Estate Planning and Payroll

¶ … Smiths to Minimize Their Total Tax Liability

Mr. and Mrs. Smith's concerns about their future income and estate tax bills are important because of their need to engage in tax planning, which can be described as organizing personal financial affairs in order to lessen taxes. In light of their concerns and current situation, there are several recommendations or ways with which the Smiths can reduce their future income and estate tax bills. Therefore, your advice to them on tax planning should be based on considerations of these various recommendations in light of their advantages and disadvantages in addressing their concerns.

One of the ways through which the Smith's can minimize their total tax liability is through giving annually, which will help lessen future estate taxes. As of 2015, the federal estate gift and estate tax exemption amount was $5.43 million, which implied that taxable estate exceeding this amount would be subject to estate tax bills at adjusted rates of up to 40% (Massachusetts Financial Services Company, n.d.). Since the value of the Smiths' current estate is valued at $15 million, they would be liable to estate tax rates since the value exceeds the estate tax exemption amount. Therefore, the Smiths can lessen their future income and estate tax bills through giving annually. In this case, the Smiths can give their daughter annual gifts of up to $28,000 given that each donor is allowed to make an annual tax-free gift of $14,000 per recipient. The limit applies to either spouse, which essentially means that a married couple can give a gift of up to $28,000 tax exempt as of 2015. This alternative is associated with some advantages and disadvantages in relation to minimizing the total tax liability. One of the advantages of this option is that it will enable the Smiths to significantly lessen their total tax liability through giving tax exempt gifts to their daughter. Secondly, this strategy would help ensure that the Smiths do not owe any current gift tax. However, the are some cons of this strategy including the likelihood for the Smiths' daughter to owe capital gains tax on a future sale because her tax basis on the home will be their presumably low cost for the state. Secondly, the Smiths will reduce their unified federal gift and estate tax exemption since its lessened dollar for dollar for amounts exceeding $14,000 (Bischoff, 2015).

The second recommendation is for the Smiths to pay some or all of their daughter's gift as a salary during 2015 rather than put her on the payroll of their S-corporation. This is primarily because putting their daughter on the payroll of their S-corporation would imply that they do not receive the advantage of avoiding payroll taxes when making payments to their child (Kohler, 2015). If the Smiths put their daughter on their S-corporation's payroll, they will be subject to withholding including FICA while paying her some or all of her gifts as a salary would exempt them withholding payroll taxes. The first advantage of this recommendation is that it enables them to avoid the withholding problem. Secondly, this strategy would enable their daughter to avoid paying federal income taxes on the first $6,300 of their income in 2015. However, the disadvantages include the fact the implementation of the alternative would require changing the business structure to a family management company rather than the current S-corporation. Secondly, the child would still be subjected to federal income taxes once the amount exceeds $6,300 during that year.

The final recommendation is for the Smiths to utilize an irrevocable trust i.e. a Qualified Personal Residence Trust. This is a suitable measure for them to minimize their total tax liability because it's an IRS-approved gift of their home while still living there. In this regard, Mr. and Mrs. Smith would need to put their estate into an irrevocable trust for several years while still living there. Their right to live in the house will then be determined through complex IRS calculations depending on the duration of the trust, their age, and interest rates. Once the stipulated number of years expire, the Smiths can pay their daughter rent if they decide to continue living there, which will further decrease the size of their taxable estate (Bischoff, 2015). One of the advantages of this strategy is that it will enable the Smiths to lessen the size of their taxable estate and their overall tax liability. Secondly, it will enable them to get residence out of their taxable estate while still living there. The drawbacks include the need to outlive the stipulated number of years in order to enjoy the taxation benefits. Secondly, the strategy is likely to result in the failure of their daughter to receive estate tax benefits if they die before the expiry of the trust's term.

The most suitable option recommendations that Mr. and Mrs. Smith should consider pursuing to reduce their total tax liability is giving annually and paying their daughter some or all of her gifts as a salary during 2015. Through this process, Mr. and Mrs. Smith will lessen their future income and estate tax bills through avoiding gift tax liability and avoiding payroll taxes when making payments to their daughter. Additionally, they will lessen their daughter's financial burden and won't owe the federal government any current gift tax.

Yours faithfully,

Partner, Williams and Nye CPAs

June 29, 2017

Mr. and Mrs. Smith

123 Writing Lane

Writing City, WA 17882

Dear Mr. and Mrs. Smith

Tax planning is an important process towards identifying suitable measures to lessen your overall tax liability. Every individual needs to be proactive in lessening his/her tax liability, which also helps in enhancing retirement planning. The major objective of the process of tax planning is to arrange personal financial affairs to lessen taxes. There are various strategies that an individual can utilize to lessen his/her tax liability including gifting, estate planning, retirement planning, and tax-smart investing.