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An effective estate planning strategy for you is likely the one that will produce the greatest tax savings for your family. Unfortunately, there can be tension between strategies that save estate tax and ones that save income tax. This is especially true now that the Tax Cuts and Jobs Act nearly doubled the gift and estate tax exemption — but only temporarily. Through 2025, income tax might be a greater concern, but, after that, estate taxes might be a bigger issue.

Fortunately, it’s possible to build an “on-off switch” into your estate plan.

Why the Conflict?

Generally, the best way to minimize estate taxes is to remove assets from your estate as early as possible (through outright gifts or gifts in trust) so that all future appreciation in value escapes estate tax. But these lifetime gifts can increase income taxes for the recipients of appreciated assets. That’s because assets you transfer by gift retain your tax basis, potentially resulting in a significant capital gains tax bill should your beneficiaries sell them.

What if the unthinkable happens and your spouse dies unexpectedly? Would you be prepared to cope emotionally and financially? As the surviving spouse, you’ll face some important tasks and challenges.

First Steps First

This is by no means complete, but the following are areas that will need to be addressed:

Death Certificates. One of the first things to do is obtain death certificates, which you’ll need to provide for various dealings with financial institutions and others. While it may be difficult to estimate how many death certificates will ultimately be requested of you, you’ll probably want to start with at least a dozen.

Notifications. You must get the word out to other interested parties, including your spouse’s employer, if applicable; credit card companies; life insurance companies; retirement plan and IRA administrators; the state motor vehicle agency; the state office for inheritance tax, if applicable; and your attorney.

Individuals who have created multiple trusts in their estate plan that are subject to high state income taxes may recognize significant tax savings by moving those trusts to a state with lower (or no) income taxes. Changing the residence of a trust, or “situs,” should not be undertaken without consulting your advisors, including your trust and estate attorney.

What’s the Tax Impact?

Only irrevocable nongrantor trusts are subject to federal and state tax at the trust level. The taxes generally apply to undistributed ordinary income or capital gains, often at higher rates than personal income taxes. Income distributed to beneficiaries is deductible by the trust and taxable to beneficiaries.

Choosing the right executor — sometimes known as a “personal representative” — is critical to the smooth administration of an estate. Yet many people treat this decision as an afterthought. Given an executor’s many responsibilities and complex tasks, it pays to put some thought into the selection.

Job Description

An executor’s duties may include:

• Collecting, protecting and taking inventory of the estate’s assets,
• Filing the estate’s tax returns and paying its taxes,
• Handling creditors’ claims and the estate’s claims against others,
• Making investment decisions,
• Distributing property to beneficiaries, and
• Liquidating assets if necessary.

An annual estate plan checkup is critical to the health of your estate plan. Because various exclusion, exemption, and deduction amounts are adjusted for inflation, they can change from year to year, impacting your plan.

2019 vs. 2018 Amounts

Here are a few key figures for 2018 and 2019:

Lifetime Gift and Estate Tax Exemption

• 2018: $11.18 million
• 2019: $11.40 million

Generation-skipping Transfer Tax Exemption

Powers of attorney are critical components of an effective estate plan. After you’ve executed powers of attorney, it’s important to review them periodically — at least every five years and preferably more frequently — and consider executing new ones.

2 Types

A sound estate plan should include two types of powers of attorney:

1. Financial power of attorney. Also referred to as a power of attorney for property, this document appoints someone to make financial decisions or execute transactions on your behalf under certain circumstances. For example, a power of attorney might authorize your agent to handle your affairs while you’re out of the country or, in the case of a “durable” power of attorney, incapacitated.

If your son or daughter currently is home from college on winter break, now is a good time to sit down and discuss a few estate planning documents he or she should have at this stage of life. Let’s take a closer look at four such documents:

1. Health Care Power of Attorney. With a health care power of attorney (sometimes referred to as a “health care proxy” or “durable medical power of attorney”), your child appoints someone — probably you or his or her other parent — to make health care decisions on his or her behalf should he or she be unable to do so. A health care power of attorney should provide guidance on how to make health care decisions. Although it’s impossible to anticipate every potential scenario, the document can provide guiding principles.

Portability allows a surviving spouse to apply a deceased spouse’s unused estate tax exemption amount toward his or her own transfers during life or at death. To secure these benefits, however, the deceased spouse’s executor must have made a portability election on a timely filed estate tax return. The return is due nine months after death, with a six-month extension option.

Unfortunately, estates that aren’t otherwise required to file a return (because they don’t meet the filing threshold) often miss the deadline. Several years ago, the IRS offered a simplified procedure for obtaining an extension, but it was available only through the end of 2014. After that, the only option was to request a private letter ruling from the IRS, a time-consuming, expensive process with no guarantee of success.

With the federal gift and estate tax exemption at $11.40 million for 2019, people whose estates are below the exemption amount are shifting their focus to income tax planning. High-income taxpayers — particularly those who live in high-income-tax states — may want to consider incomplete nongrantor trusts, which make it possible to eliminate state taxes on trust income.

What is an Incomplete Nongrantor Trust

Generally, trusts are classified as either grantor trusts or nongrantor trusts. In a grantor trust, you, as “grantor,” establish the trust and retain certain powers over it. You’re treated as the trust’s owner for income tax purposes and pay taxes on income generated by the trust assets.

In a nongrantor trust, you relinquish certain controls over the trust so that you aren’t considered the owner for income tax purposes. Instead, the trust becomes a separate legal entity, with income tax responsibility shifting to the trust itself. By setting up the trust in a no-income-tax state (typically by having it administered by a trust company located in that state), it’s possible to avoid state income taxes.

Sometimes estates that are large enough for estate taxes to be a concern are asset rich but cash poor, without the liquidity needed to pay those taxes. An intrafamily loan is one option. While a life insurance policy can be used to cover taxes and other estate expenses, a benefit of using an intrafamily loan is that, if it’s properly structured, the estate can deduct the full amount of interest upfront. Doing so reduces the estate’s size and, thus, its estate tax liability.

Deducting the Interest

An estate can deduct interest if it’s a permitted expense under local probate law, actually and necessarily incurred in the administration of the estate, ascertainable with reasonable certainty, and will be paid. Under probate law in most jurisdictions, interest is a permitted expense. And, generally, interest on a loan used to avoid a forced sale or liquidation is considered “actually and necessarily incurred.”