Posts Tagged ‘Estate Tax’

Disclaimer Ineffective When Signed After Accepting Benefit of Property

AUGUST 13, 2012 VOLUME 19 NUMBER 31
A recent Arizona appellate court decision gives us an excuse (not that we really needed one) to write about an arcane planning technique: disclaimer. How do you disclaim an interest in property, and why might you want to? We’ll see if we can give you an introduction to the concepts. Warning, though: this will be brief, and Arizona-specific. If you have a real-world question, talk to a lawyer in your jurisdiction.

When J. Scott Gardner died in Phoenix in 2008, he left a house in the Prescott area. The house had a $205,330 mortgage; Mary Richards (not her real name) lived there. Mr. Gardner’s trust directed that Ms. Richards should be able to live in the house, provided that she pay all taxes, utilities, homeowners association fees and insurance. She was also to pay “any other reasonable and customary fees that would normally accompany a property.”

The trust directed that when Ms. Richards died, Mr. Gardner’s two children would take ownership of the house. Mr. Gardner’s brother was named as trustee of the trust.

The trustee’s first question arose pretty quickly. Who was to pay the mortgage payments on the house while Ms. Richards lived there? He turned to the local probate court for instructions; the judge ruled that Ms. Richards should pay the interest on the mortgage, and the two children could pay the principal amounts due on each payment (since principal reduction on the mortgage would ultimately flow to their benefit).

Now a second problem arose. Mr. Gardner had died just before real estate values all across Arizona declined steeply, and everyone agreed that the house was no longer worth the amount of the mortgage. Ms. Richards had asserted her right to use of the house in correspondence among the parties, but had not paid the interest payments even after the probate court directed that they were her responsibility. In May, 2010 — a year and a half after Mr. Gardner’s death and Ms. Richards’ assertion of her interest in the property — she sent the trustee a letter attempting to disclaim her interest.

Why would she do that? The appellate decision does not deal with the parties’ strategy, but it is fairly easy to deduce her reasoning. If she was held to have taken possession of the house, then any money she was entitled to receive from the rest of Mr. Gardner’s trust estate would be reduced by the unpaid interest — and that interest debt would continue to accrue until the property was disposed of. Since there would likely be no net return from the sale of the house, that would mean that her inheritance was being reduced by the amount of the interest payment each month.

It doesn’t actually matter to the legal issue, but you probably are wondering what happened to the house. The trustee asked the probate court for permission to stop making any payments on the mortgage. The judge agreed that it made no economic sense to keep paying on a house with no equity, or even a negative equity, and so payments were stopped. The mortgage holder repossessed the property. But the legal problem remained: did Ms. Richards owe the trust the unpaid interest payments?

The probate court decided (and the Arizona Court of Appeals agreed) that Ms. Richards’ attempted disclaimer was invalid. To be valid under Arizona law, a disclaimer of a bequest or inheritance must be in writing, signed by the person disclaiming, and delivered (or recorded) according to the statute. If all those conditions are met, then the disclaimer can be effective — and it has the effect of causing the disclaimed person to be treated as if they had died before the person transferring the property to them.

There are two other important rules, though, and one of those tripped up Ms. Richards. A person can not disclaim property after they have already accepted it — or received the benefit of the property. Since Ms. Richards had possession of the Prescott house, knew of her liability for payment of expenses and asserted her interest in letters she wrote to the trustee, she could no longer disclaim her life estate.Estate of Gardner, August 9, 2012.

The other “rule” about disclaimers, widely understood, is actually a little bit trickier. Most lawyers, when asked about disclaimers, will recite the requirement that any disclaimer must be completed within nine months of the date on which the property interest would have passed (ordinarily, the date of death of the person leaving the property to the disclaimant). That is actually a requirement of federal tax law — in order to receive favorable tax treatment a disclaimer must be within that time limit. Some states have also adopted that nine-month limitation for all disclaimers, but Arizona has not. A disclaimer within the nine months is usually said to be a “qualified” disclaimer — a disclaimer that is otherwise valid under Arizona law but not qualified for favorable tax treatment is, unsurprisingly, known as a “non-qualified” disclaimer.

All that begs the question we began with: why would anyone want to disclaim the inheritance or gift they were set to receive? There are lots of reasons. A few of the more common ones we see:

  • The recipient has a very large estate, and is happy to have the inheritance pass on down to (usually) the next generation — perhaps to keep from having a large estate tax on their own estate, or perhaps just because they don’t want or need the inheritance.
  • The recipient has a lot of debt, and creditors standing ready to seize any property they might inherit. By disclaiming, the intended recipient can allow the property to get to the next recipient without being subject to those creditors’ claims.
  • The recipient does not feel deserving of the gift. Perhaps the decedent’s will or trust was written years earlier, when the recipient and the decedent were close friends or business associates — or romantically involved. The recipient might feel uncomfortable taking the property after a long estrangement, and recognize that the only reason the decedent didn’t make changes in his or her will or trust was the ordinary inertia that sometimes overcomes people faced with estate planning decisions.
  • The alternate beneficiary is particularly well-suited to handle the property. Perhaps it is a well-crafted special needs trust benefiting a close family member, or a charitable organization set up to deal with the property in question. The recipient might decide to just let the next person or entity in line deal with the inheritance.
  • Perhaps the property is more of a liability than a benefit — as turned out to be the case for Ms. Richards. We have seen other cases where the property subject to the inheritance was tainted by pollutants, or subject to a big property tax liability.

One key thing to understand about disclaimer: if you sign an effective disclaimer, you have no control over where the property goes. You can not disclaim “to” another person. When you disclaim, the property passes as if you had predeceased the donor; that might be to someone (or some entity) you don’t like or don’t approve of. If that troubles you, disclaimer might not be for you. The only way to control where the property goes is to accept the inheritance and then make a gift yourself — and that might involve creditor claim issues, estate tax issues or even gift tax issues. Get good legal advice. But at least now you’ll be a little bit familiar with the concepts.

Tax Identification Numbers for Trusts After Death of Spouse

MARCH 26, 2012 VOLUME 19 NUMBER 12
Here at Fleming & Curti, PLC, we keep tabs on what brings people to our website. We look at referring pages, at search terms and at a variety of other items. We are intrigued by what persistently tops the search-engine list. The most common search? It’s some variation of: “do I need a new tax ID number for my living trust?” (For those keeping score, the second-most-common question seems to be “can I leave my IRA to a living trust?“)

Why the enduring interest? Because the question is so much less complicated than people think it is. There is a surprising paucity of clear information about when you need to have a new tax ID number (an EIN, if you want to use the correct acronym). And much of the information out there is contradictory.

We have written about the question several times before. In 2009 we asked and answered the question: “Do you need a new tax ID number for your living trust?” Just last year we reviewed the question, along with some other reader questions, and provided a little more detail on when your trust needs an EIN. Since those two explanations the rules haven’t really changed — but your questions have gotten a little bit more sophisticated.

Several of those questions deal with the same basic scenario: what happens when a husband and wife have a joint trust, using one spouse’s Social Security number, and then that spouse dies? The answer will depend on what the trust provides.

First, a word about joint trusts for spouses: they are common in community property states (like Arizona), not as common in those states where community property principles do not apply. Remember, please, that we are Arizona lawyers, and so we write here about Arizona rules. Attorneys from other states are more than free to add their comments; we will post them as we receive them — but we are not vouching for the accuracy of their advice in states other than Arizona.

Let’s set up a scenario, drawn from our common experience: Husband and wife created a joint revocable trust, and their bank accounts, brokerage accounts, insurance — all of their assets, in fact — listed the husband’s Social Security number. They could do that because, as with a joint account outside of a trust, tax rules allow one owner’s identifying number to be used rather than having to use all owners’ numbers. But now the husband has died. What should the (surviving) wife do about the TIN (Taxpayer Identification Number)?

Before we answer, we need to know what happens to the trust on the death of the first spouse. Let’s assume, for a moment, that it remains in one trust, that the wife now has the power to amend or revoke it in its entirety, and that she is the sole trustee. In that case, the direction is easy: tell the bank, the brokerage house and the insurance company to change the name of the trustee from the couple to the wife, and to change the TIN to the wife’s Social Security number. How do you do that? Send them a death certificate and a letter instructing them to make the changes. Assume, incidentally, that they won’t — it will often take you two or three tries, several phone calls, and some wheedling to get the task done. But that’s what should happen.

What if the wife is not the sole trustee? Let’s say, for a moment, that the oldest daughter now becomes co-trustee with her mother, but that the trust remains revocable and amendable by the wife. In that situation, we have the same answer: switch to the wife’s Social Security number.

What if the wife has the power to revoke or amend the trust, but she is now incapacitated? The oldest daughter is the sole trustee, and isn’t sure what to tell the financial institutions. The answer is still the same: the trust is still revocable (even though there may be no practical way to revoke it if the only person with power to do so is incapacitated), and the wife’s Social Security number is the trust’s TIN (expect to have an argument with the financial institutions over this one). Is a bank trust department the successor trustee instead? Same answer — but with the ironic twist that the argument between trustee and financial institution will now occur between two branches of the same organization.

Sometimes a joint revocable trust becomes irrevocable on the death of one spouse. More commonly it splits into two (or sometimes three) portions, one (or two) of which are irrevocable. What happens then? The answer, as you might expect, is a little bit more complicated — and may not be the same in every case.

Generally speaking, an irrevocable trust that does not contain the assets originally belonging to the beneficiary is likely to need its own EIN. That may mean that one (sometimes two) of the trusts resulting from the death of one spouse needs a new EIN, and one just uses the surviving spouse’s Social Security number.

Let’s use a specific example: in our earlier scenario, after the death of the husband the joint revocable trust splits into a “Decedent’s” (sometimes “bypass”) share and a “Survivor’s” share. The Decedent’s Trust is irrevocable. Wife is the trustee, and she is entitled to all the income from the trust. She may even have the ability to distribute trust principal to herself, or to decide how the Trust is divided among the couple’s children at her death. But this trust is not  “grantor” trust — it gets taxed as a separate entity. Hence, it needs its own EIN, and it files its own tax returns.

Mechanically, the process of dividing the trust is a little more complicated than in our earlier scenario. An estate tax return may be required (although it may not). A division of trust assets needs to be completed (the assistance of a competent lawyer and a good accountant is essential here). The share to be assigned to the Decedent’s Trust needs to be identified, and then physically transferred into a new account — often titled something like “The Jones Family Trust — Decedent’s Trust” (yeah, we know — your name isn’t Jones. Stick with us anyway). And that new account needs to use the Decedent’s Trust’s new EIN.

Note that we said that the assets need to be transferred into the new account. Most financial institutions will insist on opening a new account, with a new account number, rather than simply changing the name on an existing account. But when the process is completed — however you and the financial institution get there — the Decedent’s Trust should be physically separated from the Survivor’s Trust, it will have its own EIN, and it will need to file tax returns. Note: it probably will not pay any tax as a separate entity — all its income will  probably be imputed to the surviving spouse.

Meanwhile, the remaining trust assets in our example will continue to use the wife’s Social Security number. It may not be crucial to change the name on that account to “The Jones Family Trust — Survivor’s Trust” (those Joneses — they end up will all the money anyway). If you long for clarity, we would certainly support a transfer of the Surivor’s Trust share into a new account, titled as part of that sub-trust, and bearing the wife’s Social Security number — even if it is not required.

Recall, please, that there are lots of variations on this basic scenario. Be careful about generalizing from this information to your precise circumstances. Our goal here is to give you some general notions about what needs to be done — we do not think of ourselves as a substitute for good, personalized legal advice. We think, in fact, that you should get some of that, because your situation might well be more complicated than you think it is. But we hope we’ve given you some idea of what your attorney will be asking you, and what he or she is likely to tell you.

Failure to Distribute Estate On Time Leads to Damages Award

JULY 5, 2011 VOLUME 18 NUMBER 24
Family members sometimes assume that an estate will be ready for distribution within days or weeks of a death. Those familiar with the probate process usually appreciate that it is more likely that distribution will be between six months to a year after death — and sometimes longer. When the decedent established a living trust, though, survivors often expect the final distribution to be faster. Everyone has gathered for the funeral, including out-of-town children and grandchildren — shouldn’t there be a check ready to hand out while the whole family is together?

The reality is that administration of an estate, even when a trust is involved, can take much longer. A good rule of thumb: it may still take six months to a year to prepare final income tax returns, gather trust assets, liquidate those which need to be sold (and not all will need to be sold in most cases), make calculations and actually complete the distribution. If there are more complicated issues, like estate tax liability, it may take even longer.

Delay in distribution of a trust estate was the issue involved in a recent Indiana Court of Appeals case. Harrison Eiteljorg’s will had provided a trust for his widow, Sonja Eiteljorg. When she died in 2003, the trust was to be divided into two shares — one each for Harrison’s sons Nick and Jack. Nick, a stepson and Harrison’s accountant were the co-trustees.

The trust was large — it held about $13 million of assets. That meant that an estate tax return had to be filed, and taxes totaling $6.2 million paid (remember that in 2003 tax was imposed on estates greater than $1 million). That was accomplished by late 2004, but the trustees were worried about closing out the estate and distributing the remaining assets. What would they do if the IRS disagreed with their calculations of values and imposed an additional tax liability.

At a heated meeting between the co-trustees and the two sons, Nick demanded a partial distribution of $2 million (half each to himself and Jack). The other trustees declined, saying that they worried that additional tax of up to $2 million might be imposed, and a distribution as large as Nick wanted would leave the trust with too little cash if that happened. They proposed instead to distribute $1 million to the two sons. Nick and Jack left the meeting without agreeing, and both sides hired new lawyers to battle out the timing and amount of a distribution.

A few months later Nick and Jack filed a petition with the Indiana probate court asking for removal of the co-trustees and entry of a judgment against them. Their argument: there was no reason not to distribute the requested $2 million when demanded, and failure to do so breached the trustees’ duty to the beneficiaries. The trustees answered, arguing that they needed to retain substantial liquidity until the IRS finally accepted the estate tax return (or imposed additional tax liability, if that was to be the outcome).

About a year after their original demand for partial distribution, Jack and Nick secured an order from the probate judge requiring that $1.5 million be divided between them. The co-trustees complied. The court proceedings then shifted gears to address a two-part question: did the delay in distribution amount to a breach of fiduciary duty, and (if it did) what were the damages due to Nick and Jack?

The probate judge found that the delay did amount to a breach of fiduciary duty. Nick testified that he would have put his distribution into two mutual funds, and that it would have grown significantly during the months he was deprived of its use. Jack testified that he had planned to purchase real estate in Texas, and that it would have appreciated. In addition, Nick and Jack had incurred attorneys fees totaling $403,612.81.

Based on the damages testimony, the probate judge awarded Nick $156,701 in “lost” profits from the funds he could not invest in. Jack was awarded $112,046.77 in missed real estate gains. The remaining co-trustees were ordered to pay those amounts from their own pockets, as well as all but $50,000 of the attorneys fees.

The Indiana Court of Appeals had a different take on the case, and significantly reduced the damages award. First, two of the three appellate judges agreed with the trial judge that failure to distribute the funds earlier was a breach of fiduciary duty. Rather than giving Nick and Jack the profits they said they would have earned, however, the two judges limited their damages to the interest that the $1.2 million would have earned during the nine months it was delayed — and even that damage award was to be reduced by the amount of interest the money actually earned in the trustees’ hands. The appellate court also reduced the attorneys fee award to a total of $150,000 — what they called “a more appropriate assessment.” In the Matter of Trust of Eiteljorg, June 27, 2011.

One appellate judge would not have gone even that far. According to the dissenting opinion he authored, there was no breach of fiduciary duty. After all, he reasoned, the co-trustees offered to distribute almost exactly what was ordered a few months later, and Nick and Jack rejected the partial distribution plan. Retaining at least $2 million in liquid assets until the estate tax return had been accepted was a reasonable and prudent course, according to the dissenting opinion.

What lessons can we draw from the Eiteljorg case? Several come to mind:

  • Even with a trust, it may take months or years after a death to complete the administration and make final distribution. That is not the usual circumstance, but it can happen.
  • Although avoidance of litigation is one common goal of trust planning, it is not always effective. And the cost of probate or trust litigation can be significant — note that Nick and Jack incurred legal fees of about one-third of the total amount they sought as distribution, and that the question was not whether they were entitled to the money, but only when.
  • In addition to increasing cost, litigation can slow down the process. Here, the co-trustees were ready to make a significant distribution at the first meeting, but the court-ordered distribution (of almost exactly the same amount) was delayed for nine months.
  • Acting as trustee can sometimes be costly. The co-trustees in this case will be liable for at least $150,000 out of their own pockets. We can anticipate that Nick and Jack will object to any attempt to pay the trustees’ own lawyers from trust assets, or to pay any fees to the co-trustees.

When Is a Living Trust More Appropriate Than a Will?

JUNE 6, 2011 VOLUME 18 NUMBER 20
Last week we answered a pair of questions from our readers and solicited others. Almost immediately we received an excellent question:

What are the factors you look at to determine if a client is best served w/ a will and durable power of attorney or a living trust? In other words, what are the key factors that would lead you to recommend a living trust?

Let us start with a quick disclaimer: the answer to this question is significantly different from state to state. What is true in Arizona may not be the same in other states — and some states will be wildly different. Even for lawyers in the same state there is significant difference of opinion; we are fond of saying that if you ask ten lawyers for their opinions you are bound to get at least fifteen strongly-held, well-reasoned views. Disclaimers aside, what follows is our take on the question.

We think most people do estate planning for one or more of these four reasons:

  1. To minimize taxes. Usually, but not always, that means estate taxes.
  2. To avoid probate, or (more broadly) to simplify matters for their heirs or successors.
  3. To control the way their assets are used after their death.
  4. To make it easier for someone to handle their affairs in the event of their own incapacity or disability.

Which does better at each of those tasks, a will and powers of attorney or a revocable living trust? In almost every case the trust will handle each of those tasks better than a will and powers of attorney. But that is not really the right way to address the question. Since trusts are somewhat more expensive to prepare (assume your lawyer will charge from three to ten times as much for preparation and “funding” of a trust as for a will and powers of attorney) and involve some extra effort, the analysis really becomes one of cost vs. benefit. Will the extra expense and effort of creating a living trust generate enough savings of time or money for heirs that it will turn out to be the right choice?

For most people, the answer is unclear. There are a handful of our clients for whom the trust is unquestionably the right technique, and another handful for whom the trust is not harmful but simply too much legal help for a problem that doesn’t exist. But most of our clients fit into the large middle ground — it would not be foolish of them to opt for a living trust, and it would not be foolish of them to avoid the expense and trouble now and let their heirs deal with it later.

So how do those four estate planning goals relate to the will vs. living trust question? Here’s what we think:

Taxes. Few people need to worry very much about estate taxes these days. With a federal exemption set at $5 million, and no Arizona state estate tax at all, only a tiny fraction of clients have estates large enough to make their decisions on the basis of tax effect.

It is true that the federal estate tax is scheduled to return to the $1 million level in 2013. It is also true that the Arizona legislature could decide to reimpose an estate tax (though most people think that highly unlikely). But for most people, even a taxation level set at $1 million would not make any difference in their planning.

But that’s not the end of the inquiry about taxes. Even if your estate is large enough for you to worry about estate taxation, there is no inherent tax benefit in living trusts. There used to be a way for married couples to lower their combined estate tax bill if their total estate was over the taxation level, but even that has changed (though of course it might change back in 2013). Bottom line: estate tax concerns simply do not drive the trust vs. will question in 2011 the way they did in, say, 1999. And if you are unmarried, or if you are married and your combined estate is less than about $1 million, you simply do not care about estate tax considerations.

Probate avoidance. Arizona’s probate process is not nearly as complicated as its reputation would suggest. It is also not nearly as expensive. Have you read stories about estates that have gone entirely to the lawyers because of a messed-up probate system? Yes, it does happen — but not really because of the system so much as because of family disputes over the validity of documents (including, increasingly, living trusts).

That said, most people will say that even a modest probate cost and time spent in lawyers’ offices would be something worth avoiding. What you need is a solid estimate of what it would cost to probate your estate if you relied on a will instead of a living trust, so that you can compare that cost to the cost of opting for a living trust. It is too hard to generalize about either expense, but we are prepared to go this far: in Arizona, the cost of preparing a living trust (and “funding” it — transferring all your assets into the trust’s name) will almost always be less than the cost of probating your estate later. But not necessarily by much.

There are some other points to be made here. If you own real estate in more than one state, your will must be probated in each of those states (unless you create a living trust or other probate-avoidance mechanism for some or all of those properties). That can drive the expense up considerably, and certainly complicates things for your family. On the other hand, if you have less than $50,000 worth of personal property and no real estate at the time of your death, no probate proceeding is likely to be needed anyway, since there is a “small estates” affidavit mechanism to avoid the probate process.

In general terms, larger estates tend to be more complicated to administer. More complex estates are better candidates for a living trust. So if you are wealthy, probate avoidance is more likely to be a concern for you — and especially if you have unusual assets, or real estate in multiple states, or other uncommon kinds of property issues.

One special consideration here: if you are married, you are probably comfortable putting most or all of your assets in “joint tenancy with right of survivorship” or designating your spouse as beneficiary. You might not feel the same way if you are single; it is not quite as easy (or advisable) to put your children or other beneficiaries on your bank and stock accounts as joint owners. So single people are usually better candidates for living trusts as a means of avoiding probate.

Control. We use the word advisedly. That’s what you might want to do with your funds, even after your death. Are you in a second marriage, with children from the first marriage, and a desire to provide for your spouse but ultimately pass most of your estate to those children? Maybe you have a spendthrift son (or a son who has married a spendthrift). Perhaps your daughter is disabled, and receiving government benefits she would lose if you left her an inheritance outright. Or maybe you want your money to be a retirement fund for your children, or to encourage your grandchildren to get an education, or some other laudable goal you are trying to achieve.

How can you address all of those issues? By putting your money in trust, with a trustee who has been instructed on how you want the money to be used.

You don’t have to create a living trust to put your money in trust. Instead you can create a trust in your will — what we lawyers call a “testamentary” trust. But it will cost you more, and the difference between the cost of a will (with your testamentary trust) and a living trust will shrink. So if you need (or just want) to control the uses of your funds after your death, you will be a better candidate for a living trust.

Your own incapacity. This is why you should sign a power of attorney. It is simultaneously one of the most important documents in your estate plan, and the single most dangerous one. But the cost of going through the courts (in a probate-like proceeding called a conservatorship) is almost always high and the invasion of privacy significant.

There are some times when a power of attorney just won’t solve the problem, though. Plus it is hard to predict when those times arise. Banks, title companies, the federal and state governments — none of them are required to accept the power of attorney. If you sign a living trust and transfer all of your assets to it, though, the problem becomes simpler and narrower: if your successor trustee can show the item the trust calls for (like a letter from your doctor, for instance), then the successor trustee just takes over. There will probably be somewhat fewer problems administering your affairs with a living trust than with a power of attorney.

We don’t want to overstate this benefit, however. It is almost never valuable enough to justify creating a living trust all by itself. As far as we are usually willing to go on this score is to suggest that, if one or more of the other categories make you a good candidate for a living trust, this one might put you over the top.

There’s one more category of living trusty candidates we can suggest: those who are more likely than others to (how can we say this gently?) “use” their estate plans in the next few years. In other words, the older you get the better of a candidate you become for a living trust.

So who should be considering a living trust as part of their estate plan? Look over the explanations above, and you will see that you are a better candidate for a living trust if you:

  • are older
  • are not married
  • are wealthy
  • have children who are not children of your spouse
  • have complicated assets, and especially if you
  • have real estate in more than one state
  • have beneficiaries with special needs, inability to handle money or other similar considerations

Again, we caution you against putting too much stock in these descriptions or applying them to your situation without good legal counsel. But look over this list of considerations and think about what they say about your estate planning needs. Share them with your own lawyer and ask for a thoughtful, critical evaluation. Your family and heirs will be glad you did.

Estate Tax Reform 2010 — Is It Over Yet?

DECEMBER 20, 2010 VOLUME 17 NUMBER 39
The ink is not yet dry on Congress’s tax and unemployment insurance compromise. Signed just last week by President Obama, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 has now become law. It continues previous income tax breaks for everyone, regardless of wealth. It extends unemployment insurance coverage for an additional 13 months. It also rewrites the estate tax — it does not simply carry forward the estate tax rules adopted a decade ago.

Under the new law no estate tax will be due on estates of less than $5 million. Since there is no Arizona state estate tax, that means that only the wealthiest Arizonans (or those with significant assets in other states which do impose an estate tax) need to be concerned about estate tax rules at all. It should mean that estate planning just got easier, more predictable and lower-risk for nearly all of our clients.

It should mean that, but it may not. There are a number of details to watch out for, including:

  • If you are married and your estate plan was initially prepared a decade or more ago, you might well have a two-trust arrangement. Sometimes described by the shorthand “A/B trust” designation, such an arrangement can actually now increase the total tax paid by your heirs. How could that happen? If a separate trust is created and funded at the first spouse’s death, assets assigned to that trust will not get a stepped-up basis on the death of the second spouse. Under the new law you can get an equivalent estate tax result and still preserve the 100% step-up in income tax basis at the second spouse’s death.
  • If a loved one died during 2010, the heirs get to choose which tax regimen to adopt — either the no-tax choice originally in place for 2010 or the $5 million exemption now adopted. Since the $5 million option includes full stepped-up basis (the original 2010 structure limited the step-up to $1.3 million for unmarried decedents), it may actually be beneficial to opt for the new taxable-estate option. Hard to figure out? Yes. The good news: you have until September, 2011, to decide which option is better.
  • The $5 million exemption is now “portable.” That means that if your spouse dies without having planned to use the exemption, it is still available to you. In other words, a couple effectively gets $10 million in estate tax exemption without having to prepare any planning documents. One small caveat: if the surviving spouse remarries and their new spouse predeceases, they lose the original unused exemption amount (but still get to use any unused exemption from the second spouse). It looks like Congress has (perhaps unwittingly) created a new marriage-discouraging provision for seniors — or at least for wealthy seniors.
  • For a decade we have been saying that the most important estate tax principle would be certainty. If you are pretty sure you know what the estate tax will look like for the next five years or so, you can plan accordingly. Unfortunately, Congress and the Administration have given us only two years of certainty — and much of the certainty we have is that the issue will be politically charged and intensely debated for much of that two-year period. In fact, Vice President Biden told a national television audience Sunday morning (on NBC’s Meet the Press) that “scaling back … the estate tax for the very wealthy” would be a top priority for the Administration over the next two years.
  • The new law also increases the level at which both gift taxes and “generation-skipping” taxes are an issue. Both of those also set at the $5 million level for the next two years. If either or both returns to lower levels after 2012, that could mean an important planning issue for very wealthy individuals in the meantime. Should gifts be made now, just in case? Should gifts be made to grandchildren and later generations, just in case? Expect to see more about those issues in coming months.
  • Paradoxically, the new rules could mean that more people (at least more wealthy decedents) should be filing estate tax returns — even though no estate taxes are due. Penalties for failure to file are higher, the importance to surviving spouses has increased and the stakes involved have generally gone up.

Does all of that sound like the issues are resolved? No — but the plain fact remains that a tiny minority of Americans are wealthy enough to be worried about any of these issues. How do you know if you need to worry? Take this quick four-question quiz:

  1. Is your entire estate (including life insurance, IRAs and retirement accounts) worth less than about $2 million? Whatever happens in the next two years, it is pretty unlikely that the estate tax level is going to return to a number below about $3.5 million (the favorite number kicked around by Democrats during debates over the past year).
  2. Are you married? If so, you can double the estate value in the previous question.
  3. Do you live in Arizona (or another state with no estate tax)? There are only about a dozen states where state estate tax is important — Arizona is not one of them.
  4. Are you middle-aged or older? If so, are you comfortable assuming that your net worth will not dramatically increase in the next few years?

Depending on your answers, your estate planning choices are likely to be simplified. You should check to see whether you now have estate planning provisions that are no longer needed. You should also check whether your non-tax planning issues have been addressed. Do your documents name the right person to act as trustee, health care agent, personal representative and financial agent? Do they leave your assets to the people (and organizations) and in the proportions that you want? Do they refer to events, locations or items that are no longer relevant?

How to Leave Your IRA to a Trust — And Why You Might

OCTOBER 4, 2010 VOLUME 17 NUMBER 31
Last week we wrote about how you can go about leaving your IRA (or 401(k), 403(b), etc.) to a child with a disability. In passing we mentioned that the discussion about how to leave your IRA to any trust could wait for another day. Today is that day. Let’s tackle this as a Q&A session (or, if you prefer, we can call it a FAQ list).

Can I name a trust as beneficiary of my IRA?
Yes. That was easy.

Are the rules the same for 401(k), 403(b) and other retirement accounts?
Generally, yes. If you have more esoteric retirement accounts, talk to someone to make sure you are doing the right thing. What the heck — talk to an expert in any case. Our purpose here is just to give you some background and introduce the language and issues, not to give you direct legal advice.

Before you tell me how to do it, why would I want to name a trust as beneficiary of my IRA?
There are several reasons you might:

  • If you have a child who is a spendthrift, or married to a spendthrift, or who is involved in tax issues or legal proceedings, you might want the retirement account to be protected against creditors.
  • If you worry that your child might get divorced and want to keep your retirement account out of the divorce calculations and proceedings, a trust might help protect the account (and, for that matter, other assets you are considering leaving to that child).
  • You might just want to delay the withdrawal of your retirement account as long as possible. Of course, you could name your child as beneficiary and trust him or her to withdraw the money as slowly as is permissible. With a trust you can help assure that “stretch-out” of the IRA.

Why is my banker/broker/accountant telling me I can’t name a trust as beneficiary?
That used to be the rule, and lots of professionals are not yet caught up. There are also a couple of special rules that apply when you name a trust as beneficiary — though they are not at all hard to comply with, so it’s not clear why advisers get hung up on those rules. Finally, even though the rules permit naming a trust as beneficiary they do not require all account custodians to go along — so your broker might be telling you that, while the rules permit naming a trust, your account can not take advantage of those rules.

If I want to name a trust as beneficiary, what must I do?
There are a handful of requirements. The important ones: give the IRA custodian a copy of the trust (that, by the way, can be taken care of later — but you can do it now if you want), name only one income beneficiary for the trust, and make sure your beneficiary designation comports with the trust set-up and your larger plans. That probably means you should get competent professional assistance, but that’s usually a good idea for your estate planning anyway.

Are there bad things that happen if I name a trust as beneficiary?
Yes, but not very bad. Depending on the ages of all the beneficiaries and potential beneficiaries, you might have shortened the stretch-out time to a period less than the life expectancy of the primary beneficiary.

Uh, could you please repeat that — in English?
Of course. Let’s use an illustration.

Suppose you have three children: Abigail, Ben and Candy. You are OK with Abbie and Ben getting their shares of your IRA in their names — you trust them to make sound judgments about how quickly to withdraw the money, and you don’t want to bother with a trust for them. Candy is a different story. The details of that story don’t matter: you just want to put Abigail in charge of deciding whether to withdraw more than the minimum amount each year from Candy’s share of the IRA.

You can name a trust for the benefit of Candy as beneficiary of 1/3 of your IRA (naming Abbey and Ben as the other two beneficiaries outright). But what will happen if Candy dies before the IRA is closed out?

As it happens, Candy does not have children. You decide to have the trust say that upon Candy’s death the remaining trust interest in “her” share of your IRA will go to Abigail and Ben. Abigail is ten years older than Candy. That all means that Candy will have to make her IRA withdrawals using Abigail’s age and life expectancy.

But wait. Candy does have children?
Well, why didn’t you say so? That makes it even easier. You can have the trust provide that if Candy dies before the last IRA withdrawal her children become the beneficiaries of the trust (and, indirectly, the IRA). As before, we use the oldest potential beneficiary as the determining age — and we are going to assume for the sake of this piece that Candy is older than all of her children. No effect on Candy’s withdrawal rate. But note that if Candy does die, her children will still have to withdraw from the IRA at Candy’s rate, not their own.

What about estate taxes?
Now you’re talking about a whole different kettle of fish (or something). As you know, the estate tax situation is in flux right now, and some states have their own estate tax rules. That makes it very hard to generalize, and unnecessarily complicates this discussion. Suffice it to say that your IRA will be part of your estate for estate tax purposes, and just because there is income tax due on it does not mean that there won’t also be an estate tax liability attached to it. But if your entire estate is worth less than $1 million, you probably are not going to care very much. Stay tuned for a new number to be inserted in that sentence sometime before the end of 2010.

That sounds pretty simple. Could you please make it more complicated?
We’d be happy to, but it’s not required. We could give you information about what lawyers call “conduit” trusts and “accumulation” trusts. We could explain why you can’t have the money go to a charity upon Candy’s death. We could even try to give you some better names for your imaginary children (while still adhering to the A, B and C convention). But for most of our clients, those complications are unnecessary.

The bottom line: it is not that hard to name a trust as beneficiary of your IRA, 401(k) or other qualified retirement plan. You just need to review the rules, and understand why you might want to do such a thing.

It is also permissible to consider all that, try to get the rules straight, and then decide not to bother. One thing that we don’t want to allow you to do, though: ignore the issue, prepare a will that seems to handle all of your assets, and then have an IRA beneficiary designation that doesn’t agree with the rest of your estate plan, imposes an undue burden on your children and beneficiaries, or fails to address your child’s disability, money problems or legal or financial situation.

We hope this has helped demystify a subject that lawyers and accountants often seem to enjoy complicating. Your life, however, tends to be complicated. Please get good legal, financial and investment advice before you decide what you should do.

Estate Tax or Death Tax — Who Actually Pays Any?

AUGUST 9, 2010 VOLUME 17 NUMBER 25
Want to read about the debate over estate tax reform/repeal/reinstatement? There is plenty of literature. You can easily learn about the history of the estate tax (going back to 1797 in the United States, or to the 7th century BCE elsewhere).

Want more? You can see the arguments in favor and against the estate tax, repeated endlessly, in any number of articles. Is the estate tax unfair double taxation, or an important tool to prevent outrageous asset accumulations?

How about real-life stories? You already knew that George Steinbrenner saved his family $600 million by managing to die during 2010 (although it turns out that the actual savings is much murkier and, probably, not near that number). But you probably have not heard of Iowan Eugene Sukup, who at 81 is contemplating what will happen to his considerable estate — and the family business — when he dies.

Maybe you make your decisions on the basis of the positions of famous people. How about what Bill Gates, Sr. (not the software innovator, but his father, who has spoken and written extensively on this subject) says about the estate tax? How about Alan Greenspan, former Federal Reserve chairman? Turns out it’s easier to find wealthy people speaking out in favor of the estate tax (albeit a “reasonable” estate tax) than against the tax altogether, but perhaps that is just because it is such a surprise, at least at first blush.

You know what is missing from most of the debate — and reporting — on the estate tax? Real numbers. Except for that last reference (the Washington Post’s “PostPartisan” blog), there is almost no mention in any of the articles collected here about how many people actually pay — or would pay — an estate tax on death. Are you curious? You may be surprised by the answer.

The best reference we could find is a December 18, 2009, report from the Congressional Budget Office. The non-partisan CBO manages, in a dense but readable 12-page report, to explain the interrelationship of the estate tax with gift taxation and the generation-skipping tax, provide a history of the revenue generated through the estate tax (shown as a percentage of all federal receipts), and describe the effect of all of the major proposals being considered by Congress.

It turns out that in 2004, when the estate tax applied only to estates worth more than $1.5 million, there were 19,294 estate tax returns on which the decedent’s estate owed any money to the federal government. That amounts to .82% of all deaths in 2004. Compare that to 1.14% of deaths in 2003 and 1.17% in 2002; in both of those years the estate tax applied to estates worth more than $1 million. Those details, incidentally, come from the Internal Revenue Service’s Spring, 2009 Statistics of Income Bulletin (if you try to locate the figures yourself, you’ll want to scroll down to page 222 of that lengthy report). The IRS has updated the figures for 2005 and 2006 and, not surprisingly, the percentage of taxable estates has dropped further. In 2005 (with a taxable level of $1.5 million, the same as in 2004), the percentage of taxable estates was .95. In 2006, when the taxable estate level went to $2 million, the number of estates reaching that level dropped to .63%. That was the smallest percentage since at least 1934, when the current tax code was first adopted.

So what does this all mean? Basically, with an estate tax level at about $1 – 1.5 million, right around 1% of decedents will pay any tax at all. At the $2 million level, that percentage drops to about 2/3 of 1%. If Congress proves to be paralyzed, by partisanship or otherwise, and the estate tax drops back to the $1 million level in 2011, then about 1% of decedents’ estates will, presumably, have to pay estate taxes.

That is not the end of the story, of course. It is not, for instance, the same thing as saying that 1% of people are worth a million dollars, or slightly more. Why are they not the same thing? For a variety of reasons, including:

  1. Decedents are, of course, older than the general population. It is likely that the decedents in a given year are somewhat wealthier than the population as a whole, but the statistics we have described here do not show that or even hint at how much difference we should expect. One thing the statistics DO take into account: the IRS removed deaths of children from the figures, so the percentage of ALL deaths paying estate taxes would be slightly smaller.
  2. Decedents with estates of just over the taxable limit have a variety of estate planning options to avoid any estate taxes. Married couples can plan to preserve the exemption for each spouse, those with slightly larger estates can use lifetime gifting, and devices like family limited partnerships and limited liability companies can reduce the value of the estate for tax purposes. Money left to charities or surviving spouses escapes taxation altogether. It is likely that a significant percentage of decedents transferred an amount of property to heirs that would have been taxable but for such techniques.
  3. Even if 99% of decedents avoid estate taxes completely, that does not mean that the estate tax system had no effect on any of them. Presumably another small but significant percentage (perhaps 1-5%) expended at least some funds on the estate planning necessary to avoid estate taxation. We know of no study indicating how many have done so, or at what cost.
  4. Inflation (if there is any) and wealth concentration trends will have continued since the 2002/2003 figures were calculated. In those years the percentage of decedents’ estates paying any estate tax were 1.17 and 1.14, respectively; of course, with the significant reductions in net worth for many Americans since those years the figures might actually drop for 2011. Over time, however, the percentage should be expected to grow. As it did, for instance, between 1987 and 1999, when the estate tax level remained constant at $600,000. During those twelve years, the percentage of estates subject to any tax increased from .88% (in 1987) to 2.3% (in 1999).

Of course, the estate tax level increased to $3.5 million in 2009 (before being eliminated entirely in 2010). The result of that near-doubling of the taxable level in one year has not yet been calculated and published. It will be interesting to see.

One final thought about the statistics developed by the IRS and the CBO: in 2004, with a taxable level higher than ever before and with the smallest percentage of decedent’s estates paying any tax whatsoever in the history of the modern estate tax, the IRS brought in a total of $22.2 billion. That was the fourth-highest haul in the history of the tax, and was about $4.5 higher than the two previous years, with taxable levels at $1 million (rather than the $1.5 million of 2004).

Why Do I Have To Complete That Darned Questionnaire?

MAY 31, 2010  VOLUME 17, NUMBER 18
You have made your appointment to discuss estate planning. Our office has sent you a reminder letter, an explanation of what will happen when you get here, a map with parking instructions — and an 8-page questionnaire, asking for all sorts of details about your family, your assets and your wishes. Why do we make you do all that work just to have an initial estate planning appointment? Because of William Bruinsma.

Mr. Bruinsma lived in a subsidized senior housing facility in Massachusetts. He visited his lawyer in 1993 and asked for help in preparing a “simple will.” He was very secretive, and did not want to tell his lawyer about his assets. He did insist that he didn’t want to spend too much money in legal fees, and he wanted his will to be simple.

Estate planning lawyers are very familiar with the type of client. In fact, no estate planning attorney we know has ever heard a client ask for a “complicated” will — everyone thinks their wills should be simple.

What Mr. Bruinsma wanted sounded simple enough. He wanted the income from his assets (whatever they might be) to go to his sister and his long-time friend. After both of them died, the remaining money should go to a group of charities. The simple will his lawyer prepared was just two pages long.

Five years later Mr. Bruinsma died, and it turned out that his estate was about $1.7 million. The will was so simple that his estate did not qualify for a charitable deduction — meaning his estate would pay about $466,733 in federal and state estate taxes that could have been easily avoided if the lawyer had known he needed to prepare a slightly more complex will.

Was that the result Mr. Bruinsma wanted? If he had known that the investment of a few hundred dollars during his life could have dramatically increased the income stream to his sister and friend, would he have made the investment? We will never know, because his lawyer did not know to ask those questions — Mr. Bruinsma had not provided enough information to allow the lawyer to give comprehensive legal advice.

Admittedly, the facts in Mr. Bruinsma’s case are relatively extreme. OK, you’re right — the same thing would not happen today and in Arizona, because there is no federal or Arizona state estate tax in place. But our point is still valid: if we do not have a fairly complete picture of your assets, your family and your intentions, we will not be able to prepare a good will, whether or not it is a simple will. Besides, the estate tax might just return next year at the $1 million level, in which case an Arizona version of Mr. Bruinsma would be making only a $350,000 mistake.

And now you know: if you really want to surprise your estate planning lawyer, just sit down in the first conference and insist that what you are hoping for is a complex will.

Incidentally, the charities in Mr. Bruinsma’s simple will ultimately joined forces with the sister, the friend and even the state Attorney General to ask the courts to reform the will so that the estate tax effect could be eliminated. After spending, presumably, thousands of dollars in legal fees to seek that result, they were all turned down by the Supreme Judicial Court of Massachusetts (the state’s highest court). That court ruled that there is no law permitting reformation of a will to correct an alleged error on the part of the person signing the will. Mr. Bruinsma’s secrecy — and his thrift — ended up costing nearly half a million dollars. Pellegrini v. Breitenbach, May 25, 2010.

Estate Taxes, Crystal Balls and What Might Happen This Year

MAY 24, 2010  VOLUME 17, NUMBER 17
There is no estate tax in 2010. But there might be. When will we know? What should you do?

Estate planning attorneys have joked darkly (as a group, we often have slightly off-kilter senses of humor) that 2010 is the year to die. Because of Congressional plans first adopted a decade ago, the federal estate tax has long been scheduled to disappear this year, but to return in 2011 with a sort of taxman’s vengeance. Although estates of less than $3.5 million were exempted from estate tax last year, next year the limit is scheduled to drop to $1 million.

For years we estate planners have all reassured our clients that Congress would not — could not — let that happen. Many of us even confidently predicted what Congress would do. Most of us agreed that it was likely Congress would leave the estate tax in place, with the $3.5 million exemption figure or maybe a slightly higher number, and tinker with some of the mechanics. Don’t worry, we all said, there is no way the estate tax will return to the $1 million level — nor will it disappear altogether in 2010, even just for a year.

We were all wrong. Congress has been unable to reach any agreement about how to act, it is now 2010 and there is no estate tax.

But there might be. Speculation has swirled for months about whether Congress has the power to reinstate the estate tax now and make it retroactive to the first of the year. Even if it is legal (and it is not completely clear that it is), every passing day makes it politically less palatable. One idea now being discussed: could Congress reinstate the estate tax but let the executor of each estate decide whether to apply the “new” estate tax or the eliminated estate tax rules?

Why would anyone want to be subject to the estate tax? Because of something called “carryover basis.” As the rules now stand for the estate of someone dying in 2010, there is no estate tax but accumulated capital gains can be taxable if and when heirs sell the property they inherit — though there is $1.3 million of capital gains avoidance given to the estate of each decedent.

Let’s imagine a scenario: because you are a market genius, you bought $1 million worth of McDonald’s stock in early 2003. It is now worth about $5 million. That is the only thing you own, and you are not feeling very healthy. Now assume Congress adopts a new estate tax for 2010, sets a $5 million exemption amount, and allows your heirs to decide whether to apply it or the current, no-estate-tax system.

Your heirs actually do better with the imaginary new estate tax in place. They could inherit your entire estate with no tax consequences; under the current 2010 rules, they will eventually owe income tax on about $2.7 million of gain. Need the math? Here it is: your imaginary estate has $4 million of capital gains that would be untaxed under either 2009 or 2011 rules, but do not escape taxation in 2010. You do get a $1.3 million exemption, which leaves $1.7 million of gain that your heirs receive along with their McDonald’s shares. So if they ever sell their inherited stock, they will owe a significant (but uncertain) income tax on the capital gain.

The truth is, of course, that you didn’t buy a million dollars worth of McDonald’s stock in 2003. In fact, there is a slim likelihood that you are worth more than a million dollars at all. That is not because of recent market reverses — that is because only about one percent of Americans have that kind of net worth, according to the most common estimates. And if you are not worth a million dollars on the day you die, neither the current nor any proposed federal estate tax regimen will make the slightest difference to your estate or heirs. State estate tax rules vary somewhat, but Arizona imposes no estate tax at all, and most of the states that do would also exempt assets of less than $1 million.

But what if you are worth more than a million? What are you supposed to do? The best answer for now might be to keep an eye on what Congress is doing, expect to pay to have your estate plan updated before the end of this year, and in the meantime try to avoid heavy traffic or unhealthy eating. Yes, we know — that wasn’t very helpful advice.

How about this advice: if you are worth more than a million dollars, you should probably have your estate plan reviewed now and expect to have it reviewed again next year, or after we know what Congress is going to do. Depending on your net worth, the types of assets you own and your intended beneficiaries, it might turn out that you don’t need the 2011 return visit — but we won’t know until Congess acts.

Our Free Seminar Reviews 2010 Law Changes For Estate Plans

APRIL 19, 2010  VOLUME 17, NUMBER 13

This has been a tumultuous year for estate planning attorneys—and for their clients. The federal estate tax has been repealed, there are new rules in effect governing Roth IRAs, and heirs are facing higher capital gains liability. We don’t profess to have all the answers, but we think we have a pretty good handle on the questions.

You may agree with us when we say it would be productive to get together and review the current situation. In the next in our series of client education program, scheduled for Thursday, May 6, 2010, we hope to meet with as many of our clients as we are able, to review what is happening, what might change and what should be done.

As of January 1st, the federal estate tax has been eliminated – for this year only. What are the consequences of the repeal of the estate tax? What are the chances Congress will act this session to reinstate the estate tax? What does the tax look for 2011? What does the elimination of the “step-up in basis” mean for your heirs? Is it possible that your family could pay more in capital gains tax than they would have paid in estate tax?

We’ll talk about the (temporary) repeal of the estate tax and whether you should consider changes to your family trust or estate plan. We’ll talk about the competing proposals for changes to the estate tax exemption and the tax rate, and speculate about how likely it is that any one proposal will become law.

Recent rule changes make it easier for wealthier individuals to convert traditional Individual Retirement Accounts to Roth IRAs. Together, we’ll compare the ways in which IRAs and Roth IRAs are taxed, the distribution requirements for each, and the costs associated with making a conversion, so that you can decide what is right for you.

We know from talking to many of our clients that reducing the burden of probating your estate is a major concern. Beneficiary designations are an important tool for transferring assets to your family upon your death. Sadly, many people fail to take full advantage of this useful estate planning tool, or neglect to update their beneficiary designations when family situations (or estate plans) change.

We’ll take this opportunity to review the categories of assets that can be transferred via beneficiary designation, explain how the beneficiary designations work, and encourage you to review your existing designations to make sure that they are consistent with the rest of your estate plan.

This client education program is scheduled for Thursday, May 6th. The program is available to our clients (and family members and invitees) free of charge, but space is limited. To make reservations, telephone Yvette at (520) 622-0400. We look forward to seeing you there!

©2017 Fleming & Curti, PLC