By Jessica Hidalgo, CPA
Tax Manager, Blue & Co., LLC

A new year is upon us and as you plan out your goals for 2021, don’t forget about estate planning. A well-drafted estate plan is essential to ensure your assets are transferred according to your wishes. Whether you need to review an existing plan or start from scratch, this should be a priority in 2021.

Without a plan there could be unintended consequences that negatively affect your family and your business partners. In this article you can learn the basic elements of an estate plan, what documents you need, and other suggestions and considerations for building the estate plan that fits your needs.

Drafting Your Will

This is the overarching estate document and all other documents should align with your will. The basic function of the will is to make your last wishes known and dictate who you want to inherit your assets. If you have minor children, the will is where you should appoint a guardian.

Without a will your assets could pass in accordance with state law (absent title or named beneficiary designations), which may have unintended consequences with assets not going where you intended. After you draft your will you should consider whether you need to set up a trust.

Setting up Your Trusts

A revocable trust can be a great tool in avoiding probate. Probate is the legal process of administering a person’s estate. It can be expensive, lengthy, and is public knowledge so many people set up their estate plans to avoid probate. Assets titled in a revocable trust at death escape the probate process.

What You Need to Know About Trusts

A revocable trust is a trust that can be amended or revoked at any time during your life. The ability to make changes during your life makes this entity flexible. It becomes irrevocable at the time of your incapacity or at death. If you setup a revocable trust, the income is taxed to you during your lifetime, the same as if you owned the assets outright.

When the trust becomes irrevocable, a separate taxable entity is created, and the assets are dispersed per the terms of the trust. If you establish a trust but do not title the intended assets to the trust, the trust may not serve its purpose so transferring title to the trust is a very crucial step in making this work.

When creating the terms of your will or revocable trust, it is important to consider the timing of when the assets will be inherited. If you have minor or young adult children you may want to limit the amount of assets available to them for a period of time with large distributions at a designated time in the future, or in quantities over time.

Estate Planning and Business Ownership

As for individuals who have ownership in a medical or dental practice, much of the estate planning process should focus on what would happen to your ownership in the event of an unexpected death. In a perfect world you would retire or sell your practice prior to passing.

As we know the world is not perfect and there is a chance you could pass before that happens. You need to work with your partners, advisors, and possibly family members to come up with a plan for what should happen in that case.

Should your heirs sell the practice and divide the proceeds? Do you have a child that is in the family business that it should be passed on to? If you are not a solo practitioner, will the other owners buy your interest? These are all questions to be considered in determining the outcome you desire.

One tool that can be used for when there are multiple owners is a buy-sell agreement which if needed can be funded by life insurance. Whether you are setup as a partnership, LLC, C-corporation, or S-corporation, you can use a buy-sell agreement.

Working with an attorney you can structure this agreement so that in the event of a death the corporation, shareholders, or other partners would be required to buy back your ownership using a pre-determined method to set the value.

Life insurance can be a tool to fund this purchase. Other partners or shareholders can take out policies on each other, or the business itself can take out a policy on each of the owners.

Titling Your Assets and Other Important Documents

When developing your estate plan, you should review how your assets are titled. In determining who gets what assets when someone dies, title supersedes all other documents.

There are various ways assets can be titled; outright, joint tenancy, in trust, transferable or payable upon death, and so forth. It is important to understand how each asset is titled and if that asset will pass directly to someone by rights of title or if your will dictates who will receive that asset.

The best estate plans can go awry if assets are not titled correctly.

Accounts such as retirement accounts, transfer or payable on death accounts, and others that have a designated beneficiary need to be reviewed for accuracy and to make sure it aligns with your overall plan.

Retirement accounts may be a large part of your estate and if these are other than Roth accounts will always be subject to ordinary income tax rates at some point. Special attention should be given to the planning related to your retirement accounts.

Some other important estate documents to consider when developing an estate plan are general power of attorney, health care power of attorney, health care directive, and funeral plans. While we will not go into detail on these documents in this article, we do recommend you consult your attorney and advisors to get these in place.

Estate Tax vs. Income Tax

To setup a good estate plan you need to consider the two types of taxes that may occur at death, the estate tax and income tax. The estate tax is the tax on the fair market value of all your assets owned at death net of expenses and liabilities that pass to someone other than your spouse. This is a tax on your net worth. The 2021 exemption $11.7M per individual and $23.4M for married couples.

It is also very important to note that while the revocable trust discussed in detail above escapes probate it does not escape estate tax. This is because you retain an ownership in the asset. To move assets out of your estate you must relinquish control and can no longer reap the benefits of the asset. If your estate is large enough, you may want to establish an irrevocable trust.

Unlike, revocable trusts irrevocable trusts cannot be modified. Irrevocable trusts are often used for life insurance. You can gift life insurance policies or cash for the premiums to an irrevocable trust, which in turn moves the asset out of your estate.

Life insurance can be used to pay estate taxes and other estate administration fees at death. Life insurance can be especially beneficial if most of your other estate assets are illiquid. Planning should be done to ensure there are no immediate gift tax consequences to changing ownership of life insurance.

With the estate tax exemption so high, it is much more common for an estate to be subject to income tax filing requirements than estate tax requirements. Estates and trusts are taxed similarly to individuals, with some additional allowances for expenses. Estate and trust rates are higher than individual rates, but generally if distributions are made from an estate or trust the income is taxed to the beneficiary and not the estate or trust.

If your estate or trust has many income producing assets it is important to plan properly for minimizing your estate or trust income tax. Some methods for tax planning are matching income and expenses in the same tax year and distributing assets to beneficiaries if they have lower overall tax brackets.

Why Estate Planning is an Important Part in Your Overall Financial Plan

Setting up and reviewing an estate plan is an important part of your overall financial plan. Without a well-developed plan there could be hardship for your heirs and business partners. You should meet with your advisors, attorneys, and CPAs to work on a comprehensive and cohesive estate plan.

Once you have a plan in place you should review it no less than every five years and update it if necessary, for law changes or changes in your own personal situation.

To learn more about how Blue & Co., LLC can help you get started with estate planning or to review your current plan, contact your local Blue & Co. advisor.

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