Are you asking yourself: is my inheritance taxable? This is a frequently misunderstood taxation issue, and the answer can be complicated. When someone passes away, all of their assets (their estate) will be subject to estate taxation, and whatever is left after paying the estate tax passes to the decedent’s beneficiaries.

Sound bleak? Don’t worry, very few decedents’ estates ever pay any estate tax, primarily because the tax code exempts a liberal amount of the estate’s value from taxation; thus, only very large estates are subject to estate tax. In fact, with the passage of the Tax Cuts & Jobs Act, the estate tax exemption has been increased to $11,580,000* for 2020 and will be inflation-adjusted in future years. Generally, this means that estates valued at $11,580,000* or less will not pay any federal estate taxes, and those in excess of the exemption amount only pay estate tax on the excess amount. Keep in mind that there are less than 10,000 deaths each year for which the decedent’s estate exceeds the exemption amount, so for most estates, there will be no estate tax and the beneficiaries will generally inherit the entire estate.

*Please Note: As with anything tax-related, the exemption is not always a fixed amount. It must be reduced by prior gifts in excess of the annual gift exemption, and it can be increased for a surviving spouse by the decedent’s unused exemption amount.

What are estate tax guidelines in Illinois?

For decedents that are either residents of Illinois at the time of their passing or nonresidents that have property in Illinois, the estate tax exemption is $4,000,000. So, it is possible that an estate may have a state estate tax, but not a federal estate tax.

Of course, once a beneficiary (also referred to as an heir) receives the inherited asset, any income generated by that property — be it interest from cash, rent from real estate, dividends from stocks, etc. — will be taxable to the beneficiary, just as if the property had always belonged to the beneficiary.

What is the fair market value of the estate?

Because the value of an estate is based upon the fair market value (FMV) of the assets owned by the decedent on the date of their death (or in some cases, an alternative valuation date six months after the decedent’s date of death), the beneficiaries will generally receive the inherited assets with a basis equal to the same FMV determined for the estate. What this means to a beneficiary is that if they sell an inherited asset, they will measure their gain or loss from the inherited basis (i.e. the FMV at date of death).

Example #1: Joe inherits shares of XYZ Corporation from his father. Because XYZ Corporation is a publicly traded stock, the FMV can be determined by what it is trading for on the stock market on the date of his father’s passing. Thus, if the inherited basis was $40 per share and the shares are later sold for $50 a share, Joe will have a taxable gain of $10 per share. In addition, the gain will be a long-term capital gain, since all inherited assets are treated as being held long-term by the beneficiary. On the flip side, if the shares are sold for $35 a share, Joe would have a tax loss of $5 per share.

Example #2: Joe inherits his father’s home. Like other inherited property, Joe’s basis is the FMV of the home on the date of his father’s death. However, unlike the stock, the FMV of which could be determined from the trading value, the home needs to be appraised to determine its FMV. It is highly recommended that a certified appraiser performs the appraisal and that it be done reasonably close in time to the decedent’s date of death. This is frequently overlooked and can cause problems if the IRS challenges the amount used for the basis.

This FMV valuation of inherited assets is frequently referred to as a step up in basis, which is really a misnomer because the FMV can, under some circumstances, also be a step down in basis.

What about assets with deferred untaxed income?

Not all inherited assets received by the beneficiary fall under the FMV regime. If the decedent held assets that included deferred untaxed income, those assets will be treated differently by the beneficiary. Examples of those include inherited: 

Traditional IRA Accounts: These are taxable to the beneficiaries, but special rules generally allow a spouse beneficiary to spread the income over the surviving spouse’s lifetime, while the distribution period is capped at 10 years for most non-spouse beneficiaries if the decedent died after 2019. Previously, the rules allowed most non-spouse beneficiaries of decedents who died prior to 2020 to use a lifetime distribution method.

Roth IRAs: Qualified distributions are not taxable to the beneficiary.

Compensation: Amounts received after the decedent’s death as compensation for their personal services are taxable to the beneficiary.

Pension Payments: These are generally taxable to the beneficiary.

The estate tax rules could change dramatically according to the tax plan of President-Elect Joe Biden. His plan includes provisions eliminating the step up in basis. As soon as we have more information, we will update this blog.

In the meantime, if you have questions related to the tax ramifications of an inheritance, please contact Cray Kaiser at 630-953-4900.

Please note that this blog is based on tax laws effective in December 2020, and may not contain later amendments. Please contact Cray Kaiser for most recent information.

Please note that this blog is based on laws effective in September 2020 and may not contain later amendments. Please contact Cray Kaiser for the most recent information.

Regardless of the type of business you’re running, it’s safe to say that you’ve likely already been impacted by the ongoing COVID-19 pandemic. With no complete end to the situation in sight, many have begun to try to settle into whatever this “new normal” actually is. This, of course, presents its own fair share of challenges. Once you get your doors opened back up again, if they’re not already, you may start to think about other important events down the line: valuations and appraisals, risk assessments, and succession planning.

Thanks in no small part to COVID-19, many private enterprises and family-owned businesses have been forced to dramatically rethink their points of view on these strategies and other important wealth transition and succession planning topics. As a result, below are some things to take into consideration.

Business Valuations in a COVID World

One of the more unfortunate impacts that COVID-19 has had in the last few months involves a decrease in small business values across the board. The fact that both actual and expected revenues and earnings have likely decreased for many organizations, coupled with an increase in interest-bearing debt and liquidity issues in the market at large, all have a lot to do with this issue.

At the same time, it is entirely possible to mitigate risk to that end by keeping a few key things in mind. First and foremost, focus your attention on cash flows, the cost of capital, and growth as much as possible. One of the most critical considerations for a proper business valuation in these times involves figuring out what a recovery from COVID-19 will look like for your organization.

Obviously, certain industries have bounced back faster than others. Likewise, there are certain things that we just cannot know right now – like when a vaccine will be available and what effect that will have on the world. But you can focus on a few key areas – like whether you will experience a full recovery or only a partial recovery, and how long that impact will last – to make better determinations about projected cash flow and other growth-related factors.

On the plus side, all of this represents a unique opportunity for many people to take advantage of low small business valuations to minimize things like estate and gift taxes. Lower business valuations allow business owners like yourself to transfer a greater portion of your business assets and reduce your taxable estate. So, from that perspective, you’ll be able to gift assets against your lifetime exemption that would have previously been considered a taxable event had COVID-19 not occurred at all. 

Mitigating Risk and Protecting Your Legacy

In general, you need to remember that the major goals of wealth transition and succession planning are that you’re attempting to preserve as much of your wealth AND your business as possible. Yes, it’s about making a plan that you can follow over time. But it’s also about being flexible enough to evolve that plan as conditions can (and likely will) change.

This is true for COVID-19’s impact on the supply chain. Even if your small business isn’t being directly impacted right now, the same might not be true of your supply chain partners or even your largest customers. This could have a considerable impact on your own operations, and if your organization is particularly vulnerable to these types of issues, you need to start thinking about ways to mitigate them as soon as you can.

Likewise, you may be one of the lucky few businesses that wasn’t actually negatively impacted by COVID-19 at all. Some industries are absolutely thriving right now – with manufacturers of personal safety gear and even a lot of food and beverage manufacturers being among them. If this describes your situation, it’s likely that you’ve seen a short-term increase in sales and, in all likelihood, profitability. How will this impact the future of your organization? Is this what the “new normal” looks like for you, or will you eventually return to pre-COVID levels? Do you have a way to determine this right now, or is time going to have to tell the story? These are all critical questions that you need to try to answer to make the best possible decisions in terms of succession planning.

In the end, understand that wealth transition and succession planning were always complicated processes, and COVID-19 has not done anyone any favors. No matter what, you need to recognize that this is an inherently specific process. So much is impacted by your own unique circumstances and the facts surrounding your organization. Likewise, your end goals will play an important role in the decisions you make, along with how they may have changed in the last few months.

However, if you’re able to keep these core best practices in mind and look at things through this new pandemic lens, you’ll be able to create the right plan for your objectives with as few potential downsides as possible. If you’d like to discuss wealth transition and succession planning strategies for your business, please contact Cray Kaiser. We’d be happy to help you.

Please note that this blog is based on laws effective in August 2020 and may not contain later amendments. Please contact Cray Kaiser for most recent information.

With jobs at a premium during the COVID-19 pandemic, you might consider hiring your children to help out in your business. Rather than helping to support your children with your after-tax dollars, you can instead hire them and pay them with tax-deductible dollars. Of course, the employment must be legitimate and the pay commensurate with the hours and the job worked.

If this is something you’re considering, we encourage you to read the following situations that are typically encountered when choosing to hire your child:

Hiring Your Children – Under the Age of 19, or a Student Under the Age of 24

A reasonable salary paid to a child reduces the self-employment income and tax of the parents (business owners) by shifting income to the child. When a child under the age of 19 or a student under the age of 24 is claimed as a dependent of the parents, the child is generally subject to the kiddie tax rules, if their investment income is upward of $2,200. Under these rules, the child’s investment income is taxed at the same rate as the parent’s top marginal rate using a lower $1,100 standard deduction.

However, earned income (income from working) is taxed at the child’s marginal rate, and the earned income is reduced by the lesser of the earned income plus $350, or the regular standard deduction for the year, which is $12,400 for 2020. Assuming that a child has no other income, the child could be paid $12,400 and incur no federal income tax. If the child is paid more, the next $9,875 he or she earns is taxed at 10%.

Example: Let’s say you are in the 24% tax bracket and own an unincorporated business. You hire your child (who has no investment income) and pay the child $16,000 for the year. You reduce your income by $16,000, which saves you $3,840 of federal income tax (24% of $16,000), and your child has taxable income of $3,600, $16,000 less $12,400 standard deduction, on which the federal tax is $360 (10% of $3,600).

Hiring Your Children – Under the Age of 18

If the business is unincorporated and the wages are paid to a child under age 18, he or she will not be subject to FICA – Social Security and Hospital Insurance (HI, aka Medicare) – taxes since employment for FICA tax purposes doesn’t include services performed by a child under the age of 18 while employed in an unincorporated business owned by the parent. Thus, the child will not be required to pay the employee’s share of the FICA taxes, and the business won’t have to pay its half of these payroll taxes either. In addition, by paying the child and thus reducing the business’s net income, the parent’s self-employment tax payable on net self-employment income is also reduced.

Example: Continuing the same parameters as above, assume your business profits are $130,000, by paying your child $16,000, you not only reduce your self-employment income for income tax purposes, but you also reduce your self-employment tax (HI portion) by $429 (2.9% of $16,000 times the SE factor of 92.35%). And since your net profits for the year are less than the maximum SE income ($137,700 for 2020) that is subject to Social Security tax, then the savings would include the 12.4% Social Security portion in addition to the 2.9% HI portion. Thus, your total SE tax savings would be $2,261.

A similar but more liberal exemption applies for FUTA, which exempts from federal unemployment tax the earnings paid to a child under age 21 while employed by his or her parent. The FICA and FUTA exemptions also apply if a child is employed by a partnership consisting solely of his parents. However, the exemptions do not apply to businesses that are incorporated or a partnership that includes non-parent partners. Even so, there’s no extra cost to your business if you’re paying a child for work that you would pay someone else to do anyway.

Additional Savings from Retirement Plans

Additional savings are possible if the child is paid more (or works part-time past the summer) and deposits the extra earnings into a traditional IRA. For 2020, the child can make a tax-deductible contribution of up to $6,000 to his or her own IRA. The business also may be able to provide the child with retirement plan benefits, depending on the type of plan it uses and its terms, the child’s age, and the number of hours worked. By combining the standard deduction ($12,400) and the maximum deductible IRA contribution ($6,000) for 2020, a child could earn $18,400 of wages and pay no federal income tax.

Example: Referring back to the original example, the child’s federal tax to be saved by making a $6,000 traditional IRA contribution is only $360 (tax rate of 10% of $6,000 would be $600, but the savings is limited to the actual tax of $360). So, it might be appropriate to make a Roth IRA contribution instead, especially since the child has so many years before retirement and the future tax-free retirement benefits will far outweigh the current $360 savings.

State Considerations

The above only considers federal income tax savings. As every state has its own rules on tax rates and dependency exemptions, it’s important to speak with your tax advisor about potential state implications of the above federal tax planning.

If you have questions about the implications of hiring your children or other possible tax benefits, please contact Cray Kaiser.

Note: Wages paid to children and other relatives aren’t eligible for the Employee Retention Credit created by Congress in 2020 as part of the COVID-19 emergency relief measures for employers.

When was the last time you or your attorney reviewed or made an update to your will or trust? If it was before the passage of the 2017 Tax Cuts and Jobs Act (TCJA), your documents may be out of date.

Among the many changes in that law was a more than doubling of the estate tax exemption. Prior to the TCJA, if the value of an individual’s estate at his or her death was about $5.5 million or more, it was subject to the estate tax. For deaths in 2020, and based on the TCJA inflation-adjusted amounts, just over $11.5 million is exempted from estate tax. So, if your will or trust was premised on the lower value, it may need to be revised so that it provides the appropriate estate tax results for your situation.  

No doubt your will or trust was prepared with not just estate taxes in mind but so that your assets will be distributed after your death according to your wishes. However, certain events besides the tax laws being revised can cause these documents to become outdated.

Life’s ever-changing circumstances make estate planning an ongoing process. If you don’t keep your will or trust up to date, your money and assets could end up in the wrong hands. That’s why a periodic review of your will or trust is an essential part of estate planning.  Here is a partial list of occurrences that could cause your will or trust to be outdated:

• Your marital status has changed.
• Your heirs’ marital status has changed.
• You have relocated to another state.
• You’ve had or adopted children.
• Your children are no longer minors.
• Your children are now mature enough to handle their own financial matters.
• Your assets have significantly changed in value.
• You have sold or acquired a major asset(s).
• Your personal representative (executor, trustee) has changed.
• You wish to delete or add heirs.
• Your health status has changed.
• Estate laws have changed.

Are your named beneficiaries up to date on your life insurance policies, IRA accounts, and pension plans? For example, did you forget to remove your ex-spouse or a deceased relative as your beneficiary?

You should never overlook or put off these issues because once you pass on, it will be too late to make changes. If you have questions about how your changed circumstances may impact your estate taxes or if you’d like to update your will or trust, please contact Cray Kaiser at 630-953-4900.

If you asked entrepreneurs to make a list of everything they think might one day pose a threat to their company, you’d probably hear a variety of answers. Some might be (rightfully) worried about ultimately developing a product in search of a marketplace. Others may be worried about how they’re going to overcome cash flow issues. And some may still be worried about getting “taken for a ride” by the venture capital people they’re putting so much of their faith in. While all of these are understandable concerns, there’s one that’s often missing from the list: cofounder conflict.

While it’s absolutely true that founding a business with at least one other person increases your chances of becoming a success, it’s equally true that about 50% of cofounder relationships fail, and most of those failures aren’t pretty.

That’s because cofounder conflict is very real and far more common than many people assume. But by taking the time to learn as much about it as you can, you put yourself (and your colleagues) in the best position to mitigate risks from these issues as much as possible — before it’s too late.

Why Cofounder Conflict Happens

Cofounder conflict can happen for a myriad of reasons, and not all of them are going to be immediately obvious. Sometimes when you start a business with someone else, you don’t realize just how incompatible your managerial styles are because you’ve never had the chance to put them on display. But once your startup is up on its feet and real decisions are being made on a daily basis, you might discover that you and your cofounder have two very different working styles.

Other times it comes down to the fact that roles and responsibilities among cofounders are not clearly defined. Who is actually supposed to be doing what? What is your specific job description and how does it overlap with that of your cofounders? What boundaries are in place that give each of you your necessary space, but that also allow you to truly collaborate with one another in the way you need to run a successful business?

Another issue, and arguably the biggest issue, could be the absence of stipulations on how significant future changes affect the management and control of the business. Without a buy-sell agreement and succession plan in place, your business is at risk if any major event — like your partner’s death, divorce, or bankruptcy — may occur.

Mitigating Cofounder Conflict with a Buy-Sell Agreement

Remember that being an entrepreneur and founding a business with someone else ultimately requires a fair amount of give and take. Therefore, once you start to see conflict develop, don’t be afraid to address it head-on. But also understand that you must be willing to make compromises, too. Don’t just spend time identifying problems with someone else, rather, offer up solutions of your own.

In terms of mitigating some of these potential risks, a buy-sell agreement can be very effective (and should be viewed as a necessity). This legally-binding document spells out how the assets and business interests would be distributed if an owner leaves the business, becomes disabled or passes away.

Consulting with a tax and accounting professional during the process of negotiating a buy-sell agreement can be very beneficial for all parties involved. The team at Cray Kaiser has facilitated several buy-sell agreements and would welcome the opportunity to help you and your cofounder(s) with yours. Please contact us today at 630-953-4900 to get started.

If you have questions about your company’s buy-sell agreement or would like assistance putting one together, please don’t hesitate to contact Cray Kaiser today.

If you have children (or grandchildren) you have an opportunity to give them a jump-start on their journey to becoming financially responsible adults. While teaching your child about money and finances is easier when you start early, it’s never too late to impart your wisdom. Below are some age-relevant suggestions to help develop a financially savvy young adult:

• Preschool – Start by using bills and coins to teach them what the value of each is worth. Even if you don’t get into the exact values, explain that a quarter is worth more than a dime and a dollar is worth more than a quarter. From there, explain that buying things at the store comes down to a choice based on how much money you have (you can’t buy every toy you see!). You can also get them a piggy bank to start saving coins and small bills.
• Grade school – Consider starting an allowance and developing a simple spending plan. Teach them how to read price tags and do comparison shopping. Open a savings account to replace the piggy bank and teach them about interest and the importance of regular saving. Have them participate in family financial discussions about major purchases, vacations and other simple money decisions.
• Middle school – Start connecting work with earning money. Start simple with babysitting, mowing lawns or walking dogs. Open a checking account and transition the simple spending plan into a budget to save funds to make larger purchases. If you have not already done so, now is a good time to introduce the importance of donating money to church or charity.
• High school – Explain the job application and interview process. Work with them to get a part-time job to start building work experience. Add additional expense responsibility by transferring direct responsibility for things like gas, lunches and expenses for going out with friends. Introduce investing by explaining stocks, mutual funds, CDs and IRAs. Talk about financial mistakes and how to deal with them when they happen – this is typically more impactful by sharing your own experiences. If college is the goal after high school, include them in the financial planning decisions.
• College – Teach them about borrowing money and all its future implications. Explain how credit cards can be a good companion to a budget, but discuss the dangers of mismanagement or not paying the bill in full each month. Talk about the importance of their credit score and how it affects future plans like buying a house. Finally, make sure they’re aware of retirement savings and the importance of building their retirement account.

Knowing about money – how to earn it, use it, invest it and share it – is a valuable life skill. Simply talking with your children about its importance is often not enough. Find simple, age-specific ways to build their financial IQ because a financially savvy child will hopefully lead to a financially wise adult. If you have any questions about raising a financially savvy child, please contact your trusted advisor at Cray Kaiser.

Your business partner(s) should balance your strengths and support you through the good times and the bad. They should also be willing to communicate with you freely and often. And while you and your partner may agree about everything now, disagreements and unexpected events are inevitable. That’s why a written partnership agreement is so valuable. Do you and your partner(s) have one?

The Value of Your Partnership Agreement

The need for a partnership agreement can be summed up in two words: things change. It’s important to sit down now and hammer out potential scenarios and solutions in a written agreement. You never know what the future may hold for you, your partner(s) or your business. Your agreement will make sure that you have a plan ready no matter what may come your way.

What to Include

A partnership agreement should anticipate major business changes and spell out how to deal with them. The agreement should also indicate what initial capital contributions (or services) will be made when additional capital contributions will be required, and how profits and losses will be shared.

Questions to discuss include:

• What are the rights and obligations of the other partner if one partner passes away?
• Under what circumstances can a partner leave, retire or be expelled?
• What are the financial arrangements for departing partners?
• How long must an ex-partner wait before starting a competing business?

A partnership agreement can’t address every possible contingency, so consider an arbitration clause to handle disputes that you and your partner aren’t able to resolve on your own. Without such a clause, your only alternative could be costly litigation.

With a carefully designed partnership agreement, your business will run more smoothly and provide you and your partner(s) with peace of mind. Your attorney can assist you with the legal aspects of the agreement and you can contact Cray Kaiser with questions regarding your finance and tax-related aspects.