Posts Tagged ‘Estate Tax’

Estate Tax Portability — What If the Executor Refuses to File?

JANUARY 30, 2017 VOLUME 24 NUMBER 5
We knew it would happen, and now it has. A surviving spouse has sued to force the administrator of the deceased spouse’s estate to file a federal estate tax return to perfect the “portability” election. Before we can tell you how it turned out, we’ll need to explain the controversy.

April Villarreal died last year. Her estate was not large enough to require a federal estate tax return (that is, she did not have more than $5.45 million, the 2016 estate tax exemption amount). She and her husband Charlie had a prenuptial agreement, which provided that her assets would all go to her children — Charlie would have no interest in her estate at all.

April did not leave a will, but based on the prenuptial agreement her son Richard filed for and secured appointment as administrator of her estate in the Oklahoma courts. Actually, there were various legal moves and counter-moves leading up to that appointment, but within a few months of April’s death Richard was clearly in charge of administering her probate estate, and it had become clear that Charlie had waived any interest in her estate.

Seven months after April’s death, and after Richard had indicated he had no intention to file a federal estate tax return, Charlie filed a petition asking the court to order Richard to file a return. Clearly there was no tax liability — so why was he insistent?

That’s easy. Most people know that a surviving spouse “inherits” the deceased spouse’s federal estate tax exemption amount — or at least to the extent that it has not been used. In other words, if April left (just to pick a number) one million dollars to her children, then Charlie could receive an additional $4.45 million exemption to reduce — and possibly eliminate — the estate tax liability on his own, later, death. But that transfer only works if the deceased spouse’s estate administrator files a federal estate tax return.

Why would Richard refuse to file a return? There would not be any tax due or paid, though there would be some costs — and significant work — involved in preparing the return itself. Filing the return would not benefit April’s own estate in any way.

Richard argued that the prenuptial agreement Charlie had signed before the couple’s 2006 marriage expressly waived any interest in April’s estate. That’s true, responded Charlie — but that doesn’t mean that a benefit that costs her estate nothing and would help him should simply be allowed to evaporate. Besides, the agreement was signed before the portability benefit even existed under federal law.

The estate tax benefit, by the way, is properly referred to as the “Deceased Spousal Unused Exclusion Amount” (or DSUEA). The federal law creating a DSUEA system does not permit the injured spouse to file their own version of an estate tax return — it must be filed by the estate’s administrator (or the person who would have been the administrator, in cases where no administration is required).

The Oklahoma probate court ordered Richard to file the return. Because much of the information on the return would actually come from Charlie, the court ordered him to cooperate and provide the necessary documentation within a short period. Because the return was technically due in only about two months, the judge also ordered Richard to seek an extension for filing the return. Charlie was ordered to pay for the return’s preparation.

Richard appealed. The Oklahoma Supreme Court considered the case very quickly, and rendered its opinion upholding the trial judge. The order directing Richard to file the estate tax return, and to make the election to preserve the DSUEA for Charlie, was approved. Given the time-sensitive nature of the issues, the entire process (from Charlie’s original motion to the Supreme Court ruling) was accomplished in just five months.

The Oklahoma Supreme Court ruling makes clear that the probate court has jurisdiction to decide questions about estate administration. The mere fact that the issue was really about federal filings, not state issues, did not mean that the state court had no authority. The existence of the prenuptial agreement — especially since the right to carry over unused tax exemptions didn’t even exist at the time of the agreement — did not prevent Charlie from making his request. Estate of Vose v. Lee, January 17, 2017.

There has been much discussion in the professional probate and estate planning community about just this question. Can a personal representative (what used to be called an executor) refuse to file a return just because they don’t want to, or out of spite, or because they don’t want to be bothered? The opinion in April’s case notes that the personal representative has a fiduciary duty to the beneficiaries of the estate — and that a spouse is a beneficiary even if all they receive from the estate is the DSUEA election.

April’s case presents the argument very concisely. It’s hard to see what possible objection there might be to filing the estate tax return, where Charlie is ordered to provide all the documentation and pay the costs. The only reason to refuse the election would be the intransigence of the deceased spouse’s children. Given the blended families so common today, it seems like similar circumstances will arise with some frequency.

Does Your Existing Trust Split Into Two Shares On a Spouse’s Death?

MARCH 9, 2015 VOLUME 22 NUMBER 10

A letter from a reader asks: “My husband and I set up a revocable trust which will divide our assets in half when one of us dies. This was to avoid estate taxes.  Now that estate taxes are no longer a problem, are there still benefits to splitting our assets when one of us has died?”

What a great question!

The short answer: if your combined estate is well under the $5.43 million threshold for estate taxes (in 2015), there is probably no tax reason for splitting the trust on the first death. If your combined estate is less than two times that figure, the answer is probably the same. But that’s not to say that there’s no reason to provide for a split of the trust — it’s just not a tax reason.

Here are some circumstances in which you might still want to split your trust — not necessarily in half, but into two shares — on the first spouse’s death:

  • You might worry about what will happen with the surviving spouse after one spouse dies. Will he or she remarry? Become infirm and susceptible to influence from people outside the family? Begin to favor one child over the others, or disfavor one child? If you feel strongly that “your” share of the estate (and here we’re talking as much about a “moral share”, if you will, as a legal share) needs to be locked down if you die first, then you might still want to provide for a trust split on the first death. Let us talk — and by “us” I mean you, your husband and your lawyer, all together.
  • You might feel like some of the assets are really yours, not your spouse’s. Did you receive a substantial inheritance that you have kept separate? Did you bring more assets to the marriage? Is there a particular asset (your home, or a summer cottage where your children spent every summer, or stock in a family business, or something similar) that you feel particularly strongly about passing to your children? Time for us to talk.
  • Is this a second marriage, with children from prior marriages? We should probably discuss how the two of you feel about the likely connection the surviving spouse will maintain with stepchildren.
  • Does your spouse have a problem managing money, or completely different ideas from yours about how to invest or maintain assets? Guess what — we need to talk.
  • Do either (or both) of you own real property in another state? Because the estate tax answers might be different.

Note a common thread here: there are no easy, pat answers. Each consideration means we need to talk through what’s important to you and to your spouse, and what is legally possible — and efficient.

There are some downsides to splitting the trust on the first death. For one, it probably increases the cost of managing the trust. It certainly increases the responsibility of the surviving spouse to account to the children, and maybe (depending on your trust’s terms) even grandchildren or others. It might (but probably won’t — we don’t want to alarm you unnecessarily) actually increase income taxes. It probably will mean that the surviving spouse has some limitations in how they deal with the portion of the trust that becomes irrevocable on the first death — and that can be emotionally troubling. And remember that what’s sauce for the goose — well, you know the rest of that aphorism.

Incidentally, the same answers apply to a couple who never did set up a trust that splits on the first death. Even though taxes may not compel such a split, it might be a choice that makes the couple feel more comfortable about what will happen after the first death.

Here’s a thought experiment for you: we find that it’s relatively easy for married couples to imagine what life would be like if one spouse died (though it may not be pleasant to contemplate). What’s more challenging is to imagine what life will be like ten, or fifteen, or twenty years after your spouse dies — or (harder still) what life will be like for your spouse twenty years after you die.

The same client goes on:

“Is the second trust still vulnerable to nursing home expenses?”

Another good question. It takes a little explaining, but the journey should be worth it.

If you set up a trust for yourself (let’s assume you are single for a moment) and then enter a nursing home, your assets will probably not be protected from the cost of the nursing home. That’s an overgeneralization — there are actually some kinds of trusts that might protect your assets from long-term care costs. But they will usually have been in place for five years, and be very restrictive. For the moment, let’s just go with “no, the trust you create for yourself is not safe from nursing home costs”.

If your spouse dies and leaves his or her entire estate to you outright, then the trust you set up will look the same. Even if you and your spouse set up a joint trust and then he or she dies, leaving you with the power to revoke the whole trust, that will be the same as the trust you set up with your own assets. So no, the trust that does not split into two shares on the first death will not (usually) protect against nursing home costs.

But if your joint revocable trust splits into a revocable and an irrevocable share on the first death, the answer may be different. If that seems like a likely scenario, or you particularly want to pursue protection from long-term care costs, then that may be another reason for considering a split on the first death — even though there is still no estate tax reason to make the split.

This client keeps asking really good questions:

“What if my husband decides to make large gifts out of the second trust. Can he do that ?”

Sorry to be a lawyer here, but the answer is: “it depends”. Mostly it depends on the language of the trust.

Of course there’s another reality. If the surviving spouse is the trustee of the trust, and the trust terms say “whatever else he/she does, he/she is not to give a single cent to my worthless brother Arnold,” and the surviving spouse gives a few thousand dollars to Arnold, who is going to enforce the trust’s terms? The children? They likely won’t find out about it until well after it happens, and you know how likely Arnold is to pay the money back, right?

Once again, this question needs to be the subject of more discussion with your lawyer. But what excellent questions.

Important note: These off-the-cuff answers are just that, and they really should encourage you to discuss the questions with your lawyer in some depth. If you are not an Arizonan, they may not be correct at all. If we are not your lawyers, you might get a different answer, or at least different emphasis. These are actually hard questions.

Top Ten Reasons You Might Want a Trust, Rather Than Just a Will

JANUARY 26, 2015 VOLUME 22 NUMBER 4

Do you need a living trust? Even with an estate tax threshold of over $5 million (and double that, for most married couples)? That is the primary question posed by most of our estate planning clients.

For years the answer depended mostly on the size of your estate. Not that there were (or are now) any inherent estate tax benefits to having created a living trust, but it was easier to take advantage of the easy ways of minimizing taxes using a trust than otherwise. So most Arizona couples worth more than about $1 million were urged to establish a trust. Couples who hoped to be worth more than $1 million often took the step, too — on the chance that their assets might grow enough to create a possible estate tax liability.

Then the federal government started raising the tax level, ending up at $5 million and indexed for inflation (so that the threshold for 2015 is $5.43 million). They ultimately changed the rules for married couples, too, making it easier for a surviving spouse to use his or her deceased spouse’s exemption, effectively doubling the level at which estate taxes were a driving factor. The State of Arizona jumped into the act, too, by repealing its state estate tax altogether. That all means that for more than 99% of Arizona individuals (and couples), estate taxes are no longer an important reason to consider creating a trust.

Does that mean that no one needs a living trust any more? Not exactly.

First, let’s think about people who established a trust back when it was an important step — do they need to consider revoking their trusts now? No. There are almost no downsides to creating a trust, other than the cost and trouble of setting them up in the first instance. Even though it might be hard to justify setting up a trust now, the individual (or couple) who has already gone through that process should probably not undo their earlier work.

Should a person worth well less than $5 million ever create a trust? Yes — at least in some situations.

Let’s get right to the point: what are the top reasons you might want to create a trust? With thanks and a nod to our associate attorney Elizabeth N. Rollings, who created the original list, here are our offerings:

  • 10. You really, really hate the thought of probate. It’s not the monster you probably think it is, but that’s not to say it’s a lot of fun, or cost-free. We can try to persuade you that it’s not that important to avoid probate — or we can just help you avoid the process.
  • 9. You favor privacy. There’s not all that much public disclosure involved in the probate process, and most of what does need to be disclosed can just be shared with your heirs. But there are some things that get into the public record, like the text of your will and the names and addresses of the people to whom you have left money or property. Do you have unusual family dynamics, or a publicly recognizable name, business or assets? You might prefer to create a trust.
  • 8. You want to make it easier for your executor. We don’t actually use the term “executor” any more, but we know what you mean. It’s simply easier for a successor trustee to get control of your assets than it is for that same person when they are named as agent on a power of attorney. It’s also easier to arrange for an orderly transition as you are less able — from having your chosen administrator named as successor trustee to naming them as co-trustee, and dividing the job in a reasonable — and flexible — way.
  • 7. You have complicated assets. Most people don’t think their assets are complicated. “I just have Certificates of Deposit in the four Tucson banks that pay the highest interest rates,” you say. Oh, and then there are the government bonds. Plus a brokerage account at a national low-cost broker, and a rollover IRA. Did you remember to mention those almost-worthless oil and gas rights you just learned about from your grandfather’s estate? Complicated, complicated. Having a trust makes it much easier for someone to handle your assets for you — both after your death and while you are still alive but not functioning at the top of your game. Oh, and there may be income tax benefits to having your assets in the trust (though you — or your spouse — may have to die in order to get the tax benefits. So maybe we’ll soft-pedal those).
  • 6. You have complicated distribution plans. This one is related to the previous one, and — as with “complicated” assets — clients seldom think their plans are complicated. “I just want to leave everything equally to my three children,” you tell us. Oh, plus $10,000 to each grandchild, and a $100,000 gift to your church. Also, a list of personal property and who is to get it. And some thoughts about what should happen if, god forbid, one of your children should die before you. The more complicated your distribution scheme, the more you need to consider a trust. Why? Because your distribution will be more private, and it’s easier to adjust to changes in your future (should your church’s gift go up as your net worth expands, or down as you draw down your IRA?).
  • 5. You have real estate in more than one state. Probate, as we have said before, is not as difficult as you probably think. But if you have real estate in more than one state, we have to go through the process in each state. Some states are much more complicated and expensive than Arizona. So if you have your home in Arizona, a condo in California, a summer place in Wisconsin, and a timeshare in Virginia, you might want to think about a living trust. Even if you only have two of those, you might be a better candidate for a trust.
  • 4. You have professional children, or wealthy children. Your son is an architect, and your daughter is a physician. Why do they need their inheritances to be in trust? They don’t — but it’s an extra gift from you to put them in trust. You can help protect their inheritance from creditors, malpractice claims, even divorce proceedings. And you might be able to keep your assets out of their estates when they die, thereby reducing the amount of estate tax the grandchildren pay.
  • 3. You have minor children, or children (or grandchildren) under about age 25. Why 25? Recent research suggests that that’s about the age at which a child’s brain really matures, even though the legal system considers them mature at 18. Of course you get to choose the cut-off age, but we are urging people to think about 25-or-so for their planning. Even if your children are older, a share of your estate might go to grandchildren — and they could be younger than the cut-off age you choose.
  • 2. You have a family member who is just not good with money. Is your son (or, for that matter, his wife) a bit of a spendthrift? Is your youngest still trying “find” herself? You might want to provide some sort of management for that beneficiary’s share of your estate.
  • 1. You have a child or grandchild with a disability. Are they receiving public benefits like Supplemental Security Income (SSI) or Medicaid (in Arizona, AHCCCS)? You need to create a special needs trust for any share they will receive. Are they not on public benefits right now? You probably still want to consider a special needs trust, because you don’t know how things will change over time. The same rules apply for any person you plan to leave money to, including your long-time housekeeper’s son or the young woman who grew up with your kids and was treated like a member of the family. We just use “child or grandchild” because they are the most common recipients.

Any of those sound like you? Let’s talk about whether a living trust is the right choice. Oh, and if you don’t live in Arizona — talk to your own lawyer, who might rearrange the order, drop some of these points altogether, and add others.

New Tax-Related Numbers for 2015

JANUARY 12, 2015 VOLUME 22 NUMBER 2

Welcome to 2015! Who thought we’d ever make it?

The Internal Revenue Service did, that’s who. They’ve busily updated numbers for the upcoming year; most of the new numbers have actually been known for a couple months. Once you get used to writing “2015” every time, we have some other new numbers for you to memorize.

Estate tax threshold: The federal estate tax kick-in figure rises to $5.43 million for people who die in 2015. Somewhat confusingly, that is an increase from the $5.34 million figure applicable for deaths in 2014, so don’t assume that the new figure is just a transposition typo when you see it next. Of course, married couples now have a total of twice the new figure (or $10.86 million) to pass without federal estate tax — if they both die in 2015, that is.

Keep in mind that some states still impose an estate tax of their own. They might or might not increase the minimum figure with inflation (most don’t), so if you live in one of those states, or own property in one of those states, you also need to think about the state estate tax limit.

Also remember that the federal $5.43 million figure is reduced for taxable gifts you have made in past years. We’ll talk a little about gift taxes next.

Federal gift tax threshold: You don’t have to pay any federal gift tax until taxable gifts reach a lifetime total of $5.43 million — the same figure as the estate tax threshold. But gifts are even more favorably treated, since the first $14,000 you give to each recipient avoids taxation, filing or any other restriction. That $14,000 figure is the same as last year — it did not increase at all for 2015. Why not? Because, though it is indexed for inflation (and will rise in the next couple years) it only goes up in $1,000 increments. This year’s increase was not enough to cross the $1,000 notch.

You may already know that married people can pretty easily double the $14,000 gift figure. But you might not realize that it’s actually a little harder than most people think. If you and your spouse make a joint gift (if, say, the gift is from a joint account), you have nothing to file and no federal tax effect for the first $28,000 received by a given recipient. But if you write the check on your own separate account, you have to file a gift tax return (and your spouse has to sign it) in order to ignore the excess over your $14,000 gift. Confusing? Talk to your lawyer and accountant about the specifics.

This gives us a chance to mention a common misunderstanding, by the way. Again and again we hear clients say that they are limited to the $14,000 figure for gifts. That is incorrect. If our client says “oh, I knew that: I meant that I can’t give away more than $14,000 without paying a tax,” they are still wrong. It can be a little bit complicated to explain, but here’s how gift-giving works:

  1. If you give away more than $14,000 (twice that for a married couple) to a single recipient, you are required to file a gift tax return.
  2. When you do file your gift tax return, you only pay gift taxes on the amount by which your lifetime gifts exceed the $5.43 million figure (for 2015). In other words, if you have never owned more than $5.43 million in assets, you will have a very, very hard time incurring a federal gift tax, no matter what you do. You will also have a very, very hard time incurring a federal estate tax.
  3. If there is a tax on the gift, it is paid by the giver, not the recipient. Gifts are not deductible from your income tax, and they are not income to the recipient. The only federal tax associated with a gift is the federal gift tax, and it only kicks in after millions of dollars of total gifts.
  4. Married? Both the annual ($14,000) figure and the maximum lifetime gift ($5.43 million) figure are probably doubled.

Bottom line: only people who are both very wealthy and very generous need to worry about actually paying a gift tax. The real worry is about incurring the cost of filing a gift tax return — and that doesn’t kick in until that $14,000/$28,000 figure is reached.

Income tax rates: The basic chart of federal income tax rates is the same as in 2014, but with new figures for the bracket changes. In other words, in 2014 a married couple filing a joint return paid the lowest tax rate (10%) on the first $18,150 of taxable income. For 2015 that first-step threshold increases to $18,450 (a $300 increase). And the top bracket (39.6%) kicks in at a combined income of $464,850 this year, rather than the 2014 figure of $457,600.

Personal exemption and standard deduction: These two separate figures add up to an important principle for low-income taxpayers: if you don’t earn more than the combination of these two figures, you can’t be liable for any federal income tax. The personal exemption reduces your income before we even get to looking at your deductions. The standard deduction is the minimum amount that everyone gets to deduct from income before figuring out their tax liability, even if they don’t itemize deductions.

Both figures increase for 2015, but the increases are small. The personal exemption (you may get more than one, depending on marital status, age and other factors) will increase by a mere $50, to $4,000. For a married couple filing jointly, the standard deduction goes up by another $200. What does that mean for real taxpayers? If you are married filing jointly, and have just two exemptions available (and no dependent children), you don’t have to file at all unless your income exceeds $20,600 ($23,100 if you are both 65 or older).

One other “change” to mention: Last year a special tax opportunity expired. In 2013, if you had to take a minimum distribution from your IRA or 401(k), you could instead direct it to your favorite charity and avoid having to pay tax on it at all. Why was that valuable? Because even if you received the income and then gave it to charity, your charitable deduction wouldn’t cover every dollar of the gift. With this special authority, you really could avoid income tax on the distribution.

But wait! At the eleventh hour (actually, the twelfth hour) Congress brought back the 2013 deduction for 2014 — but not for 2015. So this change helps people who assumed that it would be extended, but doesn’t help anyone who tries to do the same thing in 2015. Unless, of course, Congress re-extends the authority later this year.

Even With No Estate Tax, Some Tax May Be Due on Inheritance

JUNE 9, 2014 VOLUME 21 NUMBER 21

Our clients are often confused about whether their heirs will owe any taxes on the inheritance they are set to receive. We don’t blame them — it’s confusing. Let us try to reduce the confusion.

The federal estate tax limit was raised to $5 million and indexed for inflation in 2011. That means that a decedent dying in 2014 can leave up to $5.34 million to heirs with no federal estate tax consequence at all. It is easy to double that amount for a married couple. And in 2006, Arizona eliminated its state estate tax — so there is no Arizona tax to worry about. That means that there is simply no tax concern for anyone not worth $5 million or more, right? The 99% can pass their entire wealth to their children without fear of tax consequences, right?

Of course that’s not right — it would be way too simple if that were the case. The world — at least the political world — seems to dislike simplicity as much as the physical world abhors a vacuum. Even if your estate is modest, you need to be aware of the tax consequences of leaving money to your heirs. Here are a few of the more common ways your estate might be subject to taxes on your death:

Living, and dying, somewhere other than in Arizona. About half the states, like Arizona, have no estate or inheritance tax. But that means that nearly half of the states do have a tax; some states tax the estate, and some the recipient of an inheritance. Before federal estate tax changes in 2006, it was possible to generalize about those state estate tax regimens — they tended to look alike. But no more. You need to worry about state estate taxes if you live in one of those states with a tax, if you own real estate in one of those states, or if you have heirs who live in one of those states. The details can be mind-bogglingly complex, and they are beyond our scope here. There are plenty of online resources to look up state-by-state rules — we tend to favor this 2013 article from Forbes magazine, partly because it is engagingly titled “Where Not To Die in 2013.” The information is already a year old as we write this, but not that much has changed, and it will give you a good head start.

Owning retirement accounts. You sort of knew this one already, right? You have an IRA, or a 401(k), or a 403(b) retirement plan, and you’ve named your children (or your spouse, or your helpful neighbor) as beneficiary. But keep this in mind: if you leave, say, $100,000 in an IRA to your children, they are going to receive something more like $70,000 of benefit. With careful planning, they can delay the tax liability — but they will pay ordinary income taxes on what they withdraw. Income tax will be paid by anyone receiving the retirement account (except a charity, of course — they pay no income tax), and at their ordinary tax rates. You might have arranged to minimize your own withdrawals, and pay a very low tax rate on the income you do take out — but your daughter the doctor and your son the architect might pay a much higher tax rate and have to start taking money out of the account immediately after your death.

What can you do about that issue? If you have charitable intentions, you can name a charity as beneficiary of your retirement account. You can leave it to grandchildren, who might pay a lower tax rate (and have more immediate use for the money). You can create a trust that forces your heirs to take the money out very slowly. But at the end of that process, some significant income tax is going to be paid by the recipient of your IRA or other retirement account.

Having income-producing property at your death. Arizona does not have an inheritance tax, so there is no tax cost to receiving an inheritance. Except that sometimes there is a small cost. If you leave an estate including, say, stocks and bonds, or mortgages secured by real estate, or anything else that receives income, your estate may incur a small amount of income tax liability during its administration. That can be true even if you create a revocable living trust, since it will typically take 6-12 months to settle even simple estates. But rather than your estate paying the income tax liability, it usually is passed out with distributions to your heirs. So when your daughter hears that there is no tax on her inheritance, she may be surprised when her accountant tells her she owes income tax on a few hundred — or thousands — of dollars of that inheritance.

Having property that has appreciated since you received it. Income tax is usually due on the gain in value of an asset during the time you held it. Most people realize, however, that when you die most or all of your property receives a “stepped-up” basis for calculation of capital gains. That means that your heirs usually do not pay any income tax on the increase in value during the time you owned property.

But be careful — that is not always true. If you gave the property away before your death, or you inherited it in a trust (like a spousal credit shelter trust), it might not get a stepped-up basis. That can mean that the property your heirs receive carries a significant built-in income tax liability. It might not be due immediately on your death, but it might limit their choices about when to sell or give away the property. This is much more of a problem today than it was just a few years ago — with the proliferation of A/B (credit shelter, or survivor/decedent’s) trust planning in the past three decades, a lot of property is now held in trusts and will not get a stepped-up basis on the surviving spouse’s death.

Owning an annuity. You might have done some clever tax planning by buying a tax-sheltered annuity five years ago. But if you die holding that annuity, your heirs might have to pay the income tax on the income accumulated during the years you have held the annuity, and they might have to pay it immediately. Note that tax-sheltered annuities are not called tax-free annuities — they are just a mechanism to delay the income tax liability to a later date when, one presumes, your tax rate might be lower. If your currently-employed children step into your shoes, that assumption might turn out to have been incorrect.

Planning options.  What can you do if you fit into any of these categories? If we are preparing your estate plan, we will talk with you about the issues. Any capable estate planning attorney should be able to see whether you have issues to be concerned about. But that is why we always ask you for detailed information about your assets, your family and your circumstances. Yes, the estate tax regimen has gotten simpler — but that doesn’t meant that the decision-making is necessarily simple.

Simple Estate Planning for a Married Couple

AUGUST 12, 2013 VOLUME 20 NUMBER 30

Last week we saw a married couple in our office. The couple had come to us for estate planning. They did not have children with disabilities, or spendthrift sons-in-law or daughters-in-law. Their assets were not unusual (some Arizona real estate, a brokerage account, several bank accounts). Their net worth was well under the $5.25 million that would have made us want to talk about federal estate tax issues. They intend to leave their estates to one another and, on the second death, to relatives and a few charities. In short, they were a pretty typical couple.

This couple already held everything they owned as “joint tenants with right of survivorship.” That, of course, means that on the death of the first partner, the survivor would receive everything without having to go through the probate process. Ordinarily we would have told them that they ought to have fairly simple wills and Arizona powers of attorney. We would have suggested that they transfer all their real estate and brokerage assets into “community property with right of survivorship.” That’s a slight improvement on joint tenancy because on the first death the survivor gets a stepped-up income tax basis on the entire value of assets held as community property. It is an option that is only available to married couples, and it’s usually worth considering.

Though our couple was married, they did have one legal issue that complicates their estate planning. They are both of the same gender. They got married in another state, where same-sex marriages are recognized, and then retired to Arizona. They are looking forward to enjoying the sunshine, outdoor recreation opportunities, and casual lifestyle of The Grand Canyon State. Though Arizona was once known as The Valentine State (do you know why?), our state Constitution expressly invalidates this couple’s marriage.

Or does it? They have arrived in Arizona at a time of legal ferment. The U.S. Supreme Court has invalidated a federal ban on same-sex marriages; is invalidation of Arizona’s ban (and those in place in dozens of other states) far behind? And, more importantly for our couple, what are legally married gay couples supposed to do in the meantime?

Reasonable minds can differ on what our couple should do. In fact, we are fond of saying that if you get ten lawyers in a room and discuss legal issues, you will get at least twenty firmly-held, well-reasoned opinions. But here is what we discussed with our clients:

  • Consider creating a joint revocable trust. Declare in the trust that everything you own is community property, and file any future tax returns on that assumption. The worst that could happen would be that the IRS ultimately disagrees, and then you are back where you would be if you did nothing of the sort. BUT note that the establishment and funding of a trust is more expensive (by, perhaps, a factor of three or four), and opposite-sex married couples don’t have to go through this kind of silliness.
  • At least create reciprocal wills, and guard them more carefully than opposite-sex couples need to. If a couple whose marriage is recognized in Arizona never get around to making a will, or misplace their wills, it is likely that the default rules will follow what they wrote in their wills. If the marriage is not recognized, though, a missing will could mean biological family members of the deceased spouse take in preference over the surviving spouse — or at least that litigation is required to establish the validity of the out-of-Arizona marriage.
  • Critically important for gay couples, married or not, is signing of a document directing funeral arrangements and disposition of remains. Time and again we have seen same-sex partners shut out of funeral and burial arrangements, even by family members who professed affection for the surviving partner in the hours before death. The advent of same-sex marriages might turn out to have eased that kind of pain, but it may be yet another opportunity for litigation, and at a time of high emotional fragility.
  • Go ahead and try putting real estate and brokerage accounts in “community property with right of survivorship.” Expect a little different experience between stockbrokers and the County Recorder; the former is probably used to same-sex community property declarations, and the latter probably thinks it has a responsibility to uphold Arizona’s misguided law. Do you want to be a little bit subversive and act as an agent for positive change, albeit a small change? Talk with us — we like both of those ideas.
  • Review and update your plans more often than other couples need to. We usually counsel that estate plans have about a five-year life, and we expect to actually see clients again in about 7-10 years. Same-sex married couples ought to shorten that to 3-5 years, as there will be changes AND we want to have recent documents in the ultimate time of need (that’s a not-very-disguised euphemism for “when you get sick or die”).

We were very chagrined to have to advise this delightful couple that Arizona is so unwelcoming. We really want to help them secure the benefits of their marriage in Arizona. We can accomplish almost everything that an opposite-sex married couple can get with their Arizona-recognized marriage, except for the (admittedly small) income-tax benefit of “community property with right of survivorship” titling. But we can’t really tell our couple that they have a moral or legal duty to carry the torch for change in this arena, because the reality is that the benefit is modest for most couples. That’s because:

  1. Your real estate may well appreciate during your life, but if the only real estate you own is your residence then you already get a significant income tax avoidance opportunity (up to $250,000 in gain) without regard to your marital status. Be careful about relying on this as your sole tax-avoidance technique, but for most people it means that they will not ever pay taxes on increases in their home’s value anyway.
  2. Although capital gains in your stock holdings do not have the same partial exclusion opportunity, it is still easy to avoid paying income tax on the increased value by simply not selling the stocks. That means that an “unmarried” couple like our clients would have lost flexibility, not cash — still a negative, but not with as obvious a dollar cost.

For our part, we are looking forward to a time (we hope that it is soon) when these kinds of distinctions are no longer necessary. Meanwhile, we wish the very best for all our clients who have retired to The Valentine State.

 

Bypass Trusts, Disclaimer Trusts and Portability in Estate Planning

MAY 6, 2013 VOLUME 20 NUMBER 18
Last week we wrote about questions we often hear from our clients in the wake of big changes to the federal estate tax structure. Almost immediately we heard from a reader asking about portability and disclaimer trusts; our reader suggested we try to explain the two concepts and how they are related. It’s a good idea.

First, a caveat: if you are not married OR if you are married but you and your spouse are “worth” less than about $5 million, then your interest in this topic is probably academic. That doesn’t mean you shouldn’t read on, but only that the explanation won’t affect you much — except perhaps to alert you if you have a more-complicated estate plan than you need.

Let’s start, as we often do, with a brief explanation of the classic A/B trust setup that prevailed in estate planning for married couples for nearly three decades. In an environment where estate taxes kicked in at the relatively low level of $600,000 of net worth, many couples had estate plans that created an irrevocable trust (sometimes called the “bypass” or “decedent’s” trust) on the first death. That typically allowed the surviving spouse to get the benefit of the money left to the trust, but not include it in her (or his) estate — thereby effectively doubling the $600,000 exemption amount to a total of as much as $1.2 million.

Of course, over the last decade the exemption amount rose from $600,000 to $3.5 million and then settled at $5 million (plus an annual increase for inflation). That meant that only couples with estates  of $5 million would need to create the two-trust setup, and that their estates would be covered up to a total of over $10 million with fairly simple estate planning.

But the other change made by the 2010 tax law (and made permanent effective this year) makes it harder to explain the planning options. That change is usually called “portability.” Here’s how it works:

Each spouse in a married couple has an exemption amount of $5 million (plus the inflation adjustment effective the year of that spouse’s death). If, say, the husband dies in 2013, with a $5.25 million exemption amount, but leaves his entire estate outright to his wife — she inherits his estate PLUS his exemption amount. She immediately has a $10.5 million exemption amount, and it goes up (or at least “her” half does) next year for inflation. No irrevocable trust needed. No fancy estate planning required. No legal fees, no accounting or tax preparation until the surviving spouse dies.

That’s a great outcome. It should save money for most married couples, and it is much easier to understand (and execute) than the two-trust solution. The hardest thing to understand about portability might just be its formal name: DSUEA (“Deceased Spousal Unused Exclusion Amount”).

There are, though, a number of wrinkles that well-informed planners need to appreciate. Note that these wrinkles do not mean that you should not rely on the portability arrangement. Most people will not be affected by them.

Generation-skipping tax. The generation-skipping tax exemption is a flat $5.25 million this year (it is also indexed for inflation). if you and your spouse are worth more than about $5 million AND you plan on leaving your assets to grandchildren, or in trusts for your children lasting past their deaths, then you might not want to rely on the portability arrangement.

Filing an estate tax return. The portability of the exemption amount is not automatic. The surviving spouse can only keep the deceased spouse’s exemption amount IF a federal estate tax return is filed. Say what? In order to get this benefit you have to file a return that almost no one else has to file, and to incur the expense of valuing assets (which would not have to be done otherwise)? Yes.

State estate taxes may not work the same way. Arizona, as we keep reminding clients, does not have a state estate tax. But a number of other states still do, and they will apply even to Arizona residents if they own real estate in one of those states. So portability may not be enough in cases where there are significant out-of-state assets.

Remarriage can cause loss of the portability exemption. Let’s sketch out a story. Martha’s husband David died in 2011, leaving his $2 million estate to Martha. She filed a federal estate tax return and claimed David’s $5 million unused estate tax exemption. In 2013, she has $10.25 million in exemption equivalent amount (David’s $5 million plus her $5.25 million). Note that she inherited more exemption amount from David than she inherited of actual estate value.

This year Martha’s wealthy parents died, leaving her their estate; she is now worth $8 million. She remarries. Her new husband, Hal, is a wealthy and very generous man; he has previously given his children a total of $5 million in gifts.

Does this story seem absurdly fanciful? Do you wish you had these problems? Do you want to tell Martha she shouldn’t have married Hal? Because if Hal dies, Martha “loses” David’s unused estate tax exemption, and gets Hal’s instead — and that could mean estate tax on a couple million of her estate. On the other hand, if Martha dies Hal inherits her unused exemption (the exact amount depends on who she leaves her estate to), making it possible for him to give several millions of dollars more to his children with no gift or estate tax consequences.

Can you just imagine the prenuptial agreement? And aren’t you glad that the estate tax system has been simplified?

The truth is, of course, that it has been simplified — vastly simplified, in fact, for individuals and couples worth less than about $5 million. That means most of us — about a quarter of one percent of American households are worth more than $5 million, according to some calculations.

What does all this say about disclaimer trusts? As we reported last week, having a back-up trust for your spouse might make sense in at least some circumstances, and one way to do that would be to give the surviving spouse the power to fund the trust by disclaiming the ability to inherit outright. But we predict that disclaimer trusts will be implemented infrequently.

Some Questions We’re Being Asked a Lot Lately

APRIL 29, 2013 VOLUME 20 NUMBER 17
You probably have read that Congress has made big changes to the estate tax system. More accurately, Congress has made “permanent” the big (but piecemeal and temporary) changes introduced over the past decade. We hear a lot of questions from our clients about what those changes mean. Here are some of the more common questions we get asked:

Should I revoke the living trust I signed a few years ago? The answer is almost certainly no, but it might require some explanation.

Trusts (and here we generally mean revocable living trusts) have been useful for the past few decades, and help address a number of concerns. They can make it easier for you to avoid the necessity of probate of your estate. They can provide more efficient and clear-cut management of your assets if you become incapacitated. They can spell out any limitations on your heirs’ access to your estate after your death. And (especially for married couples) they can help minimize estate taxes — or at least they have traditionally been useful for that purpose.

The federal government’s change in estate tax limits means that very, very, few estates of decedents will pay any estate tax whatsoever. But does that mean that your trust will no longer be helpful?

Even though your estate will likely not be subject to any estate taxes, the other benefits provided by your living trust will continue to be available. Probate avoidance is still easier with a trust. So is protection of your assets in the event you become incapacitated. So is control over your children’s inheritance.

If you had not already created a living trust, the recent changes in tax law might make it less compelling for you to sign a trust today. But if you have already created your trust, there is little likelihood that you will be better off by revoking it. The only real downside to creating a trust (in most, nearly all cases) is the cost (our fees) and the difficulty of transferring assets into the trust (the “funding” process). You’ve already incurred both of those, so it probably makes little sense to undo your trust now.

Do my spouse and I still need a two-trust arrangement? It has been common in Arizona (and other community property states) for a husband and wife to create a single, joint trust that divides into two trusts upon the first death. Those trusts are sometimes called “survivors” and “decedents” trusts, or “family” and “marital”, or more simply A and B trusts. Many practitioners think they are outmoded now — and they might be right.

The recent tax law changes make permanent the concept of “portability” of the estate tax exemption. That means that when one spouse dies, the surviving spouse gets to keep the deceased spouse’s $5 million estate tax exemption (it’s actually even better than that, since the $5 million figure is indexed for inflation and has already risen to $5.25 million). No fancy trusts are necessary to allow a combined estate of up to $10.5 million (or more) to completely escape federal estate tax.

For a number of reasons, though, some lawyers favor keeping the two-trust split in place. There might be a state estate tax to consider (there isn’t in Arizona, but perhaps you have property in another state where there is an estate tax). There is still the generation-skipping tax issue, if you are putting money in trust for your children (which we favor) or leaving money directly to grandchildren.

This issue takes a lot of individualized consideration. The answer may depend not only on the size of your estate, but also who you intend to leave your money to and whether you will be leaving it in trust. Suffice it to say that married couples with combined estates of well under the $5 million threshold probably don’t need the two-trust arrangement, while couples worth more than twice the $5 million figure likely do. But even those generalizations are uncertain — your mileage definitely might vary. Talk to your lawyer.

What if my spouse died several years ago, and an irrevocable trust was set up — do I still need to keep it going? It might well turn out that you don’t, but you may not have control over the question.

For couples worth more than a few hundred thousand dollars a decade ago, the division into two trusts was commonplace. If one spouse has already died the division might well have already taken place. If so, the irrevocable trust files separate tax returns, has its own EIN (Employer Identification Number — the trust’s equivalent of a Social Security Number) and has requirements that some form of accounting information is provided to the ultimate beneficiaries. Would it be advisable (or even possible) to terminate that trust?

It might, particularly if the total value of the irrevocable trust and the living spouse’s own estate does not exceed $5 million. Recent changes in Arizona law might make it easier to terminate the trust and save the cost and hassle of administering it. But it is not always easy to terminate the irrevocable trust, and there may be some costs associated with doing so. Talk to your lawyer. You might find yourself discussing merger, termination or “decanting” of the irrevocable trust.

Are these changes really permanent, or will we be revisiting everything again in two years? This really looks permanent — or at least permanent for the next decade or two. Can Congress revisit the estate tax? Yes, of course. Have they done so over the past fifteen years? Yes, repeatedly. Is there any move afoot to make further changes? Yes, some politicians talk about eliminating the estate tax altogether. But even with all that said, there is little indication that any serious changes are going to be discussed in the next few years. And even if Congress significantly lowered the estate tax limit, the result would be that the tax could affect a handful more than the half-percent (or so) of people who now need to worry about estate taxes.

Estate Planning in 2013 — Is It Time To Make Changes?

JANUARY 14, 2013 VOLUME 20 NUMBER 2
Congress acted (not just at the last minute, but after the last minute). The update to the estate tax provisions is permanent, or at least what passes for permanent in the world of taxes and politics. So does that mean you need to make changes to your estate plan?

In a word, yes. Mind you, that answer does not apply to everyone — but it does apply to most middle-class married couples and wealthy individuals and couples.

For a decade now we’ve been telling clients that they will need to revisit their estate plans once the scheduled changes in the tax law were resolved. They are now resolved. Of course Congress could act again, and make further changes — but that seems unlikely, and probably would only happen after a lot of discussion. In other words, you should treat the current federal estate tax law as likely to outlast the life expectancy of your estate plan.

What needs changing, and how do you know if you are a candidate for change? Of course we can only answer that after a consultation, and for that you need to make an appointment and bring us detailed (and, for existing clients, updated) information. But here is a preview of what you are likely to talk with us about:

Do you have an existing A/B (or marital/bypass, or survivor’s/decedent’s) trust split in your plan? You probably do if you are married, if you are worth anything close to $1 million (or more), and if you had your estate plan prepared in the past quarter-century or so. Do you still need that trust split? Likely not. Does it hurt anything to have it in your plan? Maybe — it might make your estate plan unnecessarily complicated, but it might actually have negative income tax consequences.

Does your existing trust have “disclaimer trust” provisions? If so, you might consider revising to take them out. They probably don’t hurt anything, other than to make your estate plan that much more complicated, and to distract you from your real concerns — taking care of your family, supporting your favorite charitable cause(s), or whatever is truly important to you and your estate plan.

Are you a surviving spouse, living with an already-funded bypass/credit shelter/decedent’s trust? You might be able to make changes. State laws vary, and circumstances vary even more — but at least in Arizona there might be some opportunity to simplify  your life, reduce administrative costs (like annual tax returns) and even save your heirs a few dollars in income tax liability.

Has it been more than five years since you last visited a lawyer? If so, it’s time to update your estate plan anyway — just think for a moment about where you were five years ago, what you didn’t yet know about your family, your finances or whatever has changed. Even with no congressional action it would have been time to revisit your estate plan if it’s been that long.

Have your circumstances changed very much since your last estate planning visit? Have you gotten a new child or grandchild? (Mazel tov!) Have you moved to a new state,  married or divorced, become significantly more wealthy (or less)? Bought a vacation home in another state? Become interested in a new charitable undertaking? If any of those things describe you, it’s time to talk to your estate planning lawyer.

Are you worth between about one million dollars and five million dollars (make that ten million for married couples)? Then you are in the group of people who most need to check in with your estate planning lawyer.

Is this just a thinly-disguised attempt to drum up business? No. We’re in total agreement if you have someone else doing your estate planning and you go back to them. We obviously can’t handle your estate planning if you don’t live in Arizona, and it’s difficult for you and us if you live outside of southern Arizona. We just want to encourage everyone to update their estate plans in light of the relative permanence in the federal estate tax rules.

What bad things happen if you make an appointment with your estate planning attorney? Well, you will probably have to write a check — but of course the cost of failing to plan is usually much higher than the cost of planning. You will also have to gather some information — but we are more interested in round numbers and rough conceptions about your assets than in picky details about which stock investments have done well or precise values of your family business. We strive to make your visit no more unpleasant than a routine dental checkup.

That reminds us. We need to call our dentist.

Gift Tax Limit Will Rise to $14,000 in 2013

NOVEMBER 19, 2012 VOLUME 19 NUMBER 42
Here’s the headline: the annual gift tax exclusion amount, which has been set at $13,000 per year since 2009, will increase next year by $1,000. That means you can give up to the higher figure ($14,000) to any one other person without having to file a federal gift tax return.

This confuses people, though it’s not really that complicated. Let’s take a shot at simplifying it.

The U.S. government imposes a tax on substantial gifts. It does that partly to protect the estate tax — if it was easy to just give away all your assets during your life, no one would ever be liable for an estate tax. But the government is not interested in making everyone file gift tax returns for the wool stocking cap and slippers you plan on giving your aunt for Christmas this year, so it has a threshold amount it ignores. In fact, that amount was well over the stocking cap and slippers in 1997, the last time Congress tinkered with it.

That year you could give $10,000 in a year. Your spouse could give another $10,000 (in fact, you could give $20,000 and just say half was from your spouse). Congress decided that figure ought to be adjusted each year for inflation, but no one relished having to remember that in 1998 the figure was $10,257 or some such number — so they set it to increase only in $1,000 increments. The first time it actually increased (to $11,000) was in 2002. It’s been at $13,000 since 2009, and next year it will go up to $14,000.

Here’s the confusing part, at least for most people: it doesn’t mean that you can’t give more than $14,000 (next year) to someone. It doesn’t even mean that you’ll pay a tax if you do. It just means that if you give more than $14,000 to one person, you will have to file a gift tax return. No tax will be due until the total amount of gifts in your lifetime exceeds — well, this is another confusing part of the story. Let’s just say, for now, that all the gifts in excess of the applicable annual exclusion amount each year must total $1 million over your lifetime before you owe any gift tax.

You may have read that the actual figure for 2013 (the amount you have to give away, in excess of your annual exclusion amounts) is $5.12 million. That figure is scheduled to revert to $1 million next year. Nearly everyone who follows these things expects Congress to change the $1 million figure to something larger, though it is unclear what the final figure might be. No one is sure when that change will be finalized, though few expect Congress to act before December 31 of this year.

Does that mean that the $14,000 figure is unsettled? No, it does not. This scheduled increase in the annual gift tax exclusion amount is independent of the tax cuts scheduled to expire next year, and is unlikely to be changed by Congress even if it does act on the larger tax questions.

Many people, and many tax advisers, have counseled wealthy individuals that they ought to consider making substantial gifts before the scheduled reversion to (approximately) 2002 tax levels. For people worth substantially more than $1 million, and especially for those worth well over $5 million, that is probably good advice. But for most people, the increase in the gift tax exclusion figure — the new $14,000 number — is actually more important. It allows the modestly wealthy to make larger lifetime gifts without worrying very much about gift taxes or the prospect of estate taxes.

Let us assume, for a moment, that you are in your sixties or seventies, that you have three adult children and six grandchildren, that you are married, and that you and your spouse are worth $1.5 million. Should you hurry and give away most of your money before the end of 2012? Probably not, as you are likely to be uncomfortable with the prospect of not having complete control over your money for the next decade or two.

That is especially true starting next year, when you and your spouse can give $28,000 per year to each of your children (and, if you are so inclined, another $28,000 to each of their spouses). On top of that, you can give $28,000 to each of your six grandchildren each year. If you feel the need to reduce the size of your estate to below the $1 million taxation level, you can give away over $250,000 without even having to file a tax return — much less pay any tax. You have quite a few years left to accomplish that goal, and you can probably wait to see what Congress does before making any rash decisions.

Your circumstances will almost certainly vary, of course, and that is what good legal advice is all about. You should discuss your individual situation with your estate planning attorney to determine the best course of action for you. But the increase in the annual gift tax exclusion amount gives you just a little more flexibility as you make your plans.

There are at least two other points we should make about the gift tax rules before we leave the subject:

  1. Arizona does not have a gift tax (or, for that matter, an estate tax) at all. If you live and die in Arizona, and all your property is here, you simply do not have to worry about state taxes on the transfer of your wealth to your children or other beneficiaries.
  2. The gift tax exclusion is not the only way you can make tax-free gifts. You can also pay for medical and education costs (you have to pay directly, not just make a gift to one of your children earmarked for college, for example). You can also make charitable gifts without worrying about the limit (your charitable gifts may also give you some income tax breaks, but that is a completely different story).

We hope that helps you understand the gift tax system. We plan on providing updates on the estate tax changes we expect to see over the next few months; stay tuned for the next wave of complications. But we think it pretty likely that this small scheduled change will actually be more important to most readers than what Congress does with the estate and gift tax system.

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