Discussing Planning and Finances with Loved Ones

     Discussing estate planning with clients can be particularly challenging, as people are frequently reluctant to contemplate their death or to discuss the state of their personal finances. This discussion likely is more difficult when it occurs between an aging parent and their adult child. As parents age it, becomes more and more important for adult children to understand the state of their parents’ planning or lack thereof. While such discussions may be difficult, they can be the difference between a smooth estate administration and months of problems in a probate court.

     Discussing estate planning is much more than simply learning whether a Will or Trust exists. This does not mean that parents need to share those documents with their adult children, but it is advisable that adult children know the location of the documents, who is designated to handle their parents’ affairs, and contact information for their parents’ attorneys and advisors. It is also important for adult children to know if their parents have other documents to address lifetime issues, such as Durable Powers of Attorney, Patient Advocate Designations, and Living Wills. This knowledge sets the stage for a larger discussion of the parents' finances. This discussion is important because an organized list of assets, income, and expenses allows the people named under powers of attorney or designated to administer the estate to handle the parents’ finances efficiently. As with the discussion of estate planning, this discussion does not need to include a complete disclosure of the parents’ finances. It should at a minimum result in the parent preparing a list of information that includes:

• Information on all bank and investment accounts
• Information on all sources of income, including annuities, IRA, retirement accounts, and Social Security
• Information on all regular expenses, including utility bills, mortgages, car payments, regular donations
• Contact information for financial advisors, insurance agents, and attorneys

As with the estate planning information, the parents’ should keep this list of financial information where it is readily accessible and the location known to those people designated to make decisions or administer the estate.

     Having a discussion with parents and other loved ones regarding the state of their planning, their finances, and organization is never easy, but the information gained from such a discussion makes all the difference when it comes time to administer an estate or make decisions on behalf of a loved one. It is all too common for client to meet with us to prepare an estate plan after experiencing the results of handling a parent’s estate without a plan. It is important for clients to share this information with their loved ones after executing documents and to address these issues with their parents to avoid future issues.

Matt Ferrara

Using Non-Compete Clauses to Protect the Value of Business Assets

On Tuesday, we discussed how a Buy Sell Agreement keeps the value of a client’s business, frequently their most valuable asset, from evaporating following the owner’s death. While many business owners prepare for physical disasters though the use of insurance and some prepare for ownership transitions with Buy Sell Agreements, most fail to protect their business from a trusted employee who leaves to start a competing business.

Well-drafted, up to date, Non-Compete Agreements (or Non-Compete Clauses in Employment Agreements) can protect the business owner from losing valuable trained employees to competing ventures, but such documents must be narrowly tailored in order to be effective. While the courts enforce contractual agreements, there is a reluctance to enforce agreements when the employer does not compensate the employee in some manner for accepting the Non-Compete Agreement or where the restriction on competition is unreasonably broad.

Fortunately, acceptable compensation for assenting to a Non-Compete Clause/Agreement includes promotion to a new position or access to new information regarding the operation of a particular business. This allows the business owner to implement a Non-Compete Agreement with a small group of key employees whom the owner sees as potential successors without the worry that one of them will then leave to start a competing business.

In addition to requiring compensation to enforce a Non-Compete Agreement, the agreement must not be so broad as to restrict the employee from making a living. The breadth of restriction applies both to geography and to length of time. This means that an agreement that bars working in a similar business within thirty miles of an existing employer for two years is likely enforceable, while an agreement barring employment in a whole industry for ten years will likely be overturned. It is important that the agreement balance the scope of restriction against the time the business needs to recover from the employee’s departure. When considering whether to enforce a Non-Compete Clause courts also examine whether the clause serves a legitimate business purpose or appears to be purely punitive to limit the employee's ability to make a living.

Unfortunately, all too frequently employers only come to us after an employee leaves a business. The owner will want to stop the employee from using key business information, such as processes, client lists, or technological developments to compete in the absence of a Non-Compete Agreement. While Michigan law will protect the "trade secrets" of a business to a certain extent, only properly drafted documents before a problem arises will maximize that protection.

Our clients work hard to build valuable assets they hope will provide for them and their loved ones far into the future. It is important for us as advisors to work with our clients to protect their investment in the company during their ownership as well as establish a plan that provides the client, or their loved ones, with a smooth transition to new owners to best maintain the value of the business. 

Matt Ferrara

Protecting the Business Owner

A client's business is often the largest asset in their estate. Yet, despite spending years growing the business and making it successful, some clients think their business has nothing to do with their estate planning. The payoff of all that hard work is a high-value asset that will support the client during their retirement and provide for their loved ones in the event they pass away unexpectedly. Unfortunately, clients often fail to protect that asset because they neglect to plan for future transitions.

Clients work hard to grow a business, yet fail to implement plans to maintain the value of that business in the event of an unexpected death. While a business have significant value while the business owner is alive, if the strength of that business is the owner, it may have little or no value because of his or her sudden death. It is not enough to have a successful business. Owners must develop employees that are willing and able to take over the business. A buy-sell arrangement can solidify the value and longevity of the business by guaranteeing that key employees are buyers for the business in the event the owner decides to retire, becomes incapacitated or dies. In addition to creating a succession plan, Buy Sell Agreements can help protect the value of the business by requiring that the future owners purchase a life insurance policy on the current owner to guarantee purchase funds are available at death.

It is important that a well-drafted Buy Sell Agreement not only be in place, but that clients update that agreement as appropriate. Often terms that seemed reasonable in the initial agreement fail to reflect events and changes that occur as a business grows. Key provisions of a Buy Sell Agreement should include:

• Triggering events when the buyer must purchase the business, such as death, disability, or retirement. 
• An initial value for the business as well as a method for redetermining that value at the time of sale. 
• Payment terms that are fair to the seller, but are not so onerous to the buyer that there is an eventual default

      We are encouraged to have annual check-ups to maintain our health. We are now engaging some of our business clients in a "business health audit" to determine if all of their business documents are up to date and protect their business value. I would encourage all business owners to consider similar steps with their professionals to protect the biggest value in their estate. Later this week we will discuss how clients protect their business from employees who become competitors, using Non-Compete Clauses/Agreements.

Alan Ferrara

A Lifetime of Planning

     Many perceive estate planning as a tool older, wealthy individuals use to protect their assets. While estate planning offers clear benefits to the very wealthy, a better explanation of estate planning is that it is a lifetime process with different benefits for people of different ages and situations. Many of my clients are surprised when I suggest that the most appropriate time to begin the estate planning process is when a person reaches age eighteen.

     When children reach eighteen, they are legal adults  under Michigan law, and their parents no longer have the authority to make legal and medical decisions on their behalf. By beginning the estate planning process at this time, the newly designated adult can execute a Durable Power of Attorney and Patient Advocate Designation that allow parents to continue to make legal and medical decisions in the event of incapacity. This initial step of estate planning introduces young adults to an attorney and provides them (and their parents) with peace of mind knowing that mom and dad can still help them if needed

     As these young adults move through the next few years, complete their education, join the workforce, and begin to accumulate assets, the estate plan that started with only lifetime documents protecting on incapacity then expands to include a simple Will. At this time the client learns about the probate process and begins to understand how proper planning will make things easier for their loved ones should something happen to them. It also helps to remind the young adult of their own mortality and the importance of preparing for the future.

     As the client marries and starts a family,  their planning expands at the same time as the family. Wills become more complex and include guardianship provisions to protect minor children. Additionally, the attorney-client relationship grows, giving the client access to the attorney's advice regarding employment issues, assistance in starting businesses, and referrals to financial advisors.

     As a married couple’s assets and family continue to grow, at a certain point it will make sense to include a Living Trust in their estate plan. By this time, the couple has experience with their attorney and with estate planning. They are equipped to understand the benefits of expanding their estate plan. From this point forward, as the client’s life changes, their long-standing relationship with their estate planning attorney provides them the opportunity to learn about more advanced techniques if those techniques are relevant to their personal and financial situation.

     When a client treats estate planning as a lifetime process, the client develops a sense of the importance of estate planning at various stages of their life. It can also provide a peace of mind that loved ones are protected in the event of unexpected illness or death.  By establishing a relationship with professionals while they are still young these clients can avoid expensive mistakes in the future.

     For planning to be successful, both the client and the attorney must be engaged in the process on the long-term basis. If either the attorney or the client treats estate planning as a "one-time event", long-term benefits and protection of estate planning will be missing. If both the client and the attorney are proactive in developing the relationship, the client will enjoy the benefits of the long-term planning and the protection and peace of mind that goes with it.

Matt Ferrara

Estate Planning for Unmarried Couples

The percentage of unmarried households grew 24% in the last decade. While not yet commonplace, it is no longer unusual for us as planners to have clients who are unmarried couples. For professionals working with unmarried couples, whether heterosexual or same-sex couples, it is important to plan differently for the sudden death of one of the partners because surviving partners are not entitled to the same rights as married couples. Specific planning is necessary to protect unmarried partners, because under state law these partners could be "disinherited". Pay careful attention to titling assets and providing specific disposition of assets if the parties desire the other partner to receive anything.

The Michigan intestacy statute provides that, in the absence of a Will, family members, not the unmarried partner, receive all the assets. In addition, various statutes designed to protect surviving spouses will not apply to an unmarried couple. While a properly prepared Will, with appropriate distribution provisions for the unmarried partner, insures protection of that partner above family members a Will alone cannot address all the issues an unmarried couple may face. As with any couple, due to different earning and savings potentials, assets may be held in separate accounts. Unless the account names both members of the couple as owners of the account, transfer on death designations should be used to insure that the surviving partner retains full control of the accounts. A regular review of the client’s finances can help detect potential problems and help protect the surviving partner.

Similarly, it is unlikely that the default distribution for a life insurance policy will include an unmarried spouse. In the absence of a validly prepared beneficiary designation most policies will pay out to the probate estate, which as we have discussed above, may be of no use to the surviving partner. Further, while federal retirement law provides some protections to insure that surviving spouses inherit retirement benefits, there must be a specific and valid beneficiary designation to the unmarried partner in order to inherit a retirement plan or IRA. Even then, provisions which would allow a spouse to "stretch out" IRA distributions to minimize taxes do not apply to an unmarried partner. The unmarried partner may have immediate tax consequences on receipt of qualified plan benefits.

Often unmarried partners will purchase a home together and will jointly own the house. Unless unmarried partners own the residence "as joint tenants with right of survivorship", on the death of one partner, that partner's share will go to family members rather than the surviving partner. The surviving partner may have to pay many thousands of dollars to pay off a family's claim in the house. You may even have a situation where the surviving unmarried partner is solely responsible for the mortgage, yet must still pay the family to maintain the residence.

Another major concern that an unmarried couples may not consider is who has the legal authority for care in the event of illness or disability. The couple should prepare documents that specifically state their intent that they want each other to make medical and/or legal decisions in the event of illness or disability. Similarly, because most states provide that family members control the funeral and burial arrangements, it is important to provide the surviving partner with the authority to determine how and where the deceased partner is buried.

We have discussed the use of trusts for many other reasons in prior posts. A trust can be very valuable in a situation with unmarried couples because you can specifically state where your assets (which presumably are funded to the trust prior to death) are to be distributed without worrying about any probate rules. The private, contractual nature of a trust lends itself to administering the assets of couples whose relationships lack recognition in the eyes of the law.

As you can see, the situation for unmarried couples can be fraught with problems. These problems can be avoided with careful analysis and specific drafting of documents. Assistance from a qualified professional is very helpful in these situations.

Alan Ferrara

Estate Tax and Non-citizen Surviving Spouses

     In the age of growing globalization, advisors increasingly must be aware of the potential that one or both of married clients may not be a United States citizen. With estate planning, citizenship particularly is important when dealing with the marital deduction against Federal  Estate Tax. While normally all assets transferred to a surviving spouse are exempt from Federal estate taxation, this deduction is disallowed if the surviving spouse is not a United States citizen.

     However, assets transferred to a Qualified Domestic Trust (QDT) allow the noncitizen spouse to make use of the marital deduction. A QDT functions much like any other trust for a spouse in the decedent's living trust. However, a QDT must have at least one trustee who is a citizen of the United States and provide that no distribution (other than the distribution of income) may be made from the QDT unless a trustee who is a citizen of the United States has the right to withhold from such distribution the tax imposed. The typical result when using a QDT is for the surviving spouse to receive all of the income from the trust automatically with the principal of the trust being distributed after the death of the surviving spouse. If the trust provisions for the spouse do not qualify as a QDT prior to the death of the taxpayer, the statute allows the trust to be reformed by a judicial proceeding as long as that judicial proceeding is commenced before the tax return is filed. Thus, through a court ruling, the trust is judicially modified so that it qualifies as a QDT.

     If the noncitizen spouse prefers not to have the trust assets restricted by the terms of the QDT, the statute also allows the noncitizen spouse, to become a citizen and therefore be qualified for the marital deduction.  The noncitizen surviving spouse must be a continuous resident of the United States following the death of the citizen spouse. The spouse must also become a citizen before the day the Federal Estate Tax Return is due. However, it is important to note that when an estate tax return is filed late in order for the surviving spouse to complete citizenship proceedings, the late return is treated as if it was filed on the actual filing date and the noncitizen spouse does not receive the protection of the marital deduction. If the noncitizen spouse seeks the protection of the statute, the Estate  must file for extensions until the  completion of the citizenship proceeding.

     Even if the Estate files for and receives an extension allowing time for the completion of citizenship proceedings, it is important to file quickly after the completion of those proceedings. The Court of Federal Claims has recently upheld the IRS's imposition of a penalty on an estate when the estate delayed nine months between the surviving spouse achieving citizenship and the filing of the final Estate Tax Return.

    While it is always wise to determine if either of the parties are non-citizens when discussing estate planning and drafting documents, the Internal Revenue Code still allows for solutions in the event appropriate planning is not completed before death. It is important for clients to consult with an expert on the subject of taxation to avoid unintended consequences.

Beneficiary Designations as Part of an Estate Plan

     Recently I sat down with the client who came to see me on the advice of his children. This client had more than a passing familiarity with estate plan documents and came to our meeting prepared to reject most of my advice for updating his estate plan. The client's primary argument against needing even a simple Will was his use of beneficiary designations naming each of his children as the beneficiary for various assets. As I reviewed the situation, the client's beneficiary designations were mostly correct and he had done a good job of naming primary and contingent beneficiaries for his major assets. We still decided to draft a simple Will to help organize the process of probate, but that got me thinking about the effectiveness of beneficiary designations in general.

     In most cases, beneficiary designations are the simplest manner of passing an asset at death without the need for that asset to pass through the Probate Court. Life insurance beneficiary designations, retirement plan beneficiary designations, and even "TOD" (transfer on death) designations used by banks circumvent the probate process. While this is a simple method, frequently requiring only the completion of a form, it may not be the most effective method. Due to the contractual nature of beneficiary designations, the institution holding the assets pays them directly to the named beneficiary. Unfortunately, there are scenarios where this will not happen smoothly, and the courts will become involved anyway.

     For example if your named beneficiary is incapacitated, a court-appointed Guardian or conservator will be required in order to take control of the assets. The same is also likely true if the designated beneficiary is a minor, because all financial institutions seek to avoid the potential liability of paying out to a minor, or even to a parent of the minor for the child's benefit.

Even if the beneficiary receives the assets directly from the financial institution there can still be many unintended consequences. The beneficiary of a tax-deferred retirement account may decide to cash out the asset immediately instead of taking advantage of the tax benefits of a long-term payout.

     Other designated beneficiaries may have creditor problems that consume their entire inheritance.. A spouse in divorce can reach assets received. For beneficiaries receiving federal government benefits, the sudden influx of money will likely cause the beneficiary to lose benefit eligibility.

     Frequently when we discuss beneficiary designations with our clients we recommend naming their Living Trust as the beneficiary so that the protections of the Trust extends to all of the client assets, and the Trust can act as a clearinghouse for the assets. This allows the Trust's "spendthrift" and "incapacitated beneficiary" clauses to protect the beneficiaries whose personal or financial situations might be otherwise disadvantaged by a sudden influx of money.

      This is not to say that beneficiary designations naming individuals are an ineffective form of estate planning. However, anyone relying on beneficiary designations to achieve their planning goals should take the time to review those designations and confirm they have not missed any major assets and that all contingencies are covered by those designations. As with the client who inspired me to consider this topic in the first place, it is also always advisable to execute at least a simple Will to organize the probate process and ensure that any assets passing through the Probate Court go go to those beneficiaries the client prefers.

Matt Ferrara

The Impermanence of Permanent Tax Changes

   While Congress may never pass many (or any) of President Obama’s 2014 Budget Proposals, there are a number of proposals in the President’s plan that would affect estate planning and bear watching. 

     The 2014 budget includes a proposal to restore the estate, gift, and generation-skipping tax (GST) rates and exemptions to their 2009 levels beginning in 2018. This would result in a top estate and gift tax rate and GST tax rate of 45 %, a $3.5 million estate tax applicable exclusion amount and GST exemption, and a $1 million gift tax exemption. 

     Another provision would require that all grantor retained annuity trusts (GRATs) have a minimum term of 10 years and some remainder value at the end of the term. This would greatly reduce the value of using a GRAT to pass value (including income) to other family members prior to death. 

     One proposal would affect the use of grantor trusts to transfer value and appreciation to other generations by treating as an incomplete transfer for gift and estate tax purposes a sale or exchange of property to a grantor trust deemed owned by the seller. 

     A fourth provision would limit using the GST exemption from the generation-skipping tax to a maximum of 90 years, where currently the protection is in perpetuity. Practically speaking this may not have much effect on the planning of most taxpayers but it is a significant theoretical cut back of protection. 

Other proposed provisions include: 

1. Requiring non-spouse beneficiaries of a decedent's IRA or retirement plan to take inherited distributions over no more than five years.
2. Limiting the amounts that can be contributed or accumulated within an IRA or qualified retirement plan to the amount necessary to provide the maximum annuity permitted for a tax-qualified defined benefit plan (currently $205,000).
3. Requiring that basis of property received by gift or from a decedent be determined consistently with the applicable gift or estate tax return. Currently there is no requirement that the recipient of a gift or bequest use the same value as that given to the gift or bequest under the applicable gift or estate tax return. For example, if the donor of the gift used a discounted value for gift tax purposes, the beneficiary can arguably use the full value of the asset in determining the basis and taxability for a sale of the asset.
4. Specifying that the GST exclusion for payments of medical and tuition costs applies only to direct payments by a donor to the provider of medical care or to the school in payment of tuition, and not to trust distributions. 

     While none of these proposals may find their way into estate planning law, they are a clear indication of the "impermanence" of the new "permanent estate tax law" passed late last year. It is important to be vigilant in reviewing what changes are possible and determine what steps might need to be taken to protect our clients.

Alan Ferrara