With April 15 fast-approaching, we’re focusing on recent IRS rulings and clarifications that affect estate planning and high-income individuals. Here is a roundup of some of the most important:
***The 3.8% investment surtax on rental income. Since tax year 2013, high-income earners face an additional 3.8% tax on all types of investment income: interest and dividends, capital gains, rental income, royalty income, and passive business income. The 3.8% tax kicks in for couples filing jointly with $250,000 in adjustable gross income per year ($200,000 for singles).
For those with large holdings in rental real estate, the 3.8% surtax can be substantial. However, if the income is generated by properties that the owner spends time managing, then the rental income may avoid the 3.8% surtax. To prove active management, you have to document hours worked managing the property and the tasks involved – basically, the type of work an owner of a business would do.
***The terms for selling assets to family members. One fairly common estate planning strategy is to sell a house or any other type of asset to a family member, who would then pay you back over a period of time based on the terms outlined in the sales agreement, and at an interest rate that reflects the market rate.
Here, the IRS is on the lookout for “self-cancelling” sales agreements. That’s when the seller inserts a clause that says all payments are cancelled upon his/her death, so the buyer ends up owning the asset outright at that time. The IRS will look to see if the interest rate charged is high enough to compensate for the cancellation feature.
***The discounting of units in family owned LLCs or LPs. It’s not uncommon for family businesses or other property to be owned by Limited Liability Companies (LLCs) and Limited Partnership (LPs) in which each member of the family owns a certain number of units. Upon the death of a unitholder, his units are “discounted” — priced at less than their estimated market value — because the units cannot easily be bought or sold. The size of these discounts continues to draw scrutiny from the IRS.
***The time period for Grantor Retained Annuity Trusts (aka GRATs). These types of trusts are set up as annuities – the donor transfers assets to the trust and then receives an annual payment for a fixed period of time, which up until now, has been as short as a couple of years. At the end of the term, any remaining value in the trusts – beyond the federally mandated level – goes to the beneficiaries free of gift taxes. It’s very important that GRATs and similar trusts be administered properly; if not, they can be nullified by the IRS.