The Law Office of Michael J. Howell, P.A.

Your $10,000,000 Portability Exemption

May Be in Peril of Being Lost

 

If You are a Surviving Spouse of Someone who Died in 2011, this Information May be Vitally Important

 

In December 2010, Congress passed legislation that increased the Federal Estate Tax Exemption to $5 million for an individual or $10 million for a couple.  This law is in effect for the years 2011 and 2012.  Beginning January 1, 2013, the Federal Estate Tax Exemption is scheduled to go back to $1 million, unless the House, the Senate, and the President agree on a compromise as they did in 2010.  This makes proper planning during life and after death vitally important.

 

As part of the 2010 legislation, Congress enacted a new law called “Portability”.  Under the new law, any Federal Estate Tax Exemption that remains unused as of the death of a spouse who dies in 2011 or 2012, is generally available for use by the surviving spouse and can be added to his or her own $5 million exemption for taxable transfers made during life or at death, assuming the surviving spouse does not remarry.  Under prior law, the exemption of the first spouse to die would be lost if not used.

 

The IRS recently released instructions concerning Portability that you should be aware of.  The IRS stated that if the surviving spouse desires to utilize the unused exemption of the deceased spouse, the Executor of the deceased spouse’s estate must timely file a complete IRS Form 706 to allocate any unused exemption to the surviving spouse, even if no tax is due and even if no return is otherwise required to be filed.  The failure to file a timely and complete IRS Form 706 will effectively prohibit the surviving spouse from using the deceased spouse’s unused exemption.  IRS Form 706 is due nine (9) months from the date of death so time is of the essence.

 

If you had a spouse die in 2011, you need to immediately consult with the attorney who handled the settlement of the estate.  If we can be of assistance, please do not hesitate to contact us.

We recently sent out a letter to many of our clients inviting them to come in for a review the funding of their trusts.  The program has ended and we had time to evaluate its effectiveness.

By in large, it was a successful program.  Many of the clients who came in had substantially or even in some cases wholly funded their trusts.  However, there were also a significant number who had not properly funded their trusts, but in most cases, we were able to walk them through the process and explain what they needed to do.  We also re-explained why funding a trust is so important.

Avoiding Guardianships and Conservatorships.  For those trusts that are not properly funded, it means that upon a disability, which renders you incapable of managing your own affairs, there is a heightened probability that you will have to be declared incapacitated and possibly a guardian and conservator appointed by the probate court to manage your personal and financial affairs.  Admittedly, the probability of this type of incapacity is somewhat low, but we certainly have had a number of incapacitated clients over the years.

Guardians are appointed over the person.  They more or less act like a parent does with a child.  They tell you where you can and can not go and where you will live, just to name a few of their responsibilities.  Conservators are appointed to handle financial matters for the incapacitated person.  Conservators manage assets and pay bills and work with the guardian on a budget.

Guardianships and conservatorships are ongoing processes that are subject the probate court jurisdiction and supervision.  In most cases it is for the rest of your life.  This includes annual reporting and sometimes numerous hearings.  Naturally, the process is somewhat expensive. 

Often guardians and conservators are not the people you would have chosen.  They are chosen by the probate court; albeit, usually with input from your family.  Families also often fight over who will be your guardian and conservator. It is best not to be in this situation.

In my opinion, an incapacity is much more difficult to manage than a probate proceeding.  The reason is that we more or less know where we will end up after a probate proceeding and when.  Although somewhat lengthy in time, labor intensive and expensive, postmortem procedures are fairly well defined in most cases.

Incapacities are more dynamic and have much more twists, turns and uncertainly associated with them.  After all, you are dealing with taking care, both personally and financially, of a living, breathing, human being for the rest of his or her life; all under the supervision of a probate court.

Over the years, we believe that we have seen significantly fewer cases where we have had to have conservators and guardians appointed for our clients, because most of our clients have planned estates and are able to avoid the guardianship and conservatorship process.  To complete the planning, however, the trust should be funded prior to your death or serious disability, which renders you unable to manage your own financial affairs.

Admittedly, most planned estates have built in safeguards that can be used to fund your trust after you become disabled.  However, these safeguards are emergency fall-back procedures only.  Advance funding is much more preferred.

Also, the use of a durable general power of attorney to fund your trust is subject to the approval or disapproval of third parties.  Often banks, stock brokerage firms and insurance companies, just to name a few, are hesitate to honor such powers of attorney; although, many states now have laws that provide for damages if third parties are unreasonable in their failure to honor a power of attorney and you are damaged by their not recognizing the power of attorney.  A fully funded trust can avoid this.

Avoiding Probate.  Although the number of guardianships and conservatorships is somewhat low as a percentage of the population, death is not.  Death is 100% with the possible exception of Enoch and Elijah in the Old Testament.

With a properly planned estate, probate can usually be avoided.

I estimate that I would have been able to retire in the 1990s, if only my clients had unplanned estates and had gone through a full probate proceeding.  As it is, most of them took our advice and their estates avoided probate entirely or they had fairly simple probates.   Unfortunately, as a result of planning, I still have to work.

Again, a planned estate involving trusts can only avoid probate, if the trust is properly funded.

Our Newsletters Are Not Junk Mail.  One comment that we heard in a couple of our recent trust funding review conferences, is that the clients did not know that they were supposed to fund their trusts.  Oddly enough, in these cases, there were multiple letters or memos from my office telling the clients that he, she or they needed to fund their trusts. 

These were letters or memos specifically addressed to the client.  If you have a trust, these letters are also likely in your file.

What grieved me somewhat is when I pointed out that funding your trust is also a common, recurring theme in our newsletters; I was told that they were not read because they were assumed to be “Junk Mail.”  We also recently sent out our 5 year planning survey and there were a number of responses to the effect that some of our clients do not read our Newsletters.

I will admit that in order to make sure our clients understand we are sending them a newsletter and not an official letter from their attorney; the envelopes and labels that we use are different for our newsletters.  However, this does not mean that they are junk mail.

Summary.  If you have not yet properly funded your trust, please do so.  If you need to meet with us to review the funding procedures, please call to set up a time to meet.

The cost of the review is modest when compared to the potential savings and the peace of mind that comes with it.  The peace of mind is not only your piece of mind, but also the peace of mind of those you have named to carry out the terms of your estate plan in the event of your death or disability.

Again, if you need to discuss the funding of your trust, please give us a call.  We will set up the conference and send you a letter or email letting you know what we need from you.

If you have a Revocable Trust, you need to fund it with all of your assets prior to your death or permanent disability, in order to gain the maximum benefit from your planning.  Funding refers to the process of transferring assets into the name of the Trustee. 

 

However, transferring assets into the name of the Trustee does not normally apply to IRAs, pension benefits, annuities, or other assets that generate ordinary income tax if you were to cash them in, sell them, or take money out.  These are sometimes referred to as tax-deferred assets.  

 

These types of tax-deferred assets are also often subject to beneficiary designations.  You should consult with your CPA and also with us, before changing the beneficiary of any tax-deferred assets to your Revocable Trust, or to any beneficiary.  You should also never change the ownership or title of these tax deferred assets to the Trustee or any other beneficiary, unless you have a letter from your CPA, and from us, telling you to do so, since this is seldom done.

 

Changing the name on a mutual fund, which is not tax deferred, should not be a problem, if done properly.  However, the mutual fund, itself, needs to understand that you are not anticipating a taxable transaction.  For instance, if you divide the fund or change the name on the account, it may be construed as a sale and repurchase by the fund administrator.  This can inadvertently trigger gain or loss.  Once the fund issues its tax statement for the year, it is very difficult, if not impossible, to have the transaction reversed.  If there is any indication that there might be a tax impact from changing the name on any particular fund, you should consult with me and your CPA before proceeding.

 

If you have life insurance that you are both the insured and owner of, you normally only need change the beneficiary to the trust.  If you are not both the owner and the insured, you need to consult with us before proceeding.

 

If your trust is not properly funded prior to death or permanent disability, then your estate may needlessly go through probate, or be subject to a probate court proceeding, in order to transfer the assets to your trust and then to the ultimate beneficiaries.  After your trust has been funded, or simultaneously with funding your trust, it is suggested that you consult with us, so that we can review what you are doing or what you have done.

 

If you have a Durable General Power of Attorney, this can often be used to fund a trust in the event of your disability (but not death).  However, it is best to take care of funding your trust prior to becoming disabled, so that you do not have to rely upon your Durable General Power of Attorney, which is considered a backup and only a “second best” solution.

 

If you need our help in funding your trust, please let us know.  We are here to help, if and when needed.

As discussed previously on our website, the 2010 Tax Act retroactively reinstated the estate tax to January 1, 2010. However, the Act also provided that for those dying in 2010, the estate can elect out of the estate tax system and go back to no estate tax, but with the modified carryover basis regime. 

 

The modified carryover basis regime allows a $1,300,000 step up in tax cost basis, plus a special $3,000,000 step up in basis for certain assets qualifying for the marital deduction.  As a practical matter, electing out of estate tax system and into the modified carryover basis regime will apply mostly to larger estates that are over the $5,000,000 estate tax exemption. 

 

If the estate does not elect out of the estate tax system, then they are allowed a step up or step down in basis to date of death value for assets other than most IRAs, annuities, EE Bonds and certain other assets.

 

The basis of an asset is important because it is used to determine the taxable gain on the subsequent sale of the property by an estate, trust, or other beneficiary.  The higher the basis, the lower the ultimate tax will be.

 

IRS Form 8939 is the form used to show the modified carry over basis adjustments for estates of decedents dying in 2010.  For estates of decedents dying in 2010, Form 8939 was originally required to be filed on or before April 15, 2011.  However, since this is a holiday in Washington, D.C., the due date was actually April 18, 2011.

 

The 2010 Tax Act also provided that the estate tax return filing deadline for decedents dying prior to December 17, 2010 was extended until September 17, 2011.   Since September 17, 2011 is a Saturday, the extension is effective until Monday, September 19, 2011.

 

There have been some practitioners who interpreted the new law to mean that you have until September 19, 2011 to elect out of the estate tax system and file Form 8939.  However, there has been some doubt as to whether or not this is correct.  Some thought that maybe it was the original due date for the filing of the Form 8939, i.e., April 18, 2011.

 

The IRS has provided some additional partial guidance.  First, keep in mind that neither Form 8939 for reporting modified carryover basis, nor the instructions, are complete.  The Form is available only in a draft form that was completed prior to the 2010 Tax Act.

 

What has been recently clarified by the IRS is that the due date for Form 8939 will be no less than 90 days after the final Form 8939 is published.  Since there is currently no form for use in electing out of the estate tax system, it is also likely that the Form 8939 will be used to officially opt out of estate taxation and into the modified carryover basis regime.

 

With the Form 8939 not being due any sooner than 90 days after it is finalized and published, this seems to suggest that if you elect out of the estate tax system and into the modified carryover basis regime, then the deadline may be earlier or later than the due date for filing an estate tax return, i.e., September 19, 2011.  Hopefully this will be further clarified when the Form 8939 and its instructions are finalized.

 

Another question that has come up is how you document your basis, if you do not opt out of estate taxation, but no estate tax return is due.  Keep in mind that if the taxable estate is under $5,000,000, there is no estate tax.

 

Earlier, there was some talk that the IRS may provide an easier form to use than a Form 706, when there is no taxable estate return required.  However, I have not heard of any official IRS comments on this subject.

 

In the past, when no estate tax return was due, there were two traditional methods.  First, you could file an estate tax return for the purpose of documenting your basis.  This was also often used if the estate was close to the exemption amount.  Second, you could simply gather and keep the same information needed to document the value on the estate tax return and use it to document basis if an asset was sold and if the income tax return was audited.

 

The issue with estate tax returns is that they are many times more expensive to prepare than income tax returns.  However, if it is virtually impossible to have an estate tax due, then it is possible to prepare an estate tax return with much less detail than in the past and at a cost, possibly approaching that of an income tax return.  If so, this may be the better route.  However, the determination should be made by either an attorney or CPA, experienced in estate tax return preparation.

 

As we learn more, we will update our website.  Please check our website for additional updates.

 

 Summary of Temporary Tax Relief for Estate, Gift and Generation Skipping Transfer (GST) Taxes Under The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010

(1) The estate tax has been retroactively reinstated effective January 1, 2010 with a $5,000,000 exemption and a 35% tax rate.

(2) The gift tax exemption remains at $1,000,000 for 2010 with a 35% tax rate.

(3) The estate and gift tax system has been reunified beginning January 1, 2011with a $5,000,000 combined exemption and a 35% tax rate.

(4) Generation skipping transfers also have a $5,000,000 exemption but beginning on January 1, 2010, with a special 0% tax rate in 2010, only.   After December 31, 2010, the tax rate is 35%.

(5) For 2010, only, there is a special election that allows the decedent’s estate to elect out of estate taxation, but must then use the modified carryover basis regime for the tax cost basis, rather than the stepped-up basis.

(6) The new law allows portability for surviving spouses dying after December 31, 2010.  This means that if the first spouse to die does not use up all of his or her $5,000,000 exemption, then the surviving spouse can use his or her own $5,000,000 exemption, plus the remainder of the exemption of the first spouse to die.  However, this requires timely affirmative action by the executor of the estate of the first spouse to die, in order for the surviving spouse to be able to use the exemption.

(7) The exemption amount is indexed for inflation beginning in 2012.

(8) The new law is temporary and only lasts through December 31, 2012; at which time, we revert back to the pre-Bush Tax Cuts and the $1,000,000 combined exemption for estate and gift taxes and no portability.  This also assumes that Congress does nothing further.

A More Detailed Discussion

Estate Taxes Have Been Reinstated for 2010 but with a $5,000,000 Exemption and Portability

What we have is a retroactive reinstatement of the estate tax effective January 1, 2010 with a $5,000,000 per person exemption from estate taxes.  With a married couple, if the first spouse to die does not use all of his or her exemption, then the surviving spouse is allowed to use what was not used of the first spouse’s $5,000,000 exemption, along with the survivor’s own exemption.

This is called “portability” and can provide up to a $10,000,000 exemption for married couples, if the surviving spouse dies after December 31, 2010.  However, this only applies for two (2) years.  In order to receive the benefit of the $10,000,000 in exemptions, both spouses have to die prior to January 1, 2013, unless Congress extends “portability”.  Therefore, we have the continued uncertainly with respect to estate planning.

What Will Happen When the “Extension” Expires on January 1, 2013

The new law is only good though December 31, 2012.  The question is what will happen beginning January 1, 2013?  Will Congress keep it as is, go back to the $1,000,000 pre-Bush Tax Cut exemption, make it higher or lower than $5,000,000, or increase or decrease the tax rates?   Although logic and politics usually dictate that Congress will not reduce the exemptions or increase the tax rates, once they have given the benefit, no one knows for sure.

However, keep in mind that Congress already reduced the benefits because for 2010 there was, up until this law was passed, no estate or generation skipping transfer tax.  For 2010 there is now an estate tax, and a generation skipping transfer tax.  The good news is that each has an exemption of $5,000,000.

There is also a special 0% tax rate for generation skipping transfer (GST) taxes for 2010.  The gift tax exemption remains at $1,000,000 for 2010 with a 35% tax rate.

Although, the new legislation was hailed as an extension of the Bush Tax Cuts, the portion relating to estate taxes is actually a substantial tax increase, not a decrease.  That is, unless you compare it to what we would have gone back to, which is a $1,000,000 estate tax exemption, if Congress had done nothing.  More good news is that the new law reduces the gift tax by increasing the exemption to $5,000,000 in 2011.

Reunification of the Estate and Gift Taxes

A significant change is that the estate and gift taxes have been reunified similar to the manner that they were prior to the Bush Tax Cuts, which means the $5,000,000 exemption is now shared and is both for estate and gift taxes, combined.   It also appears to be a somewhat less complex system than it was prior to the Bush Tax Cuts, due to the use of a much higher $5,000,000 exemption and one 35% tax rate for amounts in excess of the exemption.

The original Bush Tax Cuts, often referred to as EGTRRA (Economic Growth Tax Relief Reconciliation Act of 2001) bifurcated estate and gift taxes so that we ended up with two separate taxes and two separate exemptions, when finally in 2010 there was no estate or generation skipping transfer tax at all, until the passage of this legislation.

Due to the reunification of the estate and gift taxes, beginning January 1, 2011, you are once again able to the either give your property away at death or during life.  Either way, you will use up the same $5,000,000 exemption and pay the same 35% tax rate, at least until January 31, 2012.

However, the gift tax may be lower than the estate tax, because the gift tax is tax exclusive; whereas, the estate tax is tax inclusive.  This means that with an estate tax, you are paying a tax on a tax.  This also means that it takes more funds to transfer the same amount to the beneficiary at death.

With regard to gifts, individuals still have their $13,000 per donee annual exclusion amount that is adjusted for inflation.  This is in addition to the exemption amount.

If we a assume that there will be an estate tax to pay, then for those who can afford to make these gifts, it is often more tax efficient to make the gifts during life than to die with the assets.  However there can be higher subsequent capital gains taxes when the assets are sold.  This also needs to be taken into consideration in any analysis.

Although beyond the scope of this discussion, if a gift is made during life and the fair market value of the asset is less than the basis in the hands of the donor, there can be three different income tax results upon the subsequent sale of the asset by the donee.

New Generation Skipping Transfer (GST) Exemption

The new law also changed the generation skipping transfer tax (GST) exemption to $5,000,000 for 2010, but with a 0% tax. The 0% tax only applies in 2010.

This presents interesting planning opportunities, but the discussion is beyond the scope of this material.  However, for those who are very wealthy and can afford large gifts in 2010, this can be a grand slam home run.

Unfortunately, due to fact that these GST planning opportunities expire on December 31, 2010, it may be too late for such planning unless the gifts have already been made.  Anyone interested in such planning should immediately contact their estate planning attorney. 

35% Estate, Gift, and GST Tax Rates

Along with the $5,000,000 exemption, Congress gave us a new maximum estate tax rate of 35%.  Under the law as of December 31, 2009, when there was a $3,500,000 exemption, we had a 45% estate tax rate.  Prior to the Bush Tax Cuts, the rates were as high as 55% and in some cases even higher.

The 35% rate will apply to estate taxes, gift taxes, and generation skipping transfer taxes, beginning January 1, 2011.  The 35% rate already applies to gift taxes.

Although the estate and gift taxes are unified, generation skipping transfer taxes will remain separate.  As discussed above, for 2010 only, there is also a special 0% tax rate for generation skipping transfers.

The 2010 Problem - Modified Carryover Basis and The Estate Tax

There is a residual problem for 2010, which is called the modified carryover basis regime.  For decedents who die in 2010, a decision needs to be made as to whether or not to opt out of the new estate tax system and then use the modified carryover basis regime.

Under the Bush Tax Cuts, in 2010 when there was not supposed to be an estate tax, there was a new modified carryover basis regime for assets included in a decedent’s estate.  This was in lieu of the step-up (or step-down) in the tax cost basis to the fair market value of the assets at the date of death when there was an estate tax.

With some exceptions, if you use carryover basis you start with the tax cost basis of the assets just prior to the decedent’s death, unless their fair market value is lower, in which case you use the fair market value.  The exceptions are beyond the scope of this material.

On the other hand, with a step up in basis, you value the assets at their fair market value as of the date of the decedent’s death or the alternate valuation date, if the value on the alternate valuation date reduces both the value of the estate and the estate tax.  The alternate valuation date is usually 6 months after the date of death, but there are exceptions not discussed in this material.

With the 2010 modified carryover basis regime you add $1,300,000 to the carryover basis, but only up to the fair market value of the assets.  There are also other adjustments, but these are also beyond the scope of this discussion.

For assets passing to the surviving spouse and qualifying for the marital deduction and for certain trusts that also qualify for the marital deduction from estate taxes, such as a QTIP trust, these assets receive another $3,000,000 step up in basis under the modified carry over basis regime.

This means that many estates still receive the equivalent of a stepped up basis using the modified carryover basis; unless, (1) a very large estate is involved, or (2) the assets have an extremely low tax cost basis, or (3) there is no surviving spouse or marital deduction, or (4) all of the above or some combination applies.

The effect of the increase or modification of the tax cost basis is to reduce capital gains when the assets are subsequently sold.  Congress wanted decedents’ estates or those who receive the assets to either (1) pay an estate tax, presumably increase the tax cost basis and pay lower subsequent capital gains taxes, or (2) they wanted the estate to pay no estate tax, not receive a stepped up tax cost basis and presumably pay higher subsequent capital gains taxes.

It should be noted that neither the modified carryover basis regime nor the step up in basis rules apply to IRAs, 401(k)’s or similar assets, to the extent that they have no tax cost basis.  Most do not.  These types of assets are also normally subject to ordinary income tax rates rather than capital gain tax rates.

Estate Tax or Tax Cost Basis Relief for Decedent’s Dying in 2010

One of the ironies of the modified carry over basis regime and the stepped up basis rules is the assumption that assets are normally worth more at death than they originally cost, assuming the assets had been held for many years.  As the last 10 years have taught us, sometimes our original tax cost basis is higher than the value many years later.

For those decedents who die in 2010 with assets that will actually benefit more from the modified carryover basis regime than the step-up in basis value or for those estates that will pay an estate tax, there is relief under the new law.  Basically, the estate can elect out of the estate tax system and can treat the estate as though there is no estate tax in 2010, and then use the modified carryover basis regime instead of stepped up basis.  Presumably, you have to file a return to do this and you need to make an election.

Where are the Tax Forms for 2010?

Ironically, in past years, it has taken the IRS about 9 months to publish an estate tax return for decedents dying during each new calendar year.  It then takes the software providers about another month to update their software and distribute it to tax return preparers.  Compare this to income tax returns, where most forms are usually available prior to January of each calendar year.

Since there was no estate tax for 2010 until the bill was signed by President Obama on December 17, 2010, there was no estate tax return needed, so it is not clear how long it will take for the IRS to provide one.  This will most likely cause substantial delays.

CPAs Ask for Help From the IRS

The modified carryover basis regime is even creating problems for CPAs.  In early December, The American Institute of Certified Public Accounts (AICPA) sent a letter to the IRS asking for help on the modified carry over basis rules because they did not understand how to apply the law.  Some of the points raised in the letter are also why I made one or more of the comments above to the effect that certain subjects are beyond the scope of this discussion.

Decedent’s estates that opt out of the estate tax system will use a Form 8939 to report the modified carryover basis to the IRS.  It is my understanding that as of the date of this publication, you still cannot go to the IRS website and obtain a copy of the Form 8939 for the modified carry over basis.  The Form 8939 is due at the same time that a decedent’s final income tax return is due, which for 2010 is April 18, 2011.

Under certain circumstances, there can be a $10,000 penalty for not timely filing the 8939, at least under the law prior to the new legislation.  I am not certain how the new law affects the penalty, since you now have to elect out of the estate tax system and into the modified carryover basis regime for 2010, but this issue should certainly be kept in mind.

I also understand that the IRS shared the Form 8939 with certain tax practitioners in November of 2010 to see what they thought, and the forms are floating around, but are still unofficial.  I also understand that the form was withdrawn due to problems with the interpretation of the new laws.  The AICPA letter would indicate that the form did not help in understanding the law.

Update - On December 16, 2010, the IRS published a Draft Form 8939.  However, I found the form by Googling around the Internet.  When I went in the front door of the IRS website, I could not find the form for public dissemination.

Extension of Time to File Returns and Make Elections Under the New Law

The above is a problem for taxpayers who died earlier in the year because the normal filing deadlines may be coming up or are already past due.  In order to mitigate but not necessarily solve this problem, Congress is giving estates and their advisors 9 months from the date of enactment of the new legislation to file returns and make elections, where applicable.  This may not be enough time, but we will see.

Conclusion

This legislation is quite complex. There is a great deal of work that estate planning and tax practitioners will have to do and as with all such new legislation, there is a significant learning curve that takes time.  Also, the pressure is on to advise clients as soon as possible on how to proceed.

There will be a substantial amount of post-mortem planning work for something that only affects a small number of taxpayers, and for only 2010 with respect to the modified carryover basis regime, and maybe only two years for the remainder of the estate, gift, and generation skipping transfer tax rules.  This will also likely make estate planning less efficient and more costly.

For 2010, for example, the work includes, but is not limited to (1) advice on the modified carryover basis regime; (2) whether to treat the estate as though there is no estate tax in 2010; (3) whether to disclaim assets and create a credit shelter trust to reduce taxes in the future, if a disclaimer trust is being used, or if other reasons exist for making a disclaimer; (4) how much of a qualified terminable interest property (QTIP) election to make, if a QTIP Trust is being used, and (5) whether to make large gifts prior to December 31, 2010 to take advantage of the GST 0% tax rate for 2010; just to name a few. Unfortunately, some of the planning, such as large gifts to take advantage of the 0% GST tax rate for 2010 may already be too late. 

Estate planners will have to try to take into consideration what we know the law to be through December 31, 2012 and what we believe it may be after that date.  This will be a daunting, if not impossible, task at best. 

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Protect Your Estate Planning Documents and Your Estate Plan

Do Not Write on Your Documents

Be Careful What You Put in Writing to Your Children and Other Beneficiaries

Try Not to Provide Original Documents to Third Parties

Know Where Your Original Documents Are Located

 

We caution our clients on what they should and should not do with their original estate planning documents, both when we sign the documents and when we give them to our clients for safekeeping.  First, we tell them that they should never be written on after they have been executed.

 

Writing on a document can be evidence of tampering.  Also, writing on them may or may not change the terms of the document.  In some cases, striking though language (called “strike-throughs”) can serve to amend or revoke a document, but the rules are quite complex and vary from state to state.  For instance, the rules in South Carolina are quite different from those in Florida.  Similar considerations apply to adding language to trust agreements; the rules vary from state to state.

 

It should also be kept in mind that your Will is a testamentary document and will be in front of a probate court judge one day.  If the Will has writing and/or “strike-throughs” on it, it may be expensive to interpret and it may even be held invalid.  This is not the result that most people want.

 

Why do most people write on estate planning documents, such as Wills and Trust Agreements?  Sometimes, they are simply making notes, not thinking about the consequences.  At other times, there may be an emergency and they want to make sure that it is covered, not realizing that they may make the situation much worse.

 

However, after over 30 years of practice, I have found in those cases, which I have been able to discuss with my clients, that the main reason is that they were trying to save costs and avoid going to an attorney.  While saving costs is understandable, this can prove to be much more expensive to correct later, if it can be corrected at all, than going to an attorney now.

 

Similar considerations apply to those who draft their own Trust, Trust Amendment, Will and/or Codicil.  The real test comes after you are dead or permanently incapacitated and you are no longer able to explain what you meant to do.

 

In addition to writing on a document, you should be careful about letters to children and other beneficiaries.  There have been cases where simple letters from a parent to a child explaining what is to happen after the parent dies, inadvertently served to amend the parent’s Trust Agreement. There is one Illinois case where a letter, which was signed “Love Mom,” inadvertently amended the mother’s Trust Agreement.

 

In some cases, parents do not want to tell their children and other beneficiaries the truth about their testamentary desires.  In letters or other communications to their children, parents need to be candid concerning what is going to happen after their death, or not discuss it at all.

 

At other times, a positive spin is used by the parent, in writing, that can be misinterpreted by the child and can cause problems after the parent is deceased.  In other instances, the parent is just wrong about what the Will or Trust Agreement actually states.

 

This can create expensive postmortem problems, when a child produces a letter signed by mom or dad after the Trust Agreement is signed, if it expresses terms that are different from the Trust Agreement. Similar considerations apply to Wills, but the legal requirements for signing a Codicil to a Will are much stricter than for an Amendment to a Trust Agreement and, therefore, much more difficult to inadvertently amend.

 

I have noted in a number of cases over the years, that when these situations occur, most lawyers who work in this area of the law, and who did not draft the document in question, could and would take either side of the argument.  Unfortunately, this is not what the decedent wanted.  The decedent wanted clarity.

 

When a lawyer is willing to take either side of the argument, this usually means that the facts are such that representing either side will produce significant revenue for the law firm.  In many cases, the lawyer also knows that based upon the facts, a cash settlement without litigation is a high likelihood.  Obviously, it is best to avoid these problems by not contradicting your documents.

 

You should also never turn your original estate planning documents over to a third party, without a very good reason, such as the Will of a decedent being turned over to your lawyer or to a probate court; or Durable General Power of Attorney being turned over to the clerk of court.  Most of the time, a copy will suffice.

 

We have had numerous occasions where people have turned over documents to third parties, who promptly pulled apart the staples, made copies, and then put the document back together with pages missing and/or out of order. We even had one case where a health care provider took possession of a Health Care Power of Attorney and a Durable General Power of Attorney, then took them apart and put pages from the Health Care Power of Attorney in the Durable General Power of Attorney, and vice versa, and stapled them together.  Also, some pages were simply missing.  Fortunately, our client noticed something was wrong and we still had “Word” copies of the originals, and we were able to reprint and sign the documents, which solved the problem.

 

We have also found that many banks and stock brokers ask for complete copies of Trust Agreements, when opening a trust account for an individual Trustee.  In many cases, the Trustee is also the Settlor or creator of the Trust. 

 

If a bank or stock broker insists on having a complete copy of the document, this is their internal policy and not a legal requirement, as many of them may suggest or claim. This request for a complete copy may be unnecessary intrusion on your privacy.

 

The South Carolina Trust Code, which is a version of the Uniform Trust Code, allows third parties to accept and rely upon a Certificate of Trust.  One of the purposes of this provision is to prevent brokers and bankers from asking for a complete copy of the document.

 

If they require additional proof, they should only ask for copies of the front page and the signature pages of the Trust Agreement.  In some cases, they may also ask for the “powers clauses” of the Trust Agreement, to verify that the Trustee has the power to deal with them.  Under our statute, if they ask in “bad faith” for a complete copy of the Trust Agreement, they can be held liable for any damages caused.

 

You should also store your original documents in a safe place.  In most cases, your Personal Representative, Trustee, or Agent under a Health Care Power of Attorney or financial Power of Attorney, should know where your originals can be located.

 

The main points to remember are: (1) never write on an original estate planning document after it is signed; (2) never pull an original document apart to make copies or for any other reason; (3) be extremely careful in providing complete copies to banks and brokers; (4) always know where your original documents are located; and (5) contact your lawyer immediately, if you discover that you do not know where your original documents are located.

 

Following these simple procedures can avoid significant expenses and problems for you and your family.

here.

Latest Chatter on the Bush Tax Cuts (As They Relate to the Federal Estate Tax Exemption)

I attended the 32^nd Annual Duke Estate Planning Conference at the Duke Law School in Durham, North Carolina on October 14 -15, 2010.  One of the speakers gave an opinion on what is likely to happen with the Bush Tax Cuts this year after the election ----- ABSOLUTELY NOTHING!!!

REASON ----- if the Republicans pick up enough seats, then they will not agree to anything in December, since they may be able get a better deal in 2011, with more Republicans in Congress.  Sounds logical, since Republicans and the Democrats still have differing views on taxation.

So what will happen in 2011?  It is likely that we will enter 2011 with a $1,000,000 exemption from estate taxes, rather than the current situation where there is no tax, or the hoped for $3,500,000 minimum with portability so that if one spouse did not use his or her exemption, then the survivor is able to combine it with his or her own exemption for a total exemption of $7,000,000.

The thought is that the exemption will be increased in 2011, but it is not clear if they will retroactively fix it.  This means that some people could end up being taxed and some may not.

It sounds illogical, but so has the past 10 years when Congress missed opportunity after opportunity to fix the problem.  I hope that the speaker is wrong and there is some fix in December, but I fear that he may be right.

There was also a belief expressed that relates to state estate taxes.  Many states are not pushing their elected officials in Washington for reform of the estate taxes.  The reason is that if we go back to the law prior to the Bush tax cuts, then many states, including South Carolina, will pick up the state death tax credit, which they lost with the Bush tax cuts.  This could help with their budget deficits.

Supposedly the state push is somewhat subtle.  It is more in the form of not expressing any concern to their elected officials in Washington over estate taxes, rather than affirmatively opposing reform.  Again, I hope the speaker is wrong, but I fear that he may be right.

--Stay tuned for more updates!

 

The Virtual Law Office

 

The virtual law office, or VLO, is here.  Although not yet large in numbers, virtual law offices are opening up across the country.  These are law offices that may be entirely in cyberspace, or they may be in conjunction with a traditional brick and mortar law office.

 

Currently, most VLOs appear to be young lawyers who have decided to open up their own practices, but work at home.  Some of the demand for VLOs is also being driven by the number of new lawyers who are unable to find a job with a law firm due to the economy.  However, my belief is that many more firms and other lawyers will also be opening up VLOs in the future, at least for certain basic type services.

 

The idea is that many more people are Internet users who shop on-line and are amenable to legal services on the Internet.  VLOs will provide these people with a viable and economical option, but with somewhat less service and personal contact.  There may or may not be any face to face meetings, or there may be fewer such meetings.

 

With VLOs, there can also be what are called e-signings, whereby the documents are either emailed to the client, or the client downloads them from a website after they are prepared and then prints and signs them.  There will be signing instructions provided, and the time and responsibility for properly signing the documents will be shifted to the client.  If this risk and responsibility can truly be shifted to the client, then there will also be substantially reduced costs.

 

In our office, we estimate that about 20%-33.3% of the cost of estate planning is incurred by the time the first conference ends and the drafting begins.  About 33.3%-55% of the cost is incurred after the first conference and by the time the documents are drafted and mailed, or transmitted to the client, and another 25%-33.3% is incurred for the last office conference to sign the documents and complete the follow up work in providing the original documents and photocopies of the documents to the clients and closing the file.  Naturally, there can be significant additional time, if more than two conferences are needed, or if there are substantial changes and redrafting.

 

Our analysis discloses that clients can probably save at least 20%-33.3% and possibly significantly more, with a virtual law office approach.  The question is whether or not this shifting of responsibility and risk will be worth the cost savings to the client.

 

Without a face to face meeting, only very simple estate planning may be a viable candidate for a virtual law office handling estate planning matters.  This is because most complex planning requires an understanding by the client of the basic concepts and, in some cases, quite complex concepts.  This is normally accomplished by the client meeting with the attorney who explains the basics of the plan, which is incorporated into the documents.

 

Even after the explanation, in our practice, we give a written summary and can certainly provide much more written information to the client, if needed.  However, this information merely reinforces what was previously discussed during the planning conference.

 

You can not necessarily rely solely on written information to clients where complex matters are involved.  Self-study is for very few people when it comes to complex matters.  Most need the explanation that is provided in face to face meetings between clients and their attorneys.  Some clients will also take advice willingly and others will not, and require much more explanation.  This latter group is probably not a good candidate for the VLO.

 

It may be a viable alternative with clients for whom we have done estate planning work in the past.  Since they know us, and we know them, the trust, confidence, and familiarity are already in place.  In such a case, we could likely do many routine updates saving the cost of the first conference.  We would only need the necessary financial and other information that our clients already supply to us, and maybe a phone call to confirm any changes or lack of changes in family and financial circumstances.

 

A significant amount can also be saved if the draft documents can be emailed rather than mailed.  We have tried this, but most clients prefer paper copies, which cost much more to produce and mail than digital copies.  Savings can easily be in the hundreds of dollars when a significant number of documents are involved.

 

Even more can be saved with the addition of an e-signing; possibly up to 50% of the total cost, when combined with the other cost savings techniques, but with even greater risk.  Currently, a significant number of documents that we mail or email out to be signed outside of our office are not signed properly, even when written signing instructions are provided.  If the documents have to be signed and then re-signed, the cost will increase, especially if multiple parties in different locations are involved.

 

There also has to be some process whereby the client can talk to the attorney about how to sign documents, if the client has questions.  Furthermore, there needs to be some follow up review of the signed documents, all of which adds time and reduces some of the cost savings associated with VLO services.  Further complicating this process, is normal client (human) procrastination, which also adds to the cost and to the uncertainly as to when the work can be completed and the file closed, which can also add time and cost.

 

There are a number of ethical and legal implications involved with VLOs, including but not limited to, the confidentiality of information, maybe not knowing the lawyer, competence of the lawyer doing the work, quality of the work product (especially if in conjunction with a third party non-attorney Internet document provider), practicing law in a jurisdiction to which the attorney is not licensed to practice, either intentionally or by accident, and the lawyer thinking that the legal work is being done for the client, when in fact the lawyer is actually dealing with a third party pretending to be the client over the Internet and not acting in the client’s best interest (i.e. fraud).

 

There is also a concern that some of the VLOs of the future may not really be attorneys.  We have certainly all seen this problem with the Ethiopian and other emails promising riches, if we will only cooperate in sending money or information, only to find identity theft or fraud at the end of the rainbow.  Unfortunately, there are also a number of people who have unreasonable expectations about how much the cost can be reduced, and will fall prey to such schemes.

 

The America Bar Association has been studying the ethical implications and legal problems associated with virtual law offices.  The initial response has been mostly positive.  Many state bar associations are also looking into the issues.

My belief is that many of the problems can be mitigated when used in conjunction with legitimate law firms with long-standing reputations who also have traditional brick and mortar offices.  I also believe that this may be an effective way to provide legal services to many people who otherwise cannot afford the work or who will not pay for it at its current cost and are willing to assume some additional risk.

 

In the final analysis, the major problems with the virtual law office are similar to using Will drafting software.   They are both based upon saving money by shifting work, responsibility, and risk, away from the law firm, to the client.  However, with the VLO, substantially less risk is shifted to the client than with Will drafting software.

 

Even with questionnaires and checklists, many people are not likely to understand whether or not the planning documents that they choose from a non-attorney software provider and their terms are correct for their situation without some direct contact with an attorney who has the opportunity to ask questions to determine if the planning is appropriate.  Keep in mind that most problems with estate planning documents are discovered after the signer of the document is dead or disabled and can no longer correct the planning or drafting mistakes.  A similar problem comes with e-signing a document without the assistance and supervision of an attorney.  

 

There is little doubt that e-signings can save a substantial amount of the cost of estate planning documents. However, any legal documents signed without the personal supervision of an attorney and law office staff members, many of whom are more or less professional witnesses, have a substantially greater risk of improper execution and the documents not being valid when they are needed the most.  This is especially so if there is no post execution review by an attorney of the original documents, themselves, and even this will not uncover other defects that can be avoided if executed inside the law office, such as problems with the qualifications of the witnesses themselves.

 

A major issue will come down to what extent is the client allowed and willing to assume the risks in order to save the costs of meetings and supervision by an attorney.  Unfortunately, as humans, we want it both ways, meaning we want no risk and no personal responsibility or liability, but we want the reduced costs.

 

Paraphrasing the old French expression, “You can not eat your cake and also keep your cake.”  You either eat it or you keep it.  You either reduce your risk and increase costs, or you increase your risks and you reduce your costs.

 

You can not reasonably do both; although, many Internet document preparation websites may lead you to believe that you can.

 

Notwithstanding the potential problems and issues, the VLO has merit and we will be looking into this matter and will likely begin a program of studying and possibly implementing a virtual law office in conjunction with our traditional brick and mortar office.  We would very much appreciate your feedback on this matter.

New South Carolina Law Rebuttably Presumes Certain Tangible Personal Property is Owned as Joint Tenants with Right of Survivorship by the Husband and Wife Upon the Death of First Spouse

 

Summary South Carolina recently passed a new law, which provides that untitled tangible personal property, such as household and personal effects, are presumed to be owned by a husband and wife as joint tenants with right of survivorship. There are 5 exceptions, and the presumption can also be overcome or rebutted by sufficient evidence to prove that it is more likely than not, that the property was owned in a manner other than as joint tenants with right of survivorship. The law is mainly positive. What follows is a comprehensive review and discussion of the new law.

Background and Explanation

Over the years, I have noted that most married couples who come in for estate planning assume that their untitled tangible personal property, such as household and personal effects, are owned as joint tenants with right of survivorship.  Also for years, many practitioners in a pinch have relied upon this legal fiction.

I say fiction because it is almost impossible under common law principles, to own household and personal effects as joint tenants with right of survivorship.  This is due to how a joint tenancy with right of survivorship is created.  It is somewhat difficult to accomplish.  As a practical matter, it requires a bill of sale or similar legal document from a third party to those receiving the property and it must contain special survivorship language.

You almost never see this, since most tangible personal property does not come with a bill or sale, much less one with survivorship language.  Those times, when you have tangible personal property with a bill of sale or similar document, it usually involves property such as automobiles, boats, and airplanes, which require registration.

If the property is owned as joint tenants with right of survivorship, it will not require going through the probate court and the probate process to obtain ownership or title.  It automatically belongs to the survivor.  Admittedly, many spouses who had possession of the property ignored the technicalities and kept the property, subject to being challenged.

Challengers could include creditors wanting to be paid, children of the same marriage, and more problematically, children from previous marriages wanting their parent's and/or family's heirlooms and keepsakes.

A few years ago, legislation was introduced, but never passed, to change the rule with respect to such property owned by married couples so that it would be considered to be owned as joint tenants with right of survivorship, but it did not get anywhere.  Now, a new law has been passed in South Carolina that may accomplish this result and may be beneficial in avoiding probate on tangible personal property as between a husband and wife.

The new law is Section 2-805 of the Probate Code.  Basically, it creates a presumption that if tangible personal property is in the joint possession or control of the decedent and the surviving spouse at the time of the decedent's death, then it is owned by the decedent and the decedent's spouse as joint tenants with right of survivorship.  It adds the additional condition that the ownership is not otherwise evidenced by a certificate of title, bill of sale, or other writing.

This additional condition is a common sense one.  For instance, if an automobile is titled in the decedent's name alone, no one would normally believe that it should be owned as joint tenants with right of survivorship, especially since it could have been so easily titled at the highway department.

Maybe not as clear, is what it takes to be considered a bill of sale or other writing.  Some could argue that a receipt showing the decedent paid for the item may qualify for the “other writing”, if not a bill of sale.  However, this may be more useful in rebutting the presumption of ownership, which is discussed below.

The law also provides that the presumption of being owned as joint tenants with right of survivorship does not apply to property:

(1)  acquired by either spouse before marriage;

(2)  acquired by either spouse by gift or inheritance during the marriage;

(3)  used by the decedent spouse in a trade or business in which the surviving spouse has no interest;

(4)  held for another; or

(5)  devised in a written statement or list disposing of tangible personal property pursuant to Section 62-2-512.

What this means is that there is no presumption with respect to these five (5) categories.  Presumably, the burden of proof is on the one arguing that one of the exceptions in 1-5 applies.   The proof may or may not be difficult, depending upon the circumstances.

Also, unless the item is very valuable, the differences will likely be worked out among the parties.  Although, I hasten to add that this certainly will not always be the case.

For items 1 and 2, practical factors that would likely come into play include the length of the marriage and whether family heirlooms, keepsakes, or valuable property is involved.  In actual practice, it may also depend on whether the children are all from the same marriage or if the decedent had children from a previous marriage.

Subject to issues of credibility of the witness, the testimony or possibly the sworn affidavit of the surviving spouse may be sufficient.  Naturally, it would be helpful to have other testimony or documentary evidence such as a receipt for a purchase showing who purchased the item or in the case of a gift, the testimony of the donor of the gift.

Exception 3 should not be too difficult since there should be business records to prove ownership, but not always.  Over a period of years, as with all such matters, records tend to be lost. However, property located on a business premises may provide the necessary proof that it is owned by the business.  Also, the testimony of employees of the business may be sufficient.

Note that exception 3 does not seem to apply if the surviving spouse had an interest in the business. Does this mean that if the surviving spouse owns 1% of the business and the decedent owns 99%, then the business tangible personal property will be deemed to be owned as joint tenants with right of survivorship?  With a literal reading of the statute, this seems to be the case.

Does it apply to sole proprietorships only, or does it apply to entities such as LLCs, corporations, partnerships and other entities owned by the decedent in which the decedent’s spouse also has an ownership interest?   It is arguable that it does.  It is also arguable that it would not apply to LLCs and corporations owned by the decedent, nor partnerships for that matter, since the decedent does not technically own the tangible personal property, itself, but only the interest in the business that owns the property.  However, if the exception does apply, it could certainly create a problem in those cases where the business is left to a child rather than the surviving spouse. Similar considerations apply to sole proprietorships.

Item 4 appears to cover the situation where property was held by the decedent, but owned by someone else.  Take, for example, the case of the borrowed lawn mower.   It should be noted that this should not be a probate asset in any event, since the decedent did not own it.

It may also be intended to cover assets held by the decedent as Trustee, but maybe not since the decedent would not merely hold property for another, since the decedent is the legal owner of the property for the benefit of another, i.e. the beneficiary.

Item 4 could also cover property that someone asked the decedent to store for them, while they were gone, such as furniture stored in the decedent’s garage.

One might ask why you need item 4 since there may be no ownership interest to begin with and therefore no probate issue.  The reason is that the law appears to create a presumption of ownership, by virtue of joint possession or control, where no actual ownership may have otherwise existed.  Item 4 seems to be designed to mitigate the possibility that the presumption is applied to property that neither the decedent nor the decedent's spouse had any actual ownership interest in.

Item 5 is interesting.  It basically states that you can remove the presumption merely by leaving the property in question to someone by a written memorandum.  It is not clear what happens if you have a memorandum that simply states that all tangible personal property that you own, without specific identification, is transferred by the memorandum, which is what many people have done.  Under a literal reading of Item 5, this should cause the property not to be owned as joint tenants with right of survivorship; although, it may be arguable with respect to such memorandums that were executed prior to the effective date or the introduction of the new law.

Oddly enough, if the decedent were to leave the property in the body of their Will and not by a separate written memorandum, then the presumption of survivorship still appears to exist.  If so, then the property can not be devised by Will unless the presumption is rebutted.  I am not sure that this was the legislature's intent, but it may be the result.  It may also be that the Will can be used as an “other writing” to overcome the presumption itself.

The new law provides that the presumption may be overcome by a preponderance of the evidence demonstrating that ownership was held other than in joint tenancy with right of survivorship.  This basically means the presumption can be rebutted with evidence that proves “it is more likely than not” that the property was owned in a manner other than as joint tenants with right of survivorship.

Although the property may be presumed to be owned as joint tenants with right of survivorship and is not subject to the probate process, upon the death of the first spouse, if nothing further is done, then it will be subject to probate upon the death of the second spouse.  For this reason, it may still be advisable to place such property into a Revocable Living Trust, if this is your primary dispositive document.  By doing this and properly drafting the memorandum, the Will and/or the Trust Agreement, you can achieve the probate avoidance on the death of the first spouse and upon the death of the surviving spouse.

The new law appears to have a retroactive effect, meaning that for those who die after the June 2010 effective date, it will apply to property owned prior to the effective date.  For those who have used a tangible personal property memorandum, you should take a look at it to make sure that it still expresses your intent.  It is also advisable to update these and specifically refer to the new code section and that you do not intend that it apply, unless of course you want it to apply.  If you do want the presumption to apply, then you may not want to have a tangible personal property memorandum specifying who receives the property, unless you are leaving it to your surviving spouse.

Although it is beyond the scope of this discussion, the tax cost basis may be significantly different if the presumption applies or if it does apply and the property is owned solely by the decedent.

It may be beneficial in cases of death when there is a surviving spouse, to prepare a sworn affidavit to be signed by the surviving spouse that recites the appropriate portions of the statute as evidence of which tangible personal property is owned or claimed to be owned as joint tenants with right of survivorship and which property is not so owned.  If a probate file is open, it may also be advisable to file a copy with the probate court to serve as a public record of which property is owned as joint tenants with right of survivorship.  This should stand as sufficient proof, subject to being rebutted.

The new law may also have the effect of adding additional asset protection for the surviving spouse from the unsecured debts of the predeceased spouse.  Traditionally, in order to make property owned as joint tenants with right of survivorship subject to the creditor claims of the decedent, special legislation had to be passed.  For instance, joint bank accounts have such special legislation as do assets in a decedent’s Revocable Living Trust.  As you might suspect, these were added at the request of the banking lobby.

Without such special legislation, the surviving spouse may reasonably argue that the property is not subject to the creditor claims of the deceased spouse.  This can be accomplished without having to rely upon other statutory exemptions.

Naturally, this assumes that the surviving spouse is not otherwise also liable on the debt.  If this interpretation of the new legislation is correct, then look to the banking lobby to have it changed so that their creditor claims are protected.

It can also be argued that our legislature has created a de facto form of tenancy by the entirety with respect to tangible personal property.  This reinforces the argument that it is not subject to the creditor claims of the deceased spouse, unless the surviving spouse is also liable on the debt.  It can also be argued that if it is a form of tenancy by the entirety, then it is not subject to creditor claims of only one spouse, while both are alive, or even upon the death of one spouse, if the surviving spouse is not the debtor.  This means that a creditor cannot foreclose on the debt and force its sale. Admittedly, this interpretation is a stretch, since the statute refers only to the presumption being applied at the death of the first spouse.

Many states, including North Carolina, Florida, and New Jersey, have recognized tenancies by the entirety for many years as an additional protection for their citizens against overzealous creditors.  The method for a creditor to protect itself is to make sure both spouses are debtors and not just one.  This is usually accomplished by having both spouses sign a note and security agreement.  Again, if this protection against creditors interpretation is correct, then look to the banking lobby to have it changed so that their creditor claims are more easily protected.

One might ask what happens in the event of a common disaster, when both spouses are presumed to have predeceased each other.  In such a case, there is no surviving spouse.  Suppose, however, that one of the Wills has a presumption that one spouse, for instance the wife, is the survivor.   Do we have a survivor for purposes of the statute such that the property passes to the surviving spouse without being subject to probate in the first spouse’s estate?

Similar questions arise if a qualified disclaimer is filed by the surviving spouse, since the survivor is then treated as though he or she predeceased the decedent, with respect to the property disclaimed.  This is easier to manage because if you do not specify that it applies to tangible personal property, then it will not and you will have a surviving spouse and the statute should apply.

Suppose, however, that the surviving spouse does disclaim the property.  Since this means that the surviving spouse predeceased the spouse who actually died first, is the predeceased spouse now the surviving spouse for purposes of the statute?  Possibly an interesting thought for later discussion.

On balance, I believe that the new legislation will be beneficial to most South Carolina decedents and their families.  For persons with modest and simple estates (i.e., most South Carolinians) this new legislation, when combined with other property owned as joint tenants with right of survivorship, should reduce the cost of administration, possibly eliminating probate and making the process much easier.  This may be one of the few pieces of legislation passed by the legislature in recent years, in the estate planning and probate area, that actually reduces costs and for this I applaud our legislators.

 

New South Carolina Legislation Dealing with Formula Clauses

in Wills and Trust Agreements

or

Cha-ching!  Cha-ching!  Can You Hear Those Cash

Registers of Legal Fees Ring?

Below is the language of new legislation that was recently passed by the South Carolina Legislature to deal with formula clauses in Wills and Trust Agreements:

Decedents estates, trusts, proceeding to determine intent

The personal representative, trustee, or any affected beneficiary under a will, trust, or other instrument of a decedent who dies or did die after December 31, 2009, and before January 1, 2011, may bring a proceeding to determine the decedent's intent when the will, trust, or other instrument contains a formula that is based on the federal estate tax or generation-skipping tax. The proceeding must be commenced within twelve months following the death of the decedent.

There were differing opinions as to how to handle this matter.  Before reading on, please refer to my earlier blog and client newsletters on the alternatives that were being considered prior to the passing of the legislation. These can be found on our website at www.HiltonHeadEstatePlanning.com under the Howell Blog Section.

This alternative is not, in my opinion, the best alternative and accomplishes little other than making it clear that to protect themselves from possible liability, Personal Representatives and Trustees may need to seek a judicial determination.  I hasten to add, in defense of those who helped draft our legislation, that a number of other states have adopted similar legislation.

The problem was created when congress let the estate tax lapse for 2010.  For many years, most modern estate planning documents, such as Trust Agreements and Wills, contained Trusts that provided formulas to determine how much went into a particular Trust, or outright to a spouse to qualify for the marital deduction from estate taxes.

The object of the formula clauses was usually to place in a Trust, often referred to as a Credit Shelter Trust, but known by many other names, an amount that was not subject to tax when the first spouse dies, due to the estate tax exemption, and with some limited exceptions, is also not taxable when the surviving spouse subsequently dies because it is not counted as part of the surviving spouse’s taxable estate.  The remaining assets, upon the death of the first spouse, are usually left outright to the surviving spouse or to a Trust that qualifies for the marital deduction from estate taxes.  This usually ensures that no estate tax is paid at all upon the death of the first spouse and none, or greatly reduced estate taxes are paid upon the death of the surviving spouse.

The amount not subject to estate tax in 2009 was $3,500,000.  Although in 2010 there is no estate or generation skipping transfer tax, in 2011, the exemption amount will go back to $1,000,000, assuming congress takes no further action.

Earlier this year, many estate planning commentators and experts thought that the estate tax would be retroactively reinstated.  However, most commentators and experts are now doubtful that this will happen, which is why South Carolina and a number of other states enacted legislation. 

Does that sound familiar?   A state has to take action to protect its citizens because the federal government doesn’t do anything to solve the problem that it created?

Without an estate tax, many estates and trusts have been left with a situation whereby when the creator of the trust dies, the Personal Representative and/or Trustee can no longer tell if a trust is to be funded with assets and/or how much.  This is because the funding amount is defined by a formula that refers to an estate tax that no longer exists or at least doesn’t exist in 2010.

In such a case, the Personal Representative of the first spouse’s estate, or his Trustee, is in a quandary.  Do they assume that the decedent intended to place the maximum amount that he or she could into the credit shelter trust?  After all, with proper planning, you can shield it from estate taxes when the surviving spouse dies and even when the children die, if so planned.

However, suppose that there will be no estate tax on the surviving spouse’s death even if nothing goes into the credit shelter trust.  Or suppose that you just do not know the answer.  Would the decedent still want to use the trust?  Maybe, but maybe not, due to the restrictions imposed on the surviving spouse under the terms of the credit shelter trust.

Credit shelter trusts and estate tax avoidance comes at a cost.  They are excluded from a beneficiary’s estate (i.e., surviving spouse in our example) for estate tax purposes simply because the beneficiary lacks sufficient control over the assets to tax the beneficiary.

Quite frankly, placing assets in a credit shelter or similar trust, as most clients clearly understand, is an unnatural act whereby normal control over assets is relinquished.  People prefer to control their assets. 

They will, nevertheless, relinquish some or even all control if there are enough taxes to be saved. However, unless a beneficiary is disabled or there are estate taxes to pay, most people would not use a credit shelter trust due to the lack of control.  In some cases, there is no control.

One argument in favor of the new legislation is that it “opens up the courthouse doors” and makes it easier to have the case heard as far as the intent of the creator of the trust.  There was some thought that probate judges in small counties would not be willing to hear arguments on cases such as this.

First, they are too complicated.

Second, there is a question as to whether extrinsic evidence of the creator of the trust’s intent can be used.  Historically, there has been a tendency to allow extrinsic evidence if there is an ambiguity in the document.

There are also differences in latent versus patent ambiguities and evidence law.  However, these subjects are beyond the scope of this article.  Suffice it to say, the legislation may make it easier to have extrinsic evidence admitted as to the intent of the creator of the trust.

My belief is that it does not add any right that did not already exist.  As far as ambiguities and intent, such documents are not only ambiguous, you can’t even tell from reading them what to do with the assets.  Either they are clearly ambiguous or there is a whole or partial intestacy and the law tries, whenever possible, to construe a Will or Trust to dispose of all the decedent’s property. 

With an intestacy, the assets can pass as though the decedent died without a Will or Trust Agreement. If you have an ambiguity in a trust instrument, Trustees and Personal Representatives, and other interested parties, have always had the right to ask the court to construe the document, so to this extent, the new legislation does not add much.

My assessment is that the legislation does create a number of additional issues.

First, anytime you “open up the courthouse doors”, it sets up a full employment opportunity for attorneys.  In this case, it may be doubly so.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

From my own self-interest as an attorney, I think that it is a great idea.  However, from a client’s standpoint, it will add additional cost and effort that could have been avoided with more thoughtful non-lawyer legislators or at least those who had no self-interest in mind.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

Second, it sets up a situation where if you do not file a petition with the probate court within twelve (12) months of death, the courthouse doors are then abruptly closed.  Legislation as important as this takes time to disseminate to the public.  Twelve (12) months will not be long enough for many Trustees, Personal Representatives, and beneficiaries.

Also, not all attorneys specialize in probate matters.  Many do not keep up with such legislation and may not even know about it in time.  Other attorneys will not understand the reason for the legislation, even if they read it.  Unlike major federal tax legislation, it will not be in the daily news on a recurring basis and the explanations will not always be obvious to the non-expert.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?                                                                                              

Third, the legislation also raises a question of whether it imposes a legal duty on the Personal Representative and/or Trustee to notify the devisees and beneficiaries that they have the right to challenge any determination that the fiduciary makes with respect to any estate tax formula clause.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

Fourth, if the fiduciary makes the determination as to how to fund one of the formula trusts, in many cases, it will only be a best guess.  In some cases, the guess will simply be a manifestation of the Personal Representative, Trustee, or family members, as to what is the best plan for the beneficiaries rather than what the intent was of the creator of the trust.

For instance, children will almost always prefer or favor assets going into a credit shelter trust, since such a trust often “protects” the child’s inheritance, by reducing the amount of control the surviving spouse (who may or may not be the child’s parent) has over the assets.  All things being equal, the surviving spouse would likely prefer control of the assets and that the assets are not so well “protected” for the children’s benefit.

When you factor in that most Wills and Trusts have children and/or a surviving spouse as Personal Representatives and Trustees, it can also create a conflict of interest between their duties as Personal Representatives and Trustees and their duties to the income and remainder beneficiaries, including themselves and each other.

These are often quite different and much may depend upon “whose ox is being gored.”  No matter what decision is made, someone is harmed and someone is helped.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

Fifth, if the Personal Representative or Trustee makes what a beneficiary considers the wrong or improper choice as to how to fund a trust, without getting court approval, can the beneficiary sue for breach of fiduciary duty and any resulting damage or does the twelve (12) month period act as a defense or bar to shield the Trustee or Personal Representative from such damages?

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring? 

Sixth, if there is a duty to notify the beneficiaries, then this means that a breach of that duty may also impose legal liability on a Personal Representative and/or Trustee for their actions, if they fail to notify them.  Also, what duty, if any, does the Personal Representative have, themselves, to file the action within twelve (12) months?  Again, if the duty is breached and there is damage, then lawsuits can and in many cases will ensue.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

Seventh, it has been suggested by some very well known estate planning commentators, that in virtually every situation where there is a formula clause, that instead of filing the petition, the family simply enter into a family settlement agreement to construe the language.  To back up the agreement, they suggest obtaining an affidavit from the drafting attorney as to what the intent of the creator of the Trust was.

With this approach, you may end up with the substituted judgment of the attorney in place of their client.  In very few cases will an attorney be able to testify as to the intent many years after the signing of the documents under circumstances that were not necessarily anticipated.  However, many will do so anyway.  Unfortunately, in other cases, all of which have happened locally, the attorney may be deceased, incapacitated, or long retired.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

Another problem with a family settlement agreement is that its implementation assumes a harmonious relationship between the beneficiaries.  More and more the relationships are no longer harmonious even among family members.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

Also, in most instances, the attorney for the Personal Representative can not represent the beneficiaries due to the conflict of interest issues.  This means that in addition to getting multiple beneficiaries to agree, you may have to get multiple attorneys to agree.

Anyone who has ever negotiated agreements among multiple attorneys can attest to the time and expense that it can take.  In many cases, it may be more cost effective to file an action with the probate court.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

Another potential problem with a family settlement agreement is that they often entail a potential gift and resulting gift tax possibly being imposed upon one or more of the parties.  In such a case, the parties will need to be advised of the issues by their attorneys.

Cha-ching!  Cha-ching!  Can you hear those cash registers of legal fees ring?

Clients having their estate planning documents routinely reviewed and updated could solve or have solved the problem in many cases.  Unfortunately, this does not always happen.  Just like I do not go to the dentist or a physician when I should, many clients do not visit with their attorneys when they should.  Human nature is what it is.  We try to avoid pain, unpleasant situations, and costs.

We have been telling our clients to come in for an update since EGTRRA in 2001.  Most have, but many have not, and we have already had cases with the formula clause problem.  It is complicated and much more costly.

I believe that the legislature could have done a much better and more cost effective job, but what do they know about cost efficiency.  In my opinion, most major legislation affecting trusts and estates, including the Uniform Probate Code all the way back in 1987 and the more recent Uniform Trust Code have increased legal fees and costs of administration.  The real question that is almost unanswerable is whether the benefits exceeded the costs.  Personally, I have serious doubts that the benefits exceed the costs.

In order to protect yourself and your family, or other beneficiaries, we once again strongly recommend to our estate planning clients that if you have not had your estate planning documents reviewed within the last couple of years that you do so as soon as possible.

Notwithstanding the above, for those who do not or did not have their documents reviewed and updated as needed and die in 2010, we pledge to do our very best to (1) analyze the situation based upon the individual facts and circumstances, (2) guide your Personal Representative, Trustee, or maybe even your beneficiaries, through the options, costs and the processes and, (3) give them our best advice as to how to proceed.

 

A bill has been introduced in the South Carolina Legislature, which is intended to help interpret wills and trust agreements with certain formula clauses.  These formula clauses were designed to determine the amount of assets needed to fund certain types of trusts after death.  Unfortunately the formulas were based upon an estate tax law that does not currently exist.

The law ended on January 1, 2010.  However, the law will likely come back into existence on January 1, 2011, as part of the sunset of the Bush Tax Cuts from 2001.  However, they may be significant differences from the law as it existed at the end of 2009.

We sent out an emergency newsletter in January to our clients and have included the issue in all subsequent client newsletters.  We have also been routinely reminding our clients through our newsletters since 2001 of the potential issues and the need to update their estate planning documents in order to avoid the problems.

We avoided many of the problems by using Disclaimer Trusts, which allows a post mortem decision up to nine (9) months after the decedent’s date of death to determine how much goes into the credit shelter trust.  These credit shelter trusts are designed to save estate taxes upon the death of the surviving spouse, at the cost of some restrictions on the surviving spouse’s ability to access funds.  In other cases, we defined the trust funding clause so as to try to avoid the problems.

The proposed South Carolina law, as of the first week in May, was designed to fund the credit shelter trust with the formula clause being construed under the federal estate tax law as it existed on December 31, 2009 rather than the actual 2010 date of death of the settlor of the trust or the testator of the will.  As a practical matter, if passed, this would mean that the more restrictive family or credit shelter trust, which we often refer to as a Trust B, will be funded with up to $3,500,000 of the decedent’s assets. 

The vast majority of our married clients would not choose this option unless the estate tax exemption is allowed to go back to $1,000,000, which may happen in 2010; although, there are many commentators who believe that it will be changed back to the 2009 amount of $3,500,000.  The reason why most would not choose the option is because of the restrictions imposed upon the surviving spouse by a typical credit shelter trust and if there is an estate tax exemption that exceeds the value of their assets, then there may not be an estate tax in any event.  If there is no estate tax, then there is no need for the more restrictive credit shelter trust.  

However, this logic will not necessarily apply to a QTIP Trust for second marriages with children from a previous marriage or relationship.  These are often created to prevent the surviving spouse from doing as he or she pleases with the funds.  Nor does the logic necessarily apply if the beneficiary is a spendthrift or disabled person who needs to be protected. 

For large estates, the decedent may in fact want to place as much as possible into a credit shelter trust, probably with generation skipping transfer tax provisions, to protect the family wealth from future estate and generation skipping transfer taxes, especially given the uncertainty of recent years.

The proposed legislation also has a provision which will allow an interested person to petition the court for a different interpretation, if desired.  The proposed law is somewhat straight forward and could solve the problem for those who did not have their estate planning documents updated.

The proposed law apparently also creates a legal presumption that the trust or will provision should be interpreted as of December 31, 2009.  This presumption makes it more difficult on the party trying to achieve a contrary interpretation.

From talking with other practitioners around the state, there is some opposition to the proposed law.  Many attorneys would prefer a facts and circumstances approach to the problem; whereby, if an interested party wants to go to court for a different construction, then there should be no presumption to overcome.  It is believed by many that this will provide a more equitable result.

These concerns have gained some support.  The latest proposal is simply to allow a petition to the court to construe the formula clause based more or less upon facts and circumstances without any presumption being imposed.  I also understand that even this proposal is being reviewed by numerous individuals and committees and is likely to be changed even further.

Another proposal being discussed is to allow the trustee or personal representative to make an election as to how to interpret the funding clause and then leave it up to the beneficiaries to bring a petition seeking a different interpretation without any presumption being imposed.  This would be one of the least expensive proposals.

No matter which law is enacted, it will have the tendency to increase legal fees and costs for those who did not or do not update their documents.  It should also be kept in mind that the real problem has been created by the inaction of a dysfunctional United States Congress.  However, clients should have their documents reviewed and where necessary updated to avoid the problems.

We will keep you posted on our blog, if the legislation or similar legislation passes, so please check back for updates.

Many people misunderstand the role of emails and believe that they can be used in lieu of most, if not all, meetings, and will substantially reduce the cost of their legal services, when in fact, they may actually increase the costs, especially when overused or misused.  Emails, just as telephone conferences, are billed or charged in one form or another to the client.

 

Emails do, however, save the labor cost of printing a letter, making a file copy, folding it, placing the stamp on the envelope, and then placing the letter in the mailbox or taking it to the post office.  These costs do add up and are also ultimately paid by the client, in one form or another, which is why emails are used to reduce costs. 

 

Emails are also often a quicker means of communication than even a telephone conference, because you can send them and then when the recipient has time, they can respond.  This can avoid “telephone tag.”

 

It can take just as much attorney time to draft an email response, as it does a letter, and the only time that might be saved, is that of the legal assistant or paralegal, which admittedly can be a significant saving.  Even this is not necessarily correct, since emails on complex subjects are often more or less dictated, proofed, and re-proofed, prior to emailing, very much like letters on important subjects.

 

In many instances, it only takes a few emails to equal the cost of one office conference.  It is often easier for an attorney to provide a face to face verbal response to a client where there is immediate feedback, clarification, and re-explanation, when needed.

 

Similar considerations apply to telephone conferences.  They can sometimes be more effective and more cost efficient than emails, but may not be as effective as an office conference.  This is because with a telephone conference, there is also no face to face contact where reactions and understanding or misunderstanding can be more effectively judged and addressed.

 

One of the most common symptoms of overusing or misusing emails is when we receive a very short email, but the response email is much, much longer and complex.  Another common symptom is that there are a string of small emails, each one requiring a separate response.  We have also found that some emails are intended to avoid answering questions, which often wastes time and increases the fees that a client is charged.  Often these costs can be reduced by a telephone or office conference.

 

Quite frankly, sometimes there is no good substitute for an office conference and achieving the proper balance between office conferences, telephone conferences, and emails is necessary in order to have cost savings. Otherwise, the costs can be more and not less.

 

Blog here.

During this income tax season, please make sure that your income tax return preparer knows if you have made any gifts during the year. In certain cases gift tax returns are required to be filed even if there is no tax due. In other cases, it can be advisable to report all gifts whether or not they require the filing of a gift tax return.

Some years back Congress changed the laws with respect to the finality of gift tax returns to help with the preparation of estate tax returns but in the process, made things somewhat more complex. Basically, if you report a gift and provide all the details on a gift tax return, the statute of limitations will run on the gift usually in three (3) years similar to the manner that the statute runs with respect to income tax returns.

However, even if you file a gift tax return but do not report one or more gifts or do not report them completely, there is now no statute of limitations. The opposite is true of an income tax return. If income tax returns are filed and items are inadvertently left off, the statute of limitations will run on the income normally in about three years in most cases.

In some instances, where there are substantial unreported amounts, time limits can be longer. Again, the same is not true with the gift tax return. There may be no statute of limitations.

For all the above reasons, please make sure that if you made any gifts, you report them to your income tax return preparer so that he or she can consider filing a gift tax return. My suggestion is that if there is any doubt, the doubt should be resolved in favor of filing a gift tax return and reporting all gifts.

If you have engaged in any estate planning that involves the transfer of assets to a third party, make sure your income tax preparer knows about these. This also applies if you set up Charitable Remainder Trusts or Irrevocable Life Insurance Trusts. 

Also, if you are ever late in filing gift tax returns, it is better to be late than not file at all.

 

Please remember that if you placed your home that is considered your primary residence into trust during the year, you will need to reapply for your Homestead Exemption and for your special 4% assessment ratio, assuming you are otherwise entitled to them.  

Not following the procedure can cause the loss of your Homestead Exemption and increase in your taxes by more than 50%.  If you have any questions, you should contact the Beaufort County Assessor and/or the Auditor.

 

Technically to fund your trust, you transfer assets into the name of the trustee of the trust rather than to the trust as an entity.  Transferring to the trust as an entity can cause the transfer to fail; although, not in all circumstances.  However, it is not always clear when it will and when it will not fail; therefore, it is best to do it correctly and not to run the risk.

Assets such as life insurance do not have to have the ownership transferred but the beneficiary should be the trustee. This assumes that the owner and insured are the same person as the grantor or settlor (owner) of the trust.  If they are not the same person you should consult with either your CPA or an attorney experienced in estate and gift tax matters because there may be adverse tax consequences with such ownership.

With respect to annuities and Individual Retirement Accounts, the beneficiary designation on these should never be changed without the input of either your C.P.A., attorney or someone knowledgeable in these areas, otherwise, there can be severe tax consequences.
 
With respect to real estate, this is normally transferred by a deed which requires a real estate lawyer. It is never advisable to try this on your own.

With respect to stocks and bonds, ownership needs to be changed to the trustee of the revocable trust agreement. This is easier if the assets are already in a brokerage account because then it only requires one change and normally, your broker can handle it at little or no charge.

Bank accounts can also be transferred into the name of the trustee. In many cases either a brokerage account or similar account with a bank is used for all financial assets.

With respect to household and personal effects, we normally transfer these by a simple bill of sale which we prepare. The ownership of automobiles can be changed to the trustee at the highway department. The highway department is getting more of these requests than it has in the past and is now more familiar with processing them and is more efficient.

Please keep in mind that anytime you transfer the ownership of real estate, household items and personal effects or an automobile to a trust, you should let your insurance company know that you have changed the ownership to your revocable living trust agreement. They will need to note this on the policy. This may also be a good time to review your insurance coverage to make sure it is adequate.

Most of the above can be accomplished with relative ease; however, we have been having problems with closely held corporations and limited partnership interests. These types of interests are not normally traded on an established exchange and therefore cannot be handled by your broker. Many are very small operations and often there is no procedure at the corporate or partnership level to handle ownership changes. Normally we have to work with the closely held business or partnership which takes time and is, quite frankly, much more expensive and time consuming than transferring any other asset.

Even with this additional time and cost, if you are trying to fully fund your trust, you should take the additional steps to have the title to any closely held stock or limited partnership interests changed to the trustee. In the long run it will save even more time and expense.

In order to avoid a full probate proceeding, substantially all your assets need to be in your trust or in other non-probate form. Basically our statute states that if there are assets of more than $10,000, less certain liens and encumbrances, in probate form then a full probate proceeding is required in order to have them transferred to the beneficiary of your estate.

If there is any real estate in probate form, then probate is required regardless of how much the property is worth. This is why it is important to include even timeshares.

If you are a member of a club or a resident of a retirement community which has a separate membership certificate, you should remember to transfer the ownership of your membership certificate to your trust also.

Please keep in mind that many of you are your own trustees and the procedures are relatively simple. For those of you who have corporate fiduciaries, they are familiar with these procedures and should not have a problem making transfers.
 
The reason you need to try to place all your assets into your revocable living trust agreement is because no matter how hard you try, there will probably be some assets which are part of your probate estate. Often there are refunds from the state and federal governments, insurance companies, magazine subscriptions and others which can add up to over $10,000. In most cases if there is an automobile, it will be worth more than $10,000 and may itself cause a full probate proceeding.

If substantially all your assets are in your trust, then we normally file the will for probate only. This is a relatively simple procedure whereby we file your will for probate and do nothing else. It is the appointment of a personal representative which creates most of the time and expense of a probate administration. If there are assets other than real estate in probate form and the value is less than $10,000, we may be able to use a somewhat simplified affidavit procedure to transfer the assets after death.

Once you go over $10,000, you have to have a personal representative. Once a personal representative is appointed, they have to file inventories, accounting and many other documents as well as comply with certain statutory deadlines. These are the functions which produce the major cost and inconvenience of probate.

Having all your assets either in your trust or other non-probate form can reduce the cost and anguish associated with death and the administration of the estate.

There is one thing to keep in mind. Even if there is no probate, there is still tax administration required in almost all situations. This requires filing and compiling information on income, estate and gift tax returns. This process itself is time consuming and expensive, and it helps if there is no probate proceeding to compound the problem.

If you need assistance funding your trust, please let us know. If you have partially or fully funded your trust, it is always a good idea to meet with us so that we can review what has been done.

For years our family has had dachshunds.  Recently we added a chocolate beagle. As with most pet owners, we are concerned about what will happen to our pets if there is no one alive to take care of them.  Prior to the new South Carolina Trust Code, it was difficult and maybe not possible to set up a trust to take care of pets.

 

Now, under the new Trust Code, a trust for animals (i.e., a Pet Trust) may be created to provide for the care of an animal or animals that are alive or in gestation during your lifetime, whether or not the pet is alive at the time the trust is created. The trust must terminate upon the death of the last surviving animal.

Thus although the animal need not be alive at the time the trust is created, the animal must be born during your lifetime or be in gestation at the time of your death to benefit from the trust.  Since, the trust must terminate when the last animal to benefit dies, as a practical matter for dogs and cats the trust may have a limited duration.

 

A Pet Trust may be enforced by a person appointed by the terms of the trust or, if no person is appointed, then by a person appointed by the court, which is likely to be the probate court.  A person concerned about the welfare of the animal may also request that the court appoint a person to enforce the trust or to remove a person appointed.

 

Normally, the trust carefully spells out who the trustee and successor trustees are and who can question on behalf of the animal the actions taken by the trustee.  If you think about it animals unlike humans are not able to complain about their treatment nor are the mechanisms necessarily in place to force the trustee to do their job, which is why such authority to enforce the trust for the animal’s benefit needs to be clearly spelled out in the trust agreement and is often vested in someone other than the trustee.

 

Under our Trust Code, the property of the Pet Trust may be applied only to its intended use, except to the extent the court determines that the value of the trust property exceeds the amount required for the intended use.   This means that if excessive amounts are placed into a Pet Trust, the court can cause the distribution of the excess.

Except as otherwise provided in the terms of the trust, property that is not required for the intended use must be distributed to the settlor who is the person who creates the trust; otherwise to the settlor's successors in interest. Unfortunately, the South Carolina Trust Code does not clearly define the term successor in interest.  This means that the settlor needs to specify what happens to the funds; otherwise, a court proceeding may be required to make the determination.

Often people mistakenly believe that a Pet Trust is easier to structure, draft and administer than a trust for humans.  In fact, it is somewhat more complex than trusts for humans, which have many hundreds of years of statutory and common law history.  Also, due to the inability of the animal to take care of themselves and to object, it is somewhat more technical than with the majority of trusts for humans.

For instance under what circumstances will the animal be euthanized?  Who makes the final decision?  How many veterinary opinions are needed?  Who is the animal to live with and where is the animal to live.  Unlike most trusts for humans, which are not designed to be guardianships, a Pet Trust needs to include something like guardianship provisions.  Often, more decisions have to be made with a Pet Trust than for a trust for humans.

 

If you have a pet that you are particularly fond of, the law now allows you to set aside funds to take care of the pet.  However, in order to do so, you need to create the trust for your pet’s benefit. 

Other more common approaches are to rely upon family members to take the pet and to specify in your will, trust or tangible personal property memorandum to your will or trust agreement who is to receive your pet.  It is also often advisable to leave the person some cash, without strings. Otherwise, you may inadvertently create a Pet Trust, without the necessary safeguards and the person with the pet may not be able to keep the money after the pet dies. 

If you think that you might be interested in a Pet Trust, please do not hesitate to contact us.  Prior to doing so, you may want to check under the Free Consultation section of our website to see if you qualify for a free initial consultation.  If so, please download the necessary information, fill it out and call our office to schedule a time for an appointment.

In today’s economy, more and more clients have adult children who need creditor protection.  If you have children or other beneficiaries who are having problems with possible bankruptcy, judgment creditors or other creditors, you should consider protecting them with a spendthrift trust.

 

A spendthrift trust can be set up to take care of your children and their families, yet have the assets protected from their creditors.  These are assets that you would otherwise give to your children outright during your lifetime or leave to them after your death.

 

These trusts often need to be tailor made to the specific situation of the beneficiary.   Much depends upon the how serious the creditor problem is, the amount of the assets that will go into the trust, the type of assets, the number of children and grandchildren, the marital status of your children, their level of sophistication and if there are any disabilities, including the inability to handle significant sums of money.

 

It should be kept in mind that a qualified trustee is needed.  Often unless the trust assets are significant, it is difficult to find a corporate fiduciary to take on the trust.  Even if you can use one of the larger bank trust departments, they are charging minimum fees in the $10,000 - $14,000 range, so it expensive to have a bank or brokerage firm be the trustee.

 

If you use and individual trustee, it is often difficult to find a friend or relative willing to take on what may be a lifetime task with significant duties and  also potential financial liability, if they do not property manage the assets.  You then have to consider who will be the trustee, if the trustee that you named can no longer serve.

 

Once these hurdles are taken care of a spendthrift trust can give you the piece of mind of knowing that your children and their families are protected.

One consequence of Congressional inaction in addition to there being no estate tax as of January 1, 2010, has to do with the tax basis of inherited assets (other than IRAs, annuities,  pension type benefits and other “income in respect of decedent” assets).

In the past when someone died and you inherited their assets such as stocks or real estate, you took as your tax cost basis for taxable gains purposes the fair market value of the assets as of the date of death of the decedent.

This means that when you sold the asset you basically subtracted the basis from the sales price to arrive at your taxable gain on the sale.  Usually, with “ever increasing values”,  the date of death value was significantly higher than the decedent’s cost basis, if the decedent owned the asset for a long period of time.  This meant that by inheriting the asset and getting a “stepped-up” basis, your taxable gain on the subsequent sale was often less that if it had been sold by the decedent.

As of January 1, 2010, generally, you take the same basis as the decedent had which is called the carryover basis.   In theory, if a decedent held an asset for a long period of time, his or her basis would normally be less than the date of death fair market value, which meant that the taxable gain on the subsequent sale and resulting income tax would usually be higher with a carryover basis.  However, with the stock market and real estate market over the last 10 years or so, this may not be the case.

Additionally, there are special rules as of January 1, 2010 providing for a step-up in basis of $1,300,000 in assets and an additional $3,000,000 for marital deduction assets.  What this means is that for most decedents the new rule may not have a significant impact over the old rules, but it can and will require additional analysis.

So far almost all tax practitioners have ignored the problem on the theory that it would never actually come into being, but it is here.  However, although it is currently the law, most practitioners and commentators believe that Congress will retroactively reinstate the law as it was in 2009 or something similar and go back to stepped-up basis.

What Congress will actually do, is anybody’s guess these days.  However, we do want you to be aware of the potential issues and possible need to thoroughly evaluate the sale of significant inherited assets prior to sale.  Keep in mind that similar considerations apply to selling assets while you are alive that might otherwise be inherited by family members upon your death.

Lastly, please keep in mind that there may be other adjustments that may need to be made that are not discussed here.  This is not an exhaustive analysis and you should consult with your CPA, if you have any questions.

Due to there being no Federal Estate Tax, our Married clients with pre-2002 estate planning need to have their plans reviewed immediately. This is because, with the current state of the law, it may no longer be possible to tell how the trust or trusts will be funded postmortem beginning January 1, 2010.

This could result in the imposition of a postmortem court proceeding in order to interpret the meaning of your trust agreement.   Although we have written about the potential for this issue in a number of newsletters, beginning as far back as May or June of 2001, the problem has in fact arrived and now must be addressed in order to prevent the potentially negative consequences for your surviving spouse and other family members. If you have ignored the issues in the past, please do not do so now. This may be the last train leaving the station.

For additional information please review of January 2010 Client Newsletter.

Please note that any references to $3,500,000 when discussing estate tax exemptions in this website are not necessarily correct, since unless Congress takes further action there is no estate tax effective January 1, 2010.   It is believed, but is by no means certain, that Congress will extend the $3,500,000 exemption that was effective in 2009 for estate tax purposes into 2010 and later. There a numerous other consequences that we will be writing about so stay tuned for more information.