Other IRA Issues with Estate Planning

On Tuesday, I discussed funding retirement benefits to a Living Trust and some of the issues that may come about because of the funding. In response to that post I received a few comments and questions on related issues and thought it a good idea to expand on the topic in today's post.

The first comment talked about the opportunity of using a direct IRA beneficiary trust as well, to mandate a "stretch-out" of distributions and protect non-spouse beneficiaries from creditor claims. We discussed the IRA Trust in our post on November 20, 2012, but it is worthwhile discussing it again.  

The “IRA Trust”, is a stand-alone trust, separate from a Living Trust that acts as the beneficiary of IRAs or retirement other benefits. The provisions of an IRA Trust satisfy all of the regulations related to the distribution of IRAs and retirement benefits, allowing the beneficiaries to take advantage of their inherited benefits over their lifetime. Using the IRA Trust allows the client to design a special trust specifically for the IRA assets and perhaps even for different beneficiaries then for the majority of the estate under the client's Living Trust. Except for the required minimum distributions (RMDs), the IRA assets can continue to grow tax-deferred and protect beneficiaries against their own bad habits of this spending in mismanagement of money. Additionally, if an IRA trust provides for more than one beneficiary, if the IRA beneficiary designation form specifies the percentage of the account that will go to a specific sub trust for each of the beneficiaries, each beneficiary can then use their own life expectancy in calculating the RMDs for a particular year.
     A second comment asked how one meets the "see-through" trust requirements when one of the trust beneficiaries is a charity or other non-individual beneficiary. When a client names non-individual trust beneficiaries, those beneficiaries can be "removed" as a beneficiary for the purposes of determining the “see through” status of the trust. To “remove” the non-individual beneficiary the trustee must either make a distribution of the amount allocated to that beneficiary or arrange for the beneficiary to disclaim their interest. The deadline for this “removal” is September 30 of the calendar year following the calendar year of the account owner's death (the "Beneficiary Finalization Date"). If this is accomplished, the regulations exempt the non-individual trust beneficiaries for purposes of determining individual beneficiaries.
One might ask why anyone would disclaim his or her interest in a Living Trust. In some cases an older beneficiary will disclaim their interest in the IRA assets of the trust, because it will allow the younger beneficiaries (perhaps grandchildren in their 20s) to extend the IRA distributions over the lifetime of the oldest life expectancy of that group. This is important because unless you eliminate the elder beneficiary, all of the beneficiaries must use the oldest beneficiary's life expectancy in calculating the RMDs. Alternatively, a charitable beneficiary may disclaim an interest in IRA assets in exchange for a larger immediate gift that it can invest or put to use immediately.

On a final note, if there are sufficient assets in addition to the IRA to protect loved ones, and the client is charitably inclined, client may want to consider designating one or more charities as the beneficiary of the IRA. This will satisfy their charitable inclinations will save significant income taxes because the IRA will not be subject to income tax when paid to the charity. This can save a large amount of tax, especially where the estate is taxable for estate tax purposes and then the IRA is taxed for income tax purposes as it is distributed to individual beneficiaries. Naming a charity as the IRA beneficiary excludes it from taxation for federal estate tax purposes and income tax purposes.

Again, it is important that a client discusses their desires with experience counsel prior to designating beneficiaries in order to protection of beneficiaries and minimize taxation of the account.

Funding Retirement Benefits to a Living Trust

As part of the trust funding process, I normally suggest that clients change the beneficiary designation of their IRAs and retirement benefits. Most of the time, I suggest that their spouse be the primary beneficiary and the Living Trust be the secondary or contingent beneficiary, because spouses receive better distribution rights under federal law with respect to retirement benefits. If the spouse predeceases the account owner, or if it makes sense for other reasons for the spouse to disclaim the retirement benefits, the benefits then fall to the Living Trust where, in all probability, the spouse remains the primary beneficiary and if the spouse has already died, the beneficiaries of the Living Trust become beneficiaries of the retirement benefit.

After contacting their financial professional, clients will often call me concerned because their financial professional warned them against designating the Living Trust as beneficiary of the retirement benefits because their children will not be able to "stretch out" the IRA over their lifetime, and the entire benefit will be taxable immediately. While this advice may be well meaning, it is often incorrect.

The Internal Revenue Code (the "Code") and Regulations provide that a "designated beneficiary" can use the provisions which allow a beneficiary to take minimum required distributions (MRD's) over their life expectancy. Normally, only an individual can be a "designated beneficiary", therefore a Living Trust ordinarily is not a "designated beneficiary" because it is not an individual. There is an exception to that rule and, if the trust document meets certain requirements, then the Living Trust is considered a "see-through" trust and the regulations treat the beneficiaries of the Living Trust as designated beneficiaries of the decedent's retirement account. To achieve “see through” status, the Living Trust must meet the following requirements:

1. The trust is a valid trust under state law, or would be but for the fact that there is no corpus.
2. The trust is irrevocable or will, by its terms, become irrevocable upon the death of the account owner.
3. The beneficiaries of the trust with respect to the trust's interest in the employee's benefit are identifiable from the trust instrument
4. Required documentation has been given to the Plan Administrator. The Plan Administrator must receive a copy of the trust instrument and a list of all beneficiaries of the trust with a description of the conditions on their entitlement.

If the trust meets all the requirements then the Living Trust beneficiaries are deemed “designated beneficiaries", entitled to receive their MRDs over their life expectancy.

The next issue when a Living Trust is the beneficiary of IRA benefits usually arises at the account owner's death. At that point, clients want to know whether the beneficiaries can split the “inherited IRA” into separate IRAs and make their own decisions about how distributions are made. Generally, "inherited IRAs" received by beneficiaries other than a surviving spouse, cannot be rolled over to their own IRA, but the account can be split into separate IRAs for the trust beneficiaries using the designation "John Doe IRA for the benefit of Beneficiary A", etc. Beneficiaries can then decide the manner in which they want their IRA distributed. One beneficiary may take a lump sum distribution, pay the tax and invest or spend the rest. Alternatively, a beneficiary can decide to take MRD's over their designated life expectancy, deferring income tax until future distributions are made.

Along with the question of splitting an “inherited IRA”, is the question of whether the MRD's are based on each beneficiary's own life expectancy or on the life expectancy of the oldest beneficiary.

Regulations §1.401(a) (9)-8, A-2 provides the general rule that if the account owner's benefit is divided into separate accounts no later than the last day of the year following the calendar year of death, distributions subsequent to the division are treated as separate accounts and each beneficiary of each separate account can use his/her own life expectancy in determining minimum required distributions each year. However, this rule does not apply to beneficiaries receiving a "separate share" through a trust that was the beneficiary of an IRA. Therefore, even if beneficiaries split the IRA into separate accounts for each beneficiary, all the beneficiaries must use the life expectancy of the oldest beneficiary of the Living Trust in determining their MRD's.

The law and regulations governing “inherited IRAs” is both vast and complex, before designating beneficiaries of retirement benefits, you should consult with a professional expert in that area. At the death of the account owner, it is important to seek additional advice as to the best way to retitle the accounts or distribute the assets. These experts should take the time to understand your unique situation and provide you with an understanding of the consequences of decisions, not just provide you with the forms needed to make changes.

Statutory Distributions Under a Will, Part 2

     On Tuesday, we addressed the provisions of the Estates and Protected Individuals Code (EPIC) that establish allowances for surviving spouses and dependents that take precedence over other creditors’ claims against the probate estate. We also addressed a surviving spouse’s right under Michigan law to elect a statutorily mandated portion of the probate estate in lieu of the distribution scheme articulated in the decedent’s Will. Both of these statutorily created exceptions to the distribution provisions of a Will come as a result of legislature’s desire to ensure that surviving spouses are not left destitute upon the death of their spouse because the spouse "disinherited" them. Today's blog takes a further look at EPIC’s statutory provisions, this time regarding the distribution of the probate estate when a decedent dies "intestate" (without executing a Will) and when the decedent marries or has children following the execution of the Will. Clients are frequently surprised that the statute provides very different distribution provisions for family members than they would actually want. 
     The State statute determines intestate distribution of an estate, and the distributions vary depending on who survives the decedent. Different provisions of the law apply to surviving spouses, surviving dependents, and other surviving relatives. In determining intestate distribution, EPIC first addresses the decedent’s surviving spouse. Presuming that there is a surviving spouse, the share distributed to that individual is dependent on the decedent’s other surviving relatives. If the decedent is survived by a spouse but no parents or descendants, the spouse receives the entire estate. The share for the surviving spouse decreases when the decedent is survived by either parents or descendants (typically children or grandchildren). Tuesday's post details the variety of circumstances and values for the surviving spouse's distribution in the circumstances. 

     When a spouse does not survive the decedent, EPIC provides that the descendants (children, grandchildren, etc.) split the estate by "right of representation". Under Michigan law, "right of representation" means that the estate is divided per capita at each generation. This means that if the decedent had three children who are all alive at his death then the estate is split into three equal shares and distributed to those children. If, however, only one of the decedent’s three children remains alive at his death, the living child still receives a one-third share of the estate while the shares for the two deceased children are recombined and then divided equally between all the children of the deceased children. For example, if children A, B and C are all alive, and the estate is $900,000, they each receive $300,000 of the estate. If B and C have predeceased the decedent, and B has two children and C has five children, each of those children of a predeceased child will receive 1/7 of 600,000, or approximately $85,000. B's children receive a total of $170,000 (rather than splitting $300,000) and C's children received a total of $430,000 (rather than splitting $300,000). If used, EPIC can dramatically skew estate distributions among family members. 

    If the decedent has neither spouse nor any living descendants, EPIC then distributes the estate to the survivor or survivors of the decedent's parents. If there are no surviving parents, the estate then passes to the decedent’s living siblings, followed by living grandparents, then to living descendants of grandparents. If none of these potential beneficiaries are alive, the probate estate escheats (is distributed) to the State of Michigan. 

     A different rule applies if the decedent has executed a Will at some point in their life, but never updates the document after being married or having children. Michigan law provides in that case, that a surviving spouse is entitled to the share they would receive had the decedent died intestate, unless from the Will or other evidence it is clear that the Will was made in contemplation of the marriage and the spouse was purposefully omitted, in which case the surviving spouse receives nothing. 

     Children omitted from a Will are treated similarly to an omitted spouse, but the omitted child's share is dependent on whether or not other children of the decedent were provided for in the Will. If the decedent had no living children when the Will was executed and did not provide for children, an afterborn child is entitled to a share equal to that they would receive had the decedent died intestate. If however the decedent had one or more living children when the Will was executed, the omitted afterborn child is entitled to a share that is equal to the share for the non-omitted children. As with an omitted spouse, if the decedent’s Will provides clear evidence that the omission was intentional, the omitted afterborn child receives nothing 

     As this week's discussion of the probate statutes demonstrates, EPIC may provide for estate distributions significantly different from what the decedent might have provided for if the decedent had planned. Thankfully, proper planning protects loved ones and insures against accidentally disinheritance. Appropriately drafted documents can ensure that the spouse and descendants receive the share of an estate that the deceased spouse or parent actually wanted rather than what a state statute provides for. A client can avoid the probate process entirely by executing and properly funding a living trust guaranteeing that their assets are distributed to those people and institutions that are named in the trust document.

Statutory Distributions under a Will

We spend a great deal of time in the estate planning process discussing gifts and distributions with our clients. It is worth noting that when a person dies with a Will, Michigan law provides for certain automatic distributions over and above the terms of the Will. These statutorily authorized distributions exist to protect surviving spouses and children by providing them immediate access to funds needed for normal expenses. These provisions also guarantee their right to retain a substantial portion of personal property over the claims of any potential creditor. Before we continue, this is an opportune time to review legal terms commonly used in estate planning, as these terms appear often in legislation.

• Decedent: The individual who died, also known as the Deceased Individual.
• Surviving Spouse: The person married to the decedent at the time of the decedent's death.
• Descendants: The children, grandchildren, great-grandchildren, etc. of the decedent.
• Estate: The individually owned property of the decedent that must pass through the probate process at the decedent's death.
• Intestate: The state of dying without a Will

The Michigan the Estates and Protected Individuals Code ("EPIC") provides for three allowances for either a surviving spouse or surviving children. These allowances take priority over other claims against the estate, except for administration costs and expenses and reasonable funeral and burial expenses:

• Homestead Allowance: The surviving spouse or surviving children are entitled to a Homestead allowance of $15,000, adjusted for inflation. This allowance ensures that surviving family has sufficient funds to pay housing and utility costs. This allowance has priority over all successive allowances.
• Family Allowance: During the period of probate administration, the surviving spouse and any minor children whom the decedent supported are also eligible for a reasonable family allowance to cover the cost of normal living expenses. While this allowance lacks a definitive value, the allowance is limited to a single year when it is clear that an estate is inadequate to discharge all other allowable claims.
• Exempt Property: The surviving spouse is also entitled to household furniture, automobiles, furnishings, appliances, and personal effects from the estate up to a value not to exceed $10,000.

The property and assets received from these allowances are in addition to any amount that the surviving spouse or child would inherit either by intestate succession or under the decedent’s Will.

In addition to these allowances, a surviving spouse has the ability to elect a statutorily mandated share of their deceased spouse's estate in lieu of what the spouse would receive under the terms of the Will. That election entitles the surviving spouse to one half (1/2) of the sum or share that would have passed to the spouse had the testator died intestate, reduced by one half of the value of all property received by the spouse from the decedent by any means (for example, joint tenancy of assets) other than testator or intestate succession upon the decedent's death.

The intestate share of a surviving spouse varies depending on the other parties that survived the decedent. The spouse is entitled to:

• The entire intestate estate if no descendant or parent of the decedent survives the decedent.
• The first $150,000.00, plus 1/2 of any balance of the intestate estate, if all of the decedent's surviving descendants are also descendants of the surviving spouse and there is no other descendant of the surviving spouse who survives the decedent.
• The first $150,000.00, plus 3/4 of any balance of the intestate estate, if no descendant of the decedent survives the decedent, but a parent of the decedent survives the decedent.
• The first $150,000.00, plus 1/2 of any balance of the intestate estate, if all of the decedent's surviving descendants are also descendants of the surviving spouse and the surviving spouse has 1 or more surviving descendants who are not descendants of the decedent.
• The first $150,000.00, plus 1/2 of any balance of the intestate estate, if 1 or more, but not all, of the decedent's surviving descendants are not descendants of the surviving spouse.
• The first $100,000.00, plus 1/2 of any balance of the intestate estate, if none of the decedent's surviving descendants are descendants of the surviving spouse.

As with the Homestead allowance, the values listed above are adjusted on a yearly basis for inflation. However, keep in mind that when a surviving spouse elects to take this statutorily mandated share, the spouse receives only one-half of the amounts listed above.

When presented with this information, clients often express surprise and wonder why they are not allowed to dispose of their assets in any way they choose. The simple answer is the Michigan legislature has found a compelling interest in ensuring that surviving spouses are not left destitute upon the demise of their spouse because the spouse "disinherited" them. This is not to say that a married couple cannot execute a prenuptial or postnuptial agreement providing that the surviving spouse waives the right to the elective share. Such agreements however require that both parties disclose all of their assets and that separate counsel represent both parties prior to consenting to such an agreement.

It is clear that while there is substantial freedom in designating those individuals who will inherit property upon a decedent's death there are limitations. A further limitation addressed by Michigan statute is the circumstance of a marriage, or birth of a child, following the execution of a Will. On Thursday, we will discuss this limitation in more detail.

An important caveat to all of the foregoing information is that any amounts received by surviving spouses or children under allowances or an elective share of an estate apply only to those assets that are part of the decedent’s probate estate, thus any asset owned by a trust is exempt from attachment under these exceptions. This ability to bypass the statutory limits on disinheritance is another benefit of a properly executed and implemented trust. In the event that an individual seeks to disinherit their immediate family it is important to discuss this decision with an experienced attorney to ensure that all the necessary steps are taken to enforce such a decision.

Insurance as Part of an Estate Plan

When clients are in their early career years, working hard to establish themselves and starting a family, not enough time and effort is placed on setting assets aside to protect the family for the future. The thought process usually is that with hard work, we will be able to save sufficient assets for putting our children through school and providing a nice nest egg for our retirement years. However, what happens if plans go awry and the client dies unexpectedly? The family loses someone who was previously contributing to the payment of day-to-day living expenses. This can have a significant adverse effect on the lifestyle or future plans of the surviving spouse and children. This is the perfect time to consider the need for life insurance to provide that protection.

Life insurance can provide protection for a spouse and children in the event a client dies prematurely. A life insurance policy can provide funds to pay family living expenses and college education costs. It can replace the income stream lost when one spouse passes away unexpectedly, and allows the family to maintain a standard of living is otherwise lost because of that death. At this stage in a client's life, term life insurance is probably the most economical way of funding this family protection. The relatively low cost of term insurance at young ages makes it affordable for families on a limited budget. The policy can be designed to protect for a finite number of years, (for example 10, 15, 20 or 30), depending on the length of the term insurance contract chosen. If the client dies at a young age, funds are available so a family's lifestyle can be maintained and dreams of college for children can be met. If the client lives to middle age and beyond, he builds a significant estate to protect the client and family in retirement years. In that case, the client lets the policy lapse or terminates it because it is no longer necessary.

Sometimes clients have targets for what they would like to leave to their children at their death. Clients often use life insurance to fund the difference between actual assets and the theoretical target set by the client. For example, if a client has five children and wants to pass on $500,000 each of death, a client needs $2,500,000. If the client only has $1,500,000 in assets, the difference can be funded with a life insurance policy at a much smaller cost on an annual basis than hoping to save the difference before the client dies.

Some of my clients have used life insurance fund a bequest to a child while giving a specific asset to another child that values that asset. For example, the largest asset of a client’s estate may be a business in which only one of the children are active. The client desires to leave the business to that child, yet does not want to be unfair to any other children. By purchasing a life insurance policy of equal value to the business, the client can assure that there will be sufficient assets to provide an equal split of value between us children.

On occasion, a client has used a life insurance policy to fund a special needs trust for a particular child, leaving the remainder of assets to other children in order to make certain that none of the estate is required to be used for the special needs child in lieu of government benefits.

Clients who are fortunate enough to have assets in excess of lifetime exclusion of $5,000,000 can use life insurance to replace the amount of the estate loss to estate taxes. These amounts can be replaced on a leveraged basis using life insurance because the cost of a life insurance policy, whether a term policy or a permanent policy will never exceed the face value of the policy. The replacement of the assets using life insurance policy is funded at a fraction of the cost. In a situation such as this, where a life insurance will always be useful, it may be more appropriate to use a permanent policy and continue to pay premiums, because a term policy has a finite existence and may lapse or terminate or become too expensive at a time when it would be most needed. While many clients worry about the costs reducing their livestock, the reality generally is that the life insurance premiums will be paid from excess assets, not assets being currently used to support the client's lifestyle that the payment of premiums will come from excess assets, not assets otherwise used to support a client's lifestyle.

For many years, the funding of a retirement benefit or savings using a permanent life insurance policy has been out of favor for a number of reasons. Some commentators are now suggesting that because of the income tax changes in the most recent tax law, which raise income tax rates on investment income, and dividends for some taxpayers, using a life insurance policy as an estate builder can be valuable because of the tax-deferred buildup of the value of the policy. While this remains to be seen, at least make sense to consider this as a possible planning option.

Whether a term policy or permanent policy makes sense will depend upon the intended use for the proceeds. Whatever type of policy is purchased, it will usually make sense to purchase it sooner than later because life insurance is less expensive for younger, healthier clients, resulting in smaller premiums. Using life insurance, goals can be met even if an unexpected death or other event occurs for a family. Clients should always discuss the purchase of life insurance with an experienced life insurance professional and their estate planning attorney.

Talking About an Estate Plan

As we discussed previously, the estate planning process does not end with the signing of the documents. One aspect of the process that is the client’s responsibility involves discussing planning with those individuals named to make decisions and potentially with beneficiaries.

In our practice, we have found that the best plans are ones where everyone involved knows the plan and there are no surprises. This does not mean that the client need to discuss every detail of their estate with every person named in the documents. However, providing those whom the plan most affects with sufficient information makes execution of the plan significantly easier.

First, it is important to inform those people who have been designated to make decisions upon the client’s incapacity. We encourage our clients to discuss this prior to the signing, therefore avoiding a situation where a named individual intends to immediately step aside. Talking with your named designates ensures that all of the individuals named in an estate plan are willing to act if called upon, and decreases the chance that the probate court will become involved in naming a successor designee. Additionally, it is important to inform those designees where those executed documents are kept so they can be located easily in the event the need to step in arises.

In addition to informing those individuals named as designees of their potential roles and duties, it is also important to discuss with these people the client's concerns and desired treatment if called upon to act. It is important to provide designees with sufficient information regarding values, beliefs, and wishes so that they are able to make decisions that they feel are in the client's best interest and reflect decisions that the client would make were they not incapacitated. Frequently these discussions will touch upon sensitive topics such as the circumstances under which the decision to withhold medical treatment is appropriate. Many clients express a reluctance to have such discussions due to their sensitive nature. If a discussion does not occur, at a minimum we recommend providing a letter with instructions regarding those issues. The letter can be kept with the Patient Advocate Designation.

The importance of establishing guidelines for designees is not limited to those named as Patient Advocate. Should a client become incapacitated, those who will act on their behalf as Successor Trustees under the Trust and Attorneys in Fact under the Durable Power of Attorney must also be aware of the client's overall goals. Both of these roles may involve providing access to assets for dependents, continuing the client's charitable gifting, and the operation of the client’s business. If those individuals named are not familiar with the client’s desires, it makes acting on behalf of the client significantly more burdensome. Again, the client can provide many of these details in a separate writing that is kept with the relevant documents. Important information to be contained in this writing includes specific instructions as to what should be done with particular assets should the client become incapacitated, instructions for the continuance or modification of charitable giving, and instructions regarding the operation of businesses to name a few.

In addition to designees named in documents, others may benefit from receiving advanced information about the terms of an estate plan. Providing beneficiaries with information regarding potential inheritances establishes reasonable expectations and reduces the chances that a beneficiary will challenge the terms of the estate plan. How much information a client chooses to give to a beneficiary depends on the family situation. There is no correct answer to this question, as the right amount of information can vary significantly from client to client and even from beneficiary to beneficiary. Where some beneficiaries have sufficient experience and maturity to provide them with the full details of their potential inheritance, others may misuse such information and engage in patterns of reckless or irresponsible behavior.

It is been our experience however, that beneficiaries who are informed of distributions for their benefit in at least general terms create the least amount of problems following a death. When beneficiaries have an understanding of the donor's reasoning in making the gifts they make, there is often less conflict following the death. This is not to say that a discussion of potential distributions solves all problems. There are individuals who, upon learning of their share of an estate, will always feel they have been treated unfairly.

In addition to discussing the specific distributions laid out in the in the estate plan it is also frequently beneficial for a client to discuss the distribution of their personal property. By learning which items of property their loved ones feel will provide a connection to the client after death, the client is better able to ensure that their loved ones are able to retain those items and the memories associated with them. When a client discovers that multiple loved ones have an interest in the same items, it is possible to head off conflicts by designating particular individuals to receive particular items so that disputes do not occur following a death, avoiding further pain during an already difficult time.

Discussing estate planning, medical concerns, and death are difficult subjects. However like much of the rest of the estate planning process, by engaging in these discussions while people are healthy and active, it is possible to avoid a great deal of trouble should a person become incapacitated or after they have passed away. In our practice, we strive to provide clients with peace of mind that their loved ones will be cared for following their death. By encouraging our clients to engage in discussions regarding their planning we hope to avoid potential pitfalls and awkward situations as well as additional grief, strife, or problems after a client's death.

Keeping a Vacation Home in the Family

A number of my clients have family vacation homes or cottages that they and their children have enjoyed for many years. After getting so much enjoyment from owning the cottage those clients often ask how they can set up their estate planning documents to ensure that when they die, that ownership experience passes onto their children and grandchildren. While, in theory, this may be a good idea, it often creates significant problems if a not fully thought out and planned.

One issue that often causes an issue is the gift tax consequence of transferring a valuable piece of property. However, because of the most recent tax legislation, most people have a sufficient exemption amount so that gift tax is not an issue.

Transferring cottages to other family members can create thornier issues because of personal relationships. While family members may have enjoyed their time at the cottage, for many reasons they may have no interest in owning the cottage with their siblings or other family members. Issues that can arise include:

1. What is the most efficient manner of ownership of the cottage?
2. How to insure that the cottage remains in the "family"?
3. How to establish rules for the management and use of the cottage?

Generally, traditional forms of joint ownership, such as tenancy in common and joint tenancy with rights of survivorship, are inefficient methods for family ownership of the cottage. The primary risk in these types of ownership is that over time the ownership interest is subdivided or fractionalized as it is passed down to subsequent generations. While it is the dream or wish of the parents that the children continue to enjoy the cottages they have in the past, as family members grow into adulthood they may have different ideas. A family member might not have had a great experience at the cottage, may live too far away to be able to enjoy it, cannot afford the share of the cottage expenses, or may simply prefer the value of the cottage in cash to use as they may choose. With tenancy in common or joint tenancy, a family member may try to use his or her partition rights under state law, forcing the sale of the cottage or vacation home.

Co-ownership of the cottage may lead to other conflicts, such as:

1. Who controls the operation of the cottage?
2. How are operating, maintenance or repair expenses shared?
3. Who determines when and what improvements to make and how to pay for those improvements?
4. How are the most desired dates for cottage use determined or allocated among family members?
5. Are pets allowed?
6. Can family members rent their time to third parties?
7. Are nonfamily members, such as spouses and siblings, allowed to own an interest in the vacation home?
8. What happens if a family member wants to sell his interest in the cottage?

While many of these issues do not exist while the parents are alive because the parents pay all expenses of the cottage and determine how it is used, after the death of parents, these issues and others can create family disagreements or even permanent rifts.

 If the parents are still interested in trying to establish a "family cottage," a limited liability company (LLC) is an ideal ownership vehicle. An LLC has a perpetual existence. Parents can transfer the property to an LLC and then gift interests in the LLC during lifetime or at death to other family members. The LLC as an entity can protect owners from lawsuits by users of the cottage if injured on the premises. It can also prevent owners from being able to use the right of partition in order to sell the property. If used with a properly structured operating agreement, it can promote shared use and fair governance of the property.

It is possible to use an LLC operating agreement to meet the goals of the family, and should include:

1. A determination of who is the manager of the LLC--all members or a named managing member.
2. A procedure for determining what maintenance or improvement is to occur on the property and a method of allocating associated expenses.
3. A method of equitably allocating among family members the dates for using the cottage, especially during holidays, school vacations and most ideal seasons.
4. Rules for members using the cottage, including restrictions on allowance of pets, ability to invite guests, and the ability to rent out the member's time to outside parties.
5. A method for penalizing a member for violation of usage rules and/or failure to pay the required contribution for expenses.
6. A method for determining the transfer of member interests, including price and terms, for any member desiring to sell their interest. This could include a restriction on any sale to a non-family member.

While gift and estate taxes are unlikely to cause an issue, the consequences in regards to property taxes should not be forgotten when considering the transfer of a vacation home. Under Michigan law, if you convey less than 50% of ownership in real estate to others, there is no change in the property tax assessment rules for determining taxable value. Parents can gift up to 49% of the property to family members without any real estate tax consequence. If they prefer, the parents can first transfer the property to an LLC and then transfer 50% of the LLC to family members.

Because property values are still somewhat depressed, this is an opportune time to transfer the vacation property to family members and move value and future appreciation to family members and out of the parents' estate, while continuing to allow parents to maintain control of the asset.

While parents have the best interests of their family at heart, trying to maintain a vacation home in the family for a number of generations can create a nightmare scenario. It makes good sense to discuss this strategy with qualified counsel and the family itself to make sure there is sufficient interest to maintain the family cottage for future generations and to properly structure the transaction.

Providing Loved Ones with a Postmortem Checklist

     As we discuss estate planning both here in the blog and in our practice, we take pains to reinforce the idea that estate planning is more than drafting and signing a set of documents that will sit in a drawer, forgotten, until someone passes away. Estate planning is an ongoing process that requires clients to take an active role in order to be most effective. An important example of a client responsibility in the process is the preparation of a Postmortem Guide to assist their loved ones in dealing with the practical results of their death.

     While loved ones know to take care of obvious tasks, such as making funeral arrangements and gathering assets, less obvious concerns including providing notice to Social Security, canceling subscriptions, dealing with credit cards, and shutting off utilities often are forgotten. By taking the time to prepare a Postmortem Guide, it is possible to provide loved ones with a checklist of required actions and all of the information needed to complete those actions.

     Following every estate plan signing we send our clients a letter that includes a list of tasks to complete following a death, including:

•          Making funeral arrangements
•          Meeting with attorneys and accountants
•          Giving notice to Social Security
•          Giving notice to Veterans Administration (if necessary)
•          Giving notice to Pension Providers
•          Giving notice to creditors
•          Securing the contents of any safe deposit boxes
•          Gathering assets and personal effects
•          Maintaining the residence
•          Continuing the operation of existing businesses

Along with that list, we include a form that provides the client with an organized structure for providing their loved ones with the information needed to complete those tasks. This information includes:

•         Space for names and phone numbers of the individuals the client has named in those documents.
•          A section to list existing creditors, such as credit cards, mortgage companies, and other outstanding loans
•          The names and phone numbers for the client’s advisors, including brokers, insurance agents, the doctors, and spiritual leaders
•          An area to provide instructions regarding funeral and burial arrangements
•          An area to provide information regarding the location of assets
•          A section to list the names and phone numbers of utility providers
•          A section for online and other passwords

     We encourage our clients to complete this form and keep it with their estate planning documents and then to inform those people designated in the documents of the location where the documents are located.

     Occasionally a client wishes to provide their loved ones with final words of wisdom or an explanation of the reasoning used in making gifting decisions. In those circumstances, we discourage the inclusion of such information in the estate plan documents, so as to minimize any non-legal language that potentially can lead to confusion in the distribution of an estate. Instead, we suggest the client write a separate letter to their loved ones with this information and include it in the same information package as the to do list and pertinent information form.

     While it may seem obvious that having this information handy will assist loved ones in an emotionally trying time, many of our clients express thanks to us for providing them with a format to articulate the information and for encouraging them to sit down and organize the information as part of the planning process. As we have previously said, estate planning involves more than drafting documents. We see it as the duty of estate planning attorney to continue to guide their client through the lifelong process of planning, including organization, proper funding, and regularly updating documents, thus ensuring that the client’s loved ones do not face any more problems than necessary during an already difficult time in their lives.

The State of Estate Planning Post Fiscal Cliff

2013 is now three days old and we at Plainly Legal are pleased to report we have survived the "fiscal cliff" that loomed so ominously at year-end. While it took a few extra hours, some arm-twisting, and likely more than a few hurt feelings, Congress has managed a compromise and begun to address the expiration of tax cuts and mandatory spending reductions that make up the “fiscal cliff.” While the legislation passed by Congress is broad and addresses many different aspects of taxation, and Congress still needs to address a number of other areas in the next few months, I wanted to take just a few moments of your time to address impact of that legislation on the estate planning process.

The final legislation’s impact on the estate planning process is rather limited as compared to earlier proposed bills, but for the most part there is good news. The most important aspects of the bill are:

• The new law makes permanent the existing $5,000,000 exemption for each taxpayer for the Federal Estate Tax, and the law indexes this exemption to the rate of inflation so the exemption will grow slowly over time. This means that estates smaller than $5,000,000 ($10,000,000 for a married couple) are not subject to Federal Estate Taxation.
• The Lifetime Gift Tax Exemption for making gifts prior to death also remains at $5,000,000. The Lifetime Gift Tax Exemption and the Estate Tax Exemption remain linked, so every dollar of the Lifetime Gift Tax Exemption used counts against the Estate Tax Exemption.
• The legislation makes permanent the exemption portability, which is the ability of a widow or widower to make use of the unused exemption amount of a deceased spouse.
• The only substantive change in the legislation from the rules that governed for the past twelve months is an increase in the highest rate of estate taxation from 35% to 40%.

For better or worse, the legislation makes only limited changes to the law affecting estate planning. Plainly Legal will leave to others the political discourse and countless opinions expressed by elected officials, pundits, and others about the scope of the changes. Instead, we take solace in the fact that this legislation creates a level of certainty in the estate tax law that has not existed for the last few years. The certainty and permanency of exemptions and provisions that no longer have a sunset date (at least until Congress decides to actively make changes again) creates an opportunity to review a client's estate planning and determine whether it is appropriate to make any changes. With higher exemption limits, it may no longer be necessary for both a husband and wife to have a Living Trust, allowing planning simplification. In addition, concerns or issues which have been weighing on clients about family situations until the federal law was clearer can be addressed. It is also a good time to review your assets and confirm they are properly titled to avoid probate.

A Happy New Year from Plainly Legal

When I sat down to write this post around noon on December 31, I intended to use today to write about the current state of the law affecting estate planning. As you likely know, one part of the Fiscal Cliff is the expiration of the present law regarding the taxes paid on transfers of wealth at death, the Estate Tax. Tied to the Estate Tax is the Gift Tax, which taxes certain transfers of wealth during a person’s life. If Congress does nothing, when the present law expires the new threshold for estate taxation in 2013 will be $1,000,000. This means that estates with a value over $1,000,000 and lifetime gifting (with some exceptions) over $1,000,000 will be subject to taxation. The rate of taxation is also set to increase from a maximum rate of 35% of every dollar over the threshold to a maximum rate of 55% of every dollar over the threshold. This is just one of the results of the nation “going over” the Fiscal Cliff and I could spend a month of posts explaining those results.

However since as I was writing this post, Congress had not managed to find the collective moral courage to set aside partisan bickering, care more for the good of the nation than their own job security, and fulfill their oath to the American people, I find it difficult to articulate the state of the law. Ultimately, no matter what the law is as the sun rises over Washington, D.C. this New Year’s Day 2013, it can (and likely will) change. Tax rates and thresholds can be set retroactively, the difference between a tax increase and tax cut depends on the day of the week the law passes, and the nation’s economy will not split like the hull of the Titanic in the course of a single day or even a single month. Instead of a dry recitation of statutory interpretation I have for you three thoughts:

1. It is a new year. Take a moment to assess your goals from the past year, see how you did in achieving what you set out to do. Once you know where you came from, it is easier to plan for the future, so start achieving your 2013 goals today. Whatever else you do with the day is up to you, but I suggest spending it with friends and loved ones. There are 364 more days to spend making money, helping others, and fixing the dripping sink,  so why not start the year off with a little enjoyment.
2. Thank you for your trust and support. We have been writing this blog now for a little over three months and we intend to continue writing it for many more. Thank you for continuing to use us as counselors, advisors, and attorneys. It is our greatest pleasure to serve you, your families, and your clients. We truly appreciate it when we receive new clients through your referrals. If there are areas of estate planning, business planning, or other law that you would like to see us discuss here, please do not hesitate to let us know in the comments or by email.
3. Go team! As we go through the season of college football bowl games and NFL playoffs, may your team  score enough points to beat their opponent (or if you are so interested, just beat the spread).

A Happy and Successful New Year to you, your family, and everyone else in your life from everyone at Finkel Whitefield Selik and the Plainly Legal blog.

Al Ferrara

Matt Ferrara