trigger a penalty, but earnings will be taxable.
If you’re withdrawing converted principal, the five-year holding period begins on January 1 of the tax year in which you do the conversion. For instance, if you converted a traditional IRA into a Roth IRA at any time during 2017, the five-year period began January 1, 2017, and ended December 31, 2021.
Unlike earnings, however, each Roth IRA conversion is subject to a separate five-year holding period. If you do several conversions over the years, you’ll need to track each five-year period carefully to avoid triggering unexpected penalties.
Keep in mind that the five-year rule only comes into play if you’re otherwise subject to early withdrawal penalties. If you’ve reached age 59½, or a penalty exception applies, then you can withdraw converted principal penalty-free even if the five-year period hasn’t expired.
You may be wondering why the five-year rule applies to withdrawals of funds that have already been taxed. The reason is that the tax benefits of Roth and traditional IRAs are intended to promote long-term saving for retirement. Without the five-year rule, a traditional IRA owner could circumvent the penalty for early withdrawals simply by converting it to a Roth IRA, paying the tax, and immediately withdrawing it penalty-free.
Note, however, that while the five-year rule prevents this, it’s still possible to use a conversion to withdraw funds penalty-free before age 59½. For example, you could convert a traditional IRA to a Roth IRA at age 45, pay the tax, wait five years and then withdraw the converted principal penalty-free.
Generally, one who inherits a Roth IRA may withdraw the funds immediately without fear of taxes or penalties, with one exception: The five-year rule may still apply to withdrawals of earnings if the original owner of the Roth IRA hadn’t satisfied the five-year rule at the time of his or her death.
For instance, suppose you inherited a Roth IRA from your grandfather on July 1, 2021. If he made his first Roth IRA contribution on December 1, 2018, you’ll have to wait until January 1, 2023, before you can withdraw earnings tax-free.
Many people are accustomed to withdrawing retirement savings freely once they reach age 59½. But care must be taken when withdrawing funds from a Roth IRA to avoid running afoul of the five-year rule and inadvertently triggering unexpected taxes or penalties. The rule is complex — so when in doubt, consult a tax professional before making a withdrawal.
The consequences of violating the five-year rule can be costly, but fortunately, there are ordering rules that help you avoid inadvertent mistakes. Under these rules, withdrawals from a Roth IRA are presumed to come from after-tax contributions first, converted principal second, and earnings third.
So, if contributions are large enough to cover the amount you wish to withdraw, you will avoid taxes and penalties even if the five-year rule hasn’t been satisfied for converted principal or earnings. Of course, if you withdraw the entire account balance, the ordering rules won’t help you.
On October 21, 2022, the Internal Revenue Service (IRS) announced the updated contribution limits to retirement plans in Notice 2022-55. The new limits are valid beginning in tax year 2023. These limits are important, as they cap the tax benefits that can be realized from retirement plan savings contributions each year and are adjusted to account for annual inflation.
There are several options available under the ‘Employer Contribution Plans’ category. These plans are typically funded through an employer and may or may not have contributions paid for by the employer. For 401(k), 403(b), the federal government’s Thrift Savings Plan, and most 457 plans, the contribution limit will increase from $20,500 in 2022 to $22,500 in 2023.
Individuals aged 50 years and above can contribute additional funds, called ‘Catch Up Contributions.’ The catch-up contribution limit or the employer-sponsored plans mentioned above will increase from $6,500 in 2022 to $7,500 in 2023. This means those with a qualifying employer-sponsored plan who are 50 or older can contribute up to $30,000 to tax-beneficial retirement plans.
Depending on income, the IRS provides tax benefits to non-employer-sponsored retirement accounts called Individual Retirement Arrangements (IRAs). The traditional IRA offers a deduction for the income in the tax year the contribution is made, while a Roth IRA offers tax benefits when the funds are withdrawn after the qualifying retirement age.
The IRS has increased the contribution limit to these types of accounts to $6,500 in 2023 from $6,000 in 2022. For individuals eligible for a catch-up contribution, the additional contribution amount remains at $1,000.
Keep in mind that there is an income limit on both Traditional IRA and Roth IRA accounts before the tax benefits start to phase out. These limits are:
|Single Filers/Heads of Household||$73,000 to $83,000*|
|Married Filing Jointly (spouse contributing covered by employer plan)||$116,000 to $136,000*|
|Married Filing Jointly (contributor not covered by employer plan, but spouse is)||$218,000 to $228,000*|
|Married Filing Separate (contributor covered by an employer plan)||$0 to $10,000*|
|Single Filers/Heads of Household||$138,000 to $153,000*|
|Married Filing Jointly||$218,000 to $228,000*|
|Married Filing Separate||$0 to $10,000*|
Retirement Savings Contributions Credit
|Single Filers/Married Filing Separate||$36,500|
|Married Filing Jointly||$73,000|
|Heads of Household||$54,750|
*Note: Contribution limits to Traditional IRA and Roth IRA accounts phase out over the noted income range.
Need assistance understanding the tax benefits and contribution limits attached to the different tax-beneficial retirement accounts? Our team of knowledgeable professionals is here to help. Give us a call to discuss your tax strategy for retirement savings today.
If you’re thinking about selling your home, it’s important to determine whether you qualify for the home sale gain exclusion. The exclusion is one of the most generous tax breaks in the tax code, so be sure to review its requirements before you sell.
Ordinarily, when you sell real estate or other capital assets that you’ve owned for more than one year, your profit is taxable at long-term capital gains rates of 15% or 20%, depending on your tax bracket. High-income taxpayers may also be subject to an additional 3.8% net investment income (NII) tax. If you’re selling your principal residence, however, the home sale gain exclusion may allow you to avoid tax on up to $250,000 in profit for single filers and up to $500,000 for married couples filing jointly.
Don’t assume that you’re eligible for this tax break just because you’re selling your principal residence. If you’re a single filer, to qualify for the exclusion, you must have owned and used the home as your principal residence for at least 24 months of the five-year period ending on the sale date.
If you’re married filing jointly, then both you and your spouse must have lived in the home as your principal residence for 24 months of the preceding five years and at least one of you must have owned it for 24 months of the preceding five years. Special eligibility rules apply to people who become unable to care for themselves, couples who divorce or separate, military personnel, and widowed taxpayers.
You can’t use the exclusion more than once in a two-year period, even if you otherwise meet the requirements. Also, if you convert an ineligible residence into a principal residence and live in it for 24 months or more, only a portion of your gain will qualify for the exclusion.
For example, John is single and has owned a home for five years, using it as a vacation home for the first three years and as his principal residence for the last two. If he sells the home for a $300,000 gain, only 40% of his gain ($120,000) qualifies for the exclusion, and the remaining $180,000 is taxable. (Note: Nonqualified use prior to 2009 doesn’t reduce the exclusion).
What if you sell your home before you meet the 24-month threshold due to a work- or health-related move, or certain other unforeseen circumstances? You may qualify for a partial exclusion.
For example, Paul and Linda bought a home in California for $1 million. One year later, Paul’s employer transferred him to its New York office, so the couple sold the home for $1.2 million. Paul and Linda didn’t meet the 24-month threshold but, because they sold the home due to a work-related move, they qualified for a partial exclusion of 12 months/24 months, or 50%.
Note that the 50% reduction applied to the exclusion, not to the couple’s gain. Thus, their exclusion was reduced to 50% of $500,000, or $250,000, which shielded their entire $200,000 gain from tax.
Before you sell your principal residence, determine the amount of your home sale gain exclusion and your expected gain (selling price less adjusted cost basis). Keep in mind that your cost basis is increased by the cost of certain improvements and other expenses, which in turn reduces your gain. Also, be aware that capital gains attributable to depreciation deductions (for a home office, for example) will be taxable regardless of the home sale gain exclusion.
IRS audit rates are historically low, according to a recent Government Accountability Office (GAO) report, but that’s little consolation if your return is among those selected to be examined. Plus, the IRS recently received additional funding in the Inflation Reduction Act to improve customer service, upgrade technology and increase audits of high-income taxpayers. But with proper preparation and planning, you should fare well.
From tax years 2010 to 2019, audit rates of individual tax returns decreased for all income levels, according to the GAO. On average, the audit rate for all returns decreased from 0.9% to 0.25%. IRS officials attribute this to reduced staffing as a result of decreased funding. Businesses, large corporations, and high-income individuals are more likely to be audited, but overall, all types of audits are being conducted less frequently than they were a decade ago.
There’s no 100% guarantee that you won’t be picked for an audit because some tax returns are chosen randomly. However, the best way to survive an IRS audit is to prepare in advance. On an ongoing basis, you should systematically maintain documentation — invoices, bills, canceled checks, receipts, or other proof — for all items to be reported on your tax returns. Keep all records in one place.
It also helps to know what might catch the attention of the IRS. Certain types of tax-return entries are known to involve inaccuracies, so they may lead to an audit. Here are a few examples:
Certain types of deductions may be questioned by the IRS because there are strict recordkeeping requirements for them — for example, auto and travel expense deductions. In addition, an owner-employee’s salary that’s much higher or lower than those at similar companies in his or her location may catch the IRS’s eye, especially if the business is structured as a corporation.
If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS doesn’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.
Many audits simply request that you mail in documentation to support certain deductions you’ve claimed. Only the strictest version, the field audit, requires meeting with one or more IRS auditors. (Note: Ignore unsolicited emails or text messages about an audit. The IRS doesn’t contact people in this manner. These are scams.)
The tax agency doesn’t demand an immediate response to a mailed notice. You’ll be informed of the discrepancies in question and given time to prepare. Collect and organize all relevant income and expense records. If anything is missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.
If you’re audited, our firm can help you:
The IRS normally has three years within which to conduct an audit, and an audit probably won’t begin until a year or more after you file a return. Don’t panic if the IRS contacts you. Many audits are routine. By taking a meticulous, proactive approach to tracking, documenting and filing your company’s tax-related information, you’ll make an audit less painful and even decrease the chances you’ll be chosen in the first place.
Does your business need real estate to conduct operations? Or does it otherwise hold property and put the title in the name of the business? You may want to rethink this approach. Any short-term benefits may be outweighed by the tax, liability, and estate planning advantages of separating real estate ownership from the business.
Businesses that are formed as C corporations treat real estate assets as they do equipment, inventory and other business assets. Any expenses related to owning the assets appear as ordinary expenses on their income statements and are generally tax deductible in the year they’re incurred.
However, when the business sells the real estate, the profits are taxed twice — at the corporate level and at the owner’s individual level when a distribution is made. Double taxation is avoidable, though. If ownership of the real estate were transferred to a pass-through entity instead, the profit upon sale would be taxed only at the individual level.
Separating your business ownership from its real estate also provides an effective way to protect it from creditors and other claimants. For example, if your business is sued and found liable, a plaintiff may go after all of its assets, including real estate held in its name. But plaintiffs can’t touch property owned by another entity.
The strategy also can pay off if your business is forced to file for bankruptcy. Creditors generally can’t recover real estate owned separately unless it’s been pledged as collateral for credit taken out by the business.
Separating real estate from a business may give you some estate planning options, too. For example, if the company is a family business but some members of the next generation aren’t interested in actively participating, separating property gives you an extra asset to distribute. You could bequest the business to one heir and the real estate to another family member who doesn’t work in the business.
The business simply transfers ownership of the real estate and the transferee leases it back to the company. Who should own the real estate? One option: The business owner could purchase the real estate from the business and hold title in his or her name. One concern is that it’s not only the property that’ll transfer to the owner, but also any liabilities related to it.
Moreover, any liability related to the property itself could inadvertently put the business at risk. If, for example, a client suffers an injury on the property and a lawsuit ensues, the property owner’s other assets (including the interest in the business) could be in jeopardy.
An alternative is to transfer the property to a separate legal entity formed to hold the title, typically a limited liability company (LLC) or limited liability partnership (LLP). With a pass-through structure, any expenses related to the real estate will flow through to your individual tax return and offset the rental income.
An LLC is more commonly used to transfer real estate. It’s simple to set up and requires only one member. LLPs require at least two partners and aren’t permitted in every state. Some states restrict them to certain types of businesses and impose other restrictions.
Separating the ownership of a business’s real estate isn’t always advisable. If it’s worthwhile, the right approach will depend on your individual circumstances. Contact us to help determine the best approach to minimize your transfer costs and capital gains taxes while maximizing other potential benefits.