What Are Estate Planning Fees?
Estate planning fees generally encompass a range of services that include the preparation of wills, the establishment of trusts, consultation fees, and sometimes the ongoing management of those trusts. Other fees may also be charged, depending on the requirements of a client, additional estate planning fees may include advance health care directives, durable powers of attorney, other essential documents that provide clarity in the event of death or incapacity.
A core component of the estate planning process is the preparation of one or more documents that cover what happens to a person’s estate when they pass away. Most often this is a will that contains instructions on how the assets of the decedent will be distributed after their passing, and who will be responsible for administration and management of the estate. Alternatively , some people establish living trusts during their lifetimes for purposes of managing their assets, facilitation the passing of assets to their beneficiaries without the need of probate proceedings upon their death. There are a wide variety of types of trusts that can be established for these purposes, and the costs associated with creating and managing those trusts will vary.
Other fees that may be charged by estate planning lawyers include, for example, the preparation of trust transfer deeds that facilitate the transfer of real estate into trust, review of estate planning documents prepared by others, assess to other assets and estate, and accounting work for those who have passed away. All of these fees are charged pursuant to the rules and regulations that govern fee-shifting in California under the B & P Code.
Estate Planning Fees As a Tax Deduction
The IRS allows various types of expenses to be categorized as deductible, but they all must be broken into categories that tell you what sort of deduction it is. Deductible expenses are divided into these categories: If you’re filing a normal 1040 (you’re not subject to the Alternative Minimum Tax), estate planning fees generally become a miscellaneous itemized deduction, which is not deductible because it’s subject to a 2% floor. To deduct expenses as miscellaneous itemized deductions the total amount spent on the expenses must exceed 2% of your Adjusted Gross Income (AGI) and you can then deduct only the excess amount. The deduction is limited to the total of your expenses up to the amount of your AGI. For example, you have an AGI of $75,000 and total miscellaneous deductions of $3,000. Your only miscellaneous deduction is an estate planning fee of $1,500. You may only deduct $600 ($75,000 x .02 = $1,500). If you have total miscellaneous deductions of $10,000 you are only able to deduct $1,500. Various expenses are categorized as miscellaneous itemized deductions, such as unreimbursed employee business expenses, investment expenses, tax preparation fees, etc. Miscellaneous itemized deductions are not subject to a floor for taxpayers subject to the Alternative Minimum Tax (AMT). But California adds an additional type of itemized deduction and an entire Schedule CA (540) which breaks down the California itemized deductions. The California itemized deductions are categorized in the same manner as the IRS regulations. So if you’re a California resident and you have total miscellaneous itemized deductions that exceed 2% of your AGI, the miscellaneous itemized deductions are further broken down on Schedule CA (540) and each is separately examined to determine whether it is allowed as a California deduction or not. Estate planning fees do not appear as separate deductions, but rather are listed as type "i" – Other: Miscellaneous. California slightly differs from the IRS regulations in that it doesn’t allow interest expenses related to estate planning (as is allowed on the IRS form for estate planning) nor does it allow for expenses that secure collection of tax refunds (again allowed by the IRS). The following are itemized deductions that must be added back to the Federal AGI in determining California taxable income and thus are not allowed for California state income tax purposes: For those taxpayers subject to the AMT, unspecified miscellaneous itemized deductions are only allowed and included in the alternative minimum taxable income. In drafting an estate plan, it’s important to warn clients of the effect of the AMT and how their estate plan may affect their AMT, lifetime cumulative earnings and how their estate plans will affect the income tax basis of their beneficiaries.
Recent Tax Law Changes
In federal income tax law, beginning with the new tax laws from late 2017, there no longer is an allowance to deduct "miscellaneous itemized deductions." As a result, taxpayers cannot deduct ordinary and necessary expenses for carrying on a trade or business – under Internal Revenue Code section 162, as miscellaneous itemized deductions subject to 2 percent of adjusted gross income for 2018, 2019 and 2020. For California state income tax laws, the state conforms to the Federal change, and no miscellaneous itemized deduction is allowed under California tax law. But California law continues to allow the deductibility of legal fees if they would be deductible under Federal law. (See pre-2017 Tax Cuts & Jobs Act provisions of Internal Revenue Code section 67). However, under California Income Tax Regulation 17954.5, legal fees are considered nondeductible personal, living or family expenses, and thus non-deductible under California state income tax laws. This, of course, means that a fee paid for estate planning or will drafting would not be deductible. In summary, estate planning fees are no longer deductible under Federal or California laws.
Maximizing Your Tax Benefits
When exploring the tax landscape of estate planning, breaking deductible estate planning expenses into categories can optimize the efficiency of saving on estate taxes. In California, expenses are only deductible for Federal income tax purposes.
Deductible estate planning expenses fall into three categories: costs related to the procurement of a beneficial tax result, costs related to the creation of the estate plan itself, and administration expenses.
Costs relating to procurement of a beneficial tax result
Included in this category are expenses for obtaining a tax ruling from the IRS, accounting fees for preparing estate tax returns, fiduciary fees for allocating taxes from estate property, tax-related legal fees, and appraisal fees for appraisals specifically required by the IRS.
Costs relating to creation of the estate plan
Included in this category, are expenses for creating and implementing a trust, creating durable powers of attorney, serving subscriptions and notices to heirs and legatees, and other general administrative costs.
Administration expenses
Included in this category are costs incurred by the executor and administrator, trustee commissions, and miscellaneous costs incurred by the executor or administrator. Commissions are generally limited to the lesser of 1 percent of the gross estate, or 2 percent of the net estate, plus compensation for the administration of the estate .
Trusts are often used as a technique to optimize for taxation and for good reasons. Tax Deferral, Tax Exemption and Basis Adjustment are all beneficial attributes of utilizing trusts successfully.
Tax Deferral
Assets placed in certain types of trusts can grow on a tax deferred basis. Taxes may not even be paid on the trust assets until a distribution is made to a beneficiary of the trust. Since the taxes attach to the taxpayer that receives the distributions (whether it be the beneficiary or the trust), assets can be retained in the trust with a higher after-tax return.
Tax Exemption
Certain investments can be held by a trust and the tax associated with those investments completely avoided. Unlike the capital gain exclusion available for homes sold by an individual taxpayer, assets sold by certain types of trusts (like a Grantor Trust) do not incur capital gains taxes if the appreciation of the asset occurred before the transfer to the trust. This is a very powerful estate planning tool because it allows the appreciated asset to be removed from the great-grandparents estate without a return of the basis and without incurring gift taxes.
Basis Adjustment
Assets held in certain types of trusts receive a step up in basis at the death of the creator of the trust. This results in no capital gains taxes due on the sale of the asset.
Working with a Professional
To determine whether or not estate planning fees are tax deductible in California, you must consult with a tax professional. Tax professionals are specifically trained to provide practical and thorough guidance to help determine whether certain expenses qualify for certain deductions based on their particulars. Estate planning may be a simple process for some, or extremely complex for others. A common denominator, however, is that the advisor issuing the legal advice and the person receiving the advice must have some commercial type of relationship because that is the only way to prove a "proximity" to the relationship needed to grant attorney-client privilege to that transaction. While a tax professional may not be the final answer to all estate planning problems, discussing your unique financial situation and your estate plan with a qualified professional can help you better understand the particulars of your situation. The information provided by a tax professional can help you make practical decisions in regards to your estate plan that qualify for the most tax benefits possible. A tax professional will also be able to provide guidance on California specific exceptions and code sections, and what additional information can be gathered to help determine the correct answers to your questions.
Issues Relating to Deductibility
Of course, there are common misconceptions floating around regarding the deductibility of estate planning fees. The most prominent is that estate planning, and the costs involved with that planning, are tax deductible as a medical expense on federal tax returns. This is not true. Even in those rare cases where medical costs exceed 7.5% of one’s adjusted gross income the IRS does not permit a deduction for those costs. Medical costs are limited to those that are prescribed by a physician, and are closely related to an actual medical condition.
Another common misperception that frequently comes up is a taxpayer’s understanding that fees for preparing wills and certain tax related documents can be deducted on federal income tax returns. Again , this is not true. Expenses incurred for the management of a taxpayer’s property, such as management fees and legal fees, are not deductible. These same management fees are also not Capitalized. When planning for the estate in a manner that allows for minimizing taxation, such as creating a Family Trust, the cost of the cost of the Trust does not qualify as a legal fee for purposes of preparing a tax return.
We end this section noting that federal law does not match California law where such Trusts can be deducted as a cost for income tax purposes. Federal law does not allow for any such deduction and so, all Federal Trusts are actually deductible to California residents on their California tax returns.