Typically, an estate plan includes accommodations for your spouse, children, grandchildren and even future generations. But you may overlook some older family members, such as your parents or in-laws. They may also need your financial assistance and help with their estate planning.
How can you best handle the financial affairs of parents in the later stages of life? Incorporate their needs into your own estate plan while tweaking, when necessary, the arrangements they’ve already made. Here are five critical steps:
Identify key contacts. Just like you’ve done for yourself, compile the names and addresses of professionals important to your parents’ finances and medical conditions.
List and value their assets. If you’re going to be able to manage the financial affairs of your parents, having knowledge of their assets is vital. It would be wise to keep a list of their investment holdings; IRA and retirement plan accounts; and life insurance policies, including current balances and account numbers.
Open the lines of communication. Before going any further, have a frank and honest discussion with your elderly relatives, as well as other family members who may be involved, such as your siblings. Make sure you understand your parents’ wishes and explain the objectives you hope to accomplish.
Execute documents. Assuming you can agree on how to move forward, develop a plan incorporating several legal documents. If your parents have already created one or more of these documents, they may need to be revised or coordinated with new ones. Some elements commonly included in an estate plan are:
- Wills. Your parents’ wills control the disposition of their assets, such as cars and jewelry, and tie up other loose ends. (Of course, jointly owned property with rights of survivorship automatically passes to the survivor.) Notably, a will also establishes the executor of your parents’ estates. If you’re the one lending financial assistance, you may be the optimal choice.
- Living trusts. A living trust can supplement a will by providing for the disposition of selected assets. Unlike a will, a living trust doesn’t have to go through probate, so this might save time and money, while avoiding public disclosure.
- Powers of attorney. This document authorizes someone to legally act on behalf of another person. With a durable power of attorney, the most common version, the authorization continues after the person is disabled. This enables you to better handle your parents’ affairs.
- Living wills or advance medical directives. These documents provide guidance for end-of-life decisions. Make sure that your parents’ physicians have copies so they can act according to their wishes.
- Beneficiary designations. Undoubtedly, your parents have filled out beneficiary designations for retirement plans, IRAs and life insurance policies. These designations supersede references in a will, so it’s important to keep them up-to-date.
Estate planning for elderly parents, which is complex in its own right, is often intertwined with your own finances. Contact us for help developing a comprehensive plan that addresses all of your family’s needs.
If you invest in mutual funds, be aware of some potential pitfalls involved in buying and selling shares.
You may already have made taxable “sales” of part of your mutual fund investment without knowing it.
One way this can happen is if your mutual fund allows you to write checks against your fund investment. Every time you write a check against your mutual fund account, you’ve made a partial sale of your interest in the fund. Thus, except for funds such as money market funds, for which share value remains constant, you may have taxable gain (or a deductible loss) when you write a check. And each such sale is a separate transaction that must be reported on your tax return.
Here’s another way you may unexpectedly make a taxable sale. If your mutual fund sponsor allows you to make changes in the way your money is invested — for instance, lets you switch from one fund to another fund — making that switch is treated as a taxable sale of your shares in the first fund.
Carefully save all the statements that the fund sends you — not only official tax statements, such as Forms 1099-DIV, but the confirmations the fund sends you when you buy or sell shares or when dividends are reinvested in new shares. Unless you keep these records, it may be difficult to prove how much you paid for the shares, and thus, you won’t be able to establish the amount of gain that’s subject to tax (or the amount of loss you can deduct) when you sell.
You also need to keep these records to prove how long you’ve held your shares if you want to take advantage of favorable long-term capital gain tax rates. (If you get a year-end statement that lists all your transactions for the year, you can just keep that and discard quarterly or other interim statements. But save anything that specifically says it contains tax information.)
Recordkeeping is simplified by rules that require funds to report the customer’s basis in shares sold and whether any gain or loss is short-term or long-term. This is mandatory for mutual fund shares acquired after 2011, and some funds will provide this to shareholders for shares they acquired earlier, if the fund has the information.
Timing purchases and sales
If you’re planning to invest in a mutual fund, there are some important tax consequences to take into account in timing the investment. For instance, an investment shortly before payment of a dividend is something you should generally try to avoid. Your receipt of the dividend (even if reinvested in additional shares) will be treated as income and increase your tax liability. If you’re planning a sale of any of your mutual fund shares near year-end, you should weigh the tax and the non-tax consequences in the current year versus a sale in the next year.
Identify shares you sell
If you sell fewer than all of the shares that you hold in the same mutual fund, there are complicated rules for identifying which shares you’ve sold. The proper application of these rules can reduce the amount of your taxable gain or qualify the gain for favorable long-term capital gain treatment.
Contact us if you’d like to find out more about tax planning for buying and selling mutual fund shares.
You may view your will as the centerpiece of your estate plan. But other documents can complement it. For example, if you haven’t already done so, consider writing a letter of instruction.
Elements of the letter
A letter of instruction is an informal document providing your loved ones with vital information about personal and financial matters to be addressed after your death. Bear in mind that the letter, unlike a valid will, isn’t legally binding. But its informal nature allows you to easily revise it whenever you see fit.
What should be included in the letter? It will vary, depending on your personal circumstances, but here are some common elements:
Documents and financial assets. Start by stating the location of your will. Then list the location of other important documents, such as powers of attorney, trusts, living wills and health care directives. Also, provide information on birth certificates, Social Security benefits, marriage licenses and, if any, divorce documents.
Next, create an inventory of all your assets, their location, account numbers and relevant contact information. This may include, but isn’t necessarily limited to, items such as bank accounts; investment accounts; retirement plans and IRAs; health insurance plans; business insurance; life and disability income insurance; and records of Social Security and veterans’ benefits.
And don’t forget about liabilities as well. Provide information on mortgages, debts and other obligations your family should be aware of.
Funeral and burial arrangements. A letter of instruction typically includes details regarding your funeral and burial arrangements. If you prefer to be cremated rather than buried, make that clear. In addition, details can include whom you’d like to preside over the service, the setting and even music selections.
List the people you want to be notified when you pass away and include their contact information. Finally, write down your wishes for specific charities where loved ones and others can make donations in your memory.
Digital information. As many of your accounts likely have been transitioned to digital formats, including bank accounts, securities and retirement plans, it’s important that you recognize this change in your letter of instruction or update a previously written letter.
Personal items. It’s not unusual for family members to quarrel over personal effects that you don’t specifically designate in your will. Your letter can spell out who will receive items that may have little or no monetary value, but plenty of sentimental value.
A letter of instruction can offer peace of mind to your family members during a time of emotional turmoil. It can be difficult to think about writing such a letter — no one likes to contemplate his or her own death. But once you get started, you may find that most of the letter “writes itself.”
October 15 is the deadline for individual taxpayers who extended their 2019 tax returns. (The original April 15 filing deadline was extended this year to July 15 due to the COVID-19 pandemic.) If you’re finally done filing last year’s return, you might wonder: Which tax records can you toss once you’re done? Now is a good time to go through old tax records and see what you can discard.
The general rules
At minimum, you should keep tax records for as long as the IRS has the ability to audit your tax return or assess additional taxes, which generally is three years after you file your return. This means you potentially can get rid of most records related to tax returns for 2016 and earlier years.
However, the statute of limitations extends to six years for taxpayers who understate their adjusted gross income (AGI) by more than 25%. What constitutes an understatement may go beyond simply not reporting items of income. So a general rule of thumb is to save tax records for six years from filing, just to be safe.
Keep some records longer
You need to hang on to some tax-related records beyond the statute of limitations. For example:
- Keep the tax returns themselves indefinitely, so you can prove to the IRS that you actually filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or if you filed a fraudulent one.)
- Retain W-2 forms until you begin receiving Social Security benefits. Questions might arise regarding your work record or earnings for a particular year, and your W-2 helps provide the documentation needed.
- Keep records related to real estate or investments for as long as you own the assets, plus at least three years after you sell them and report the sales on your tax return (or six years if you want extra protection).
- Keep records associated with retirement accounts until you’ve depleted the accounts and reported the last withdrawal on your tax return, plus three (or six) years.
Other reasons to retain records
Keep in mind that these are the federal tax record retention guidelines. Your state and local tax record requirements may differ. In addition, lenders, co-op boards and other private parties may require you to produce copies of your tax returns as a condition to lending money, approving a purchase or otherwise doing business with you.
Contact us if you have questions or concerns about recordkeeping.
IRS audit rates are historically low, according to the latest data, but that’s little consolation if your return is among those selected to be examined. But with proper preparation and planning, you should fare well.
In fiscal year 2019, the IRS audited approximately 0.4% of individuals. Businesses, large corporations and high-income individuals are more likely to be audited but, overall, all types of audits are being conducted less frequently than they were a decade ago.
There’s no 100% guarantee that you won’t be picked for an audit, because some tax returns are chosen randomly. However, the best way to survive an IRS audit is to prepare for one in advance. On an ongoing basis you should systematically maintain documentation — invoices, bills, cancelled checks, receipts, or other proof — for all items to be reported on your tax returns. Keep all your records in one place. And it helps to know what might catch the attention of the IRS.
Audit hot spots
Certain types of tax-return entries are known to the IRS to involve inaccuracies so they may lead to an audit. Here are a few examples:
- Significant inconsistencies between tax returns filed in the past and your most current tax return,
- Gross profit margin or expenses markedly different from those of other businesses in your industry, and
- Miscalculated or unusually high deductions.
Certain types of deductions may be questioned by the IRS because there are strict recordkeeping requirements for them — for example, auto and travel expense deductions. In addition, an owner-employee salary that’s inordinately higher or lower than those in similar companies in his or her location can catch the IRS’s eye, especially if the business is structured as a corporation.
Responding to a letter
If you’re selected for an audit, you’ll be notified by letter. Generally, the IRS doesn’t make initial contact by phone. But if there’s no response to the letter, the agency may follow up with a call.
Many audits simply request that you mail in documentation to support certain deductions you’ve taken. Others may ask you to take receipts and other documents to a local IRS office. Only the harshest version, the field audit, requires meeting with one or more IRS auditors. (Note: Ignore unsolicited email messages about an audit. The IRS doesn’t contact people in this manner. These are scams.)
Keep in mind that the tax agency won’t demand an immediate response to a mailed notice. You’ll be informed of the discrepancies in question and given time to prepare. You’ll need to collect and organize all relevant income and expense records. If any records are missing, you’ll have to reconstruct the information as accurately as possible based on other documentation.
If the IRS chooses you for an audit, our firm can help you:
- Understand what the IRS is disputing (it’s not always clear),
- Gather the specific documents and information needed, and
- Respond to the auditor’s inquiries in the most expedient and effective manner.
The IRS normally has three years within which to conduct an audit, and often an audit doesn’t begin until a year or more after you file a return. Don’t panic if you’re contacted by the IRS. Many audits are routine. By taking a meticulous, proactive approach to how you track, document and file your company’s tax-related information, you’ll make an audit much less painful and even decrease the chances that one will happen in the first place.