Liquidity, Powers of Appointment, and Trusts - Sources For Estate Liquidity
Sources For Estate Liquidity
When a person dies, certain taxes and other debts must be paid within a short period of time. The taxes and costs lower the amount transferred to heirs and may include:
- Funeral expenses
- Expenses due to illness
- Debts of the decedent
- Probate and attorney costs
- Federal and state estate taxes
Availability of cash at death to cover these costs should not be overlooked. Many times, the real estate makes up the bulk of an estate. If there are debts and sizable amounts of estate taxes to be paid, how does the executor get the money? The executor may have to sell some or all of the business assets. The estate plan needs to recognize the possible need for cashthe need to have some degree of liquidity in an estate. Assets easily converted into cash, such as savings accounts, stocks and bonds and life insurance proceeds provide estate liquidity to meet current obligations and taxes. If one goal in estate planning is to keep the business intact as a going concern for the next generation, additional considerations must be given to liquidity. Trying to preserve certain assets for the next generation also increases the need for liquidity planning.
Sale of Assets
Heirs may be able to sell off the decedent's assets, for example, a home or business. This may be a last resort as it usually results in losses because you are forced to sell. However, because the property was sold after death, the property will receive a step-up in cost basis, resulting in minimizing a gain.
Life insurance may be used to provide the estate with sufficient cash to satisfy the claims of creditors and to pay the taxes and other costs resulting from death. For individuals whose estates will be subject to the federal estate tax, life insurance can also be arranged so that it is not included in the gross estate.
Just a few advantages of life insurance include:
· Proceeds are available immediately when needed.
· Proceeds are received free of federal income tax.
· The policy can be arranged to avoid probate and federal estate tax.
· Borrowing the cash at interest is also avoided, including paying the federal estate tax in installments (see below).
· Policy death proceeds will nearly always equal more than premiums that were paid, allowing death costs to be funded for cents on the dollar.
This is generally the most effective method to provide liquidity for an estate.
Loan - Installment Note
Heirs can also borrow funds to pay the debts owed. Also, if the estate assets are pledged or bonded as security, the heirs may not be able to enjoy them.
In addition, for owners of a closely held business, the heirs may be able to pay the estate taxes under an installment plan through IRC section 6166. If the estate qualifies, the tax attributable to the closely held business interest can be paid in 10 equal installments beginning four years after the decedent's death. An additional advantage of the tax deferral is that a portion of the deferred tax pays an interest rate of 2% (first $1,250,000 of business value in 2007).
The requirements include:
- The gross estate must include an interest classified as "closely held," the value of which exceeds 35% of the adjusted gross estate.
- Property must be held in sole proprietorship, partnership or corporation (aggregation is allowed if more than 20% interest is in each business).
- Business must be carried on as of the date of death.
- During the first four years (of 14) can pay interest only on taxes due.
- The interest rate will be 2% on the first $1,250,000 and is not deductible.
- IRC 303 permits heirs to get cash out of a corporation from a portion of the stock of a decedent that will not be taxes as a dividend. A Section 303 partial redemption can provide cash from the corporation without resulting in dividend treatment.
The requirements include:
· The business must be a corporation.
· The value must be more than 35% of the adjusted gross estate.
· Only an amount equal to a total of all estate taxes and administration expenses can be redeemed.
Powers Of Appointment
Financial AdvisorsInheritance is a double-edged sword, as leaving money can create estate tax burdens. Opting for a life insurance plan can help mitigate those burdens.
Retirementby Cathy Pareto, CFP®, AIF® (Contact Author | Biography) The estate tax is a type of "death tax", whereby taxes are imposed on the right to transfer or receive property at the property ...
ProfessionalsEstate Tax Filing Requirements
TaxesInheritance taxes can be tricky. Most people have to deal with them at a very inconvenient time. It's better to learn the laws now so you're ready later.
RetirementFind out why you shouldn't put off putting your affairs in order.
RetirementEstate planning can be unpleasant, but in order to get the full benefit of what you've inherited, it’s important to be prepared for the related taxes.
ProfessionalsIncome Tax Treatment
ProfessionalsAdjusted Gross Estate
A tax levied on an heir's inherited portion of an estate if the ...
The collection of preparation tasks that serve to manage an individual's ...
A tax imposed by state authorities based on the estate tax credit ...
The total dollar value of all property and assets in which an ...
A tax form distributed by the Internal Revenue Service (IRS) ...
A person who is no longer living. Just as a taxpayer's possessions ...
Discover how estates are taxed, why estate distributions are generally tax-free, and circumstances that may require an heir ... Read Answer >>
Estate planning involves making plans for the transfer of your estate after death. Your estate is all the property that you ... Read Answer >>
The costs of estate planning can be significant. Are any of these expenses deductible to the taxpayer or are they merely ... Read Answer >>
Learn how life insurance proceeds are generally not taxable to the beneficiary, but understand the unique situations in which ... Read Answer >>
Many beneficiaries miss out on one of the most significant tax deductions for inherited retirement-plan assets; the income ... Read Answer >>
Decrease the amount of taxable income on your income-producing real estate by depreciating the asset on your federal income ... Read Answer >>