Level 5 Financial Blog
Investors must be aware of the income tax implications of their trading activities. Most know that selling a financial security is a taxable event* and that doing so will usually create a realized capital gain (or loss). Brokers have long advised their clients to “harvest” capital losses as year end approaches since such a realized loss can be used to offset realized capital gains that may have been taken earlier in the tax year. The Internal Revenue Code even allows net realized capital losses (limited to $3,000 annually) to be used to offset ordinary income reported elsewhere on a client’s tax return. This loss harvesting strategy has been practiced for years and is well established in the investment/income tax toolbox. However, far fewer investors are cognizant that harvesting long term capital gains on investments (as opposed to losses) may also be a wise strategy for certain taxpayers.
Several recent posts have explained the functions of various estate planning tools that are known by their acronyms, such as QTIP and ILIT. This last posting in our series will cover the term ”springing”. A springing power is given to an attorney-in-fact or a trustee when a certain specific event occurs. Springing powers are most commonly found in the estate planning documents that are drawn up to prepare for possible incapacity or mental incompetence. Good examples are durable powers of attorney for financial affairs and/or medical affairs. These instruments appoint someone to handle the financial or medical affairs of another individual. However, the attorney-in-fact who is named in these documents does not receive the power immediately. Rather, the authority and power to make the financial or medical decision “springs” into being when the principal (who executed the document) is declared incompetent or unable to make such decisions for themselves.
The estate planning process has a great deal of complexity and legal jargon. Likewise, there are many acronyms and abbreviations. Our most recent posting discussed the ILIT which is an irrevocable life insurance trust. This estate planning tool comes into play when large amounts of cash are anticipated to be needed at death to pay an estate tax bill. Today, we will cover the acronym “QTIP” which stands for “Qualified Terminable Interest Property”. The QTIP is a special exception to normal IRS regulations regarding the need for a gift or bequeathal between spouses to be complete and unencumbered. The QTIP strategy is usually employed in the case of a blended family.
The estate planning process has a great deal of complexity and legal jargon. Likewise, there are many acronyms and abbreviations. One of the acronyms we would like to cover is the ILIT. ILIT stands for “irrevocable life insurance trust” and it can be a very useful tool for dealing with estate taxes. Let’s suppose an individual has founded a successful business which he/she would like to pass on to the children. Like many entrepreneurs, the patriarch/matriarch of this family business has reinvested nearly all of their extra cash into the business and its value has grown to millions of dollars. Even with the currently high estate tax exemption amounts ($11.7 million per person, indexed for inflation), it is easy to see how a very successful family business or farm could easily reach a value exceeding these thresholds. If the founder/owner of this business suddenly passed away, transferring its value to the next generation could be problematic because estate taxes are typically due nine months after the date of death. Where would the next generation come up with the cash to pay the estate transfer taxes that would become due? Since most excess cash has been redeployed back into the business for years, how could they quickly extract the funds needed to satisfy the bill to the IRS? Will they be forced to sell a portion or all of the business at a “fire sale” price in order to come up with the cash needed?