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Taxing Emotions: Death, Section 754 Elections and Serving the Client

Estate Planning 2Confronting the cold monetary and business realities of an estate is extraordinarily difficult in the midst of mourning. Even a well-planned estate’s complexity could mean the process drags on for months or even years, drawing out not only raw emotion but also tax exposure. Careful planning and a detailed explanation of your clients’ wishes are a must if you want to save their loved ones additional suffering.

My mother’s estate was moderate in terms of her personal holdings, but she also participated in substantial limited partnerships that passed to my brothers and me upon her death. While her home and personal effects were relatively simple to liquidate, the partnerships were a different matter.

There was no provision for a buyout of my mother’s interest upon her death. We found ourselves in business with people who didn’t know us, and had conflicting ideas about the future of the entity itself. Like so many partnerships, ours rarely had K-1s prepared in time to allow us to file our individual returns in advance of April 15th. We faced an indeterminate future of filing expensive extensions, estimating our individual tax liabilities and possibly increasing our exposure to an audit.

After consulting with a CPA, we decided to make a section 754 election to step up our basis in the partnership assets. This allowed us to reduce current income allocated to us and reduce taxable gain on the disposition of the partnership’s assets. A few years after my mother’s death, the partners sold one of the properties. Our gain was greatly limited as a result of the election, saving us an enormous amount in taxes.

While legacy partnerships are not the norm, it’s worth asking your clients who take part in them whether they have left guidance for their beneficiaries with regard to their inherited interests. In our case, not only were my brothers and I legacy partners, but our mother had been as well. We found ourselves two generations removed from the original partner, and not entirely sure of the next step. Our CPA was key to ensuring we minimized our tax liabilities. It’s important that you address the transfer and tax consequences of clients’ partnership interests in their estate plans.

Helping a family sort out the benefits from an estate can create a litany of emotional complications for the executor, and difficulties for the legal counsel and CPA. All three might have to weather multiple calls, emails and unwelcome family drama that can make the loss of a loved one even more acutely painful for all. Here are some simple steps to reduce the confusion and increase the efficiency of executing a will or trust:

  1. When possible, involve the beneficiaries in the planning process while your client is living. Be sure all parties understand their roles and benefits, and any questions are answered up front. This will serve to expedite liquidation of the estate by reducing lengthy inquiries.
  2. Have your client include instructions or suggestions for their beneficiaries about how to treat their bequeathal. This could be as simple as referring them to the family’s CPA for guidance. Remind clients that their will and any related trust documents are binding, and other instructions provided to the beneficiaries as to the property to be distributed to them can be overruled by legal authorities. Additionally, it might be helpful to have the beneficiaries meet with you and the other advisers to the estate in order to establish a relationship ahead of your client’s passing. This can help to ease implementation greatly.
  3. If your client is contemplating a distribution decision that could cause family/beneficiary controversy, consider having them explain their choices in their legal documentation if they are not comfortable doing so in person. If you identify choices that could expose beneficiaries to substantial taxes, make sure the client understands these outcomes. Assist in identifying alternate strategies that would achieve the desired goal but also eliminate such liabilities.
  4. If someone who might expect to be a beneficiary in a will is not included, encourage your client to reveal this prior to their passing. Challenges to a will or trust can greatly delay execution and distribution of the estate’s assets and incur unnecessary legal and administrative expenses.
  5. As time passes, changes in tax law and family structure can prompt a need for updates. Be sure to check with clients regularly to make provisions for marriages, divorces, new children, deaths elsewhere in the family, or a move to a new state.

Estates vary greatly in size and complexity, and beneficiaries often do not understand the tax consequences of inherited assets. Many beneficiaries assume that because the estate’s value is below that of the unified credit, they will owe no taxes at all. The more education you can offer your clients, the better they will be prepared, allowing their loved ones more time to process their loss without worrying about the more impersonal aspects of what will be one of the most trying periods of their lives.

Adam Junkroski, Lead Manager-Tax Communications, American Institute of CPAs. 

Estate planning courtesy of Shutterstock. 

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