Wednesday, October 30, 2013

Helping Clients with Their Homework

     Over the past year, we repeatedly referred to estate planning as an ongoing process requiring the participation of the attorney, client, and other affiliated professionals in order to achieve the best outcomes. Nowhere is this more evident than during the recent meeting with couple who have been long-term clients.
     Since the clients executed their documents in 2001, they have relied on us to inform them when the documents needed updating. Over the course of the last dozen years, much has changed in the clients’ lives, and we have kept their plan consistent with their goals. As we reached the end of the meeting and asked if the clients had any new assets that were not funded to their Trust, the husband, somewhat sheepishly, pulled out the funding instructions that they were given in prior meetings and said, "I know I was supposed to do something with this but I never really did. Is that important?" Because this has occurred with other clients, we now take an active role in the funding of our clients' Trusts. We work closely with our clients and there other advisors to insure that when the client leaves our office their assets are funded to their Living Trust.
     Upon discovering that the clients’ Trust owned little, we began discussing their assets, beginning with their real estate. In this case, the clients owned their home jointly. Historically when dealing with real estate most estate planning attorneys have advocated executing a quitclaim deed to a Living Trust but not recording that deed while both spouses are living. This strategy has resulted in many attorneys having filing cabinets full of unrecorded deeds. With the relatively recent adoption of the “quitclaim deed with reserved life estate to grantor”, more commonly known as the "ladybird deed”, unrecorded deeds are unnecessary. We prepared a ladybird deed for the clients’ residence so that they can continue to have the creditor protection of jointly owned property during their lifetime, and the property will automatically transfer to their Trust following the death of the second of them.
     Next, we looked at the clients’ mutual funds and other investments, with the goal to make sure that the clients' Living Trust was the titled owner of all of these accounts. By working directly with the clients’ financial planner we were able to obtain the forms needed to open a new account in the name of the clients' Living Trust, and completed them at our signing meeting. The clients actually had some mutual funds they purchased directly and we suggested they transfer these to their current planner, which the clients (and the planner) thought was a good idea. This allowed us to return the forms and a Certificate of Trust Existence to the planner, who then was able to the transfer of ownership to the Trust.
     We also reviewed the clients' beneficiary designations for retirement accounts and life insurance policies. For this particular client, both the 401(k) and life insurance policies named the wife as primary beneficiary but failed to name a contingent beneficiary in the event that the wife should predecease him. Again, we coordinated with the clients’ financial planner to have change of beneficiary forms ready at our signing meeting. These forms continued to name the wife as the primary beneficiary of the 401(k) plan account and then named the Living Trust as a contingent beneficiary. The new beneficiary of the life insurance policies was the Trust, because upon the death of the husband the wife had total control of the Trust.
     Initially the clients’ financial planner resisted naming the Living Trust as a beneficiary because he was aware of the general rule that required immediate distribution of retirement accounts if a nonperson was named as beneficiary of the 401(k). We made him aware of the important exception to that rule that allowed Trust beneficiaries to stretch distributions over the life expectancy of the oldest trust beneficiary if the Trust contained "see-through provisions", that allow the Trustee to stretch distributions from the 401(k) account over the lifetimes of beneficiaries of the Trust. By requiring that any IRA distributions pass through the Trust we were also able to protect one of the clients’ children, whose spending habits are of great concern to the clients, from electing to take their share of the IRA immediately or over a short period of time and spending it .
     Finally, we looked at the clients’ business interests. Recently the clients assisted one of their children by providing capital to open a small business. In exchange for the startup funds, the client was became a 50% owner of the business. The clients intended that their son would inherit any portion of the business the clients owned at their death, and not involve the other children in the business. To achieve this goal we prepared an Assignment of the L.L.C. interest to the Living Trust and added specific language in the Trust for distribution of that interest to the child in question.
     Trust documents and Trust funding go hand-in-hand. Because as planners we understand that many clients are unlikely to complete "homework assignments" that may be integral to the operation of their planning, it is incumbent on us to find ways to work together to make the process as simple as possible for our clients. For this reason, we strive to be as open and available to both our clients and their other advisors as possible so that we can ensure that the clients are receiving the greatest value from our services.

Wednesday, October 23, 2013

Planning for Same-Sex Couples in Michigan

While the Federal and state rules regarding same-sex marriage are changing rapidly because of the recent Supreme Court opinion and legislation in some states, Michigan currently does not recognize same-sex marriage. This failure to recognize same-sex marriage makes estate planning even more important for same-sex couples in Michigan because many protections that exist automatically for opposite-sex couples do not protect same-sex couples.
A few years ago, we met with a same-sex couple who asked how they could insure that their partner not only had the right to make legal and medical decisions in the event incapacity, but how they could guarantee their partner would be entitled to assets. While both partners worked, one contributed more monetarily and had a greater amount of assets, including their home. Knowing their desire to protect each other, we designed their estate planning documents to meet their needs.
One of the clients was particularly concerned that in the event of her incapacity some of her family, who disapproved of her relationship, would attempt to exclude her partner from being present and making decisions on her behalf. Knowing that in the absence of other instructions, the Probate Court prefers to name a family member as Guardian or Conservator, we prepared Durable Powers of Attorney, Patient Advocate Designations, and Living Wills, clearly specifying that each of the women wanted the other present and in control of making decisions in the event of their incapacity.
After addressing the clients’ concerns regarding care in the event of emergencies, we turned to what happens after one of them passes away. Under Michigan law, if a person dies without a Will or a Trust, the state intestacy statute determines how assets are distributed. That statute ignores same-sex partners in making distributions and can leave one partner homeless and perhaps even penniless. The first step we took to avoid this situation was to transfer their residence to the two of them as "joint tenants with right of survivorship." While this form of ownership does not provide the same creditor protection to same-sex couples as it does to married opposite-sex couples, it does still guarantee that the survivor of them would own the residence. Additionally, we set up a Living Trust for each of them and provided that upon the death of one, the other partner received all of the tangible personal property, household items, and jewelry to insure that neither would end up owning a home but have to give up other tangible reminders of their loved one.
The Living Trusts also provided that each of their assets would be held in trust for the survivor of them. While in some situations, for tax or personal reasons, it would make more sense to leave assets to a same-sex partner outright, it was important to our clients that in the event any assets remained after the death of the second of them those assets would go to each of their family members who supported them and their choices. However, each named their partner as the successor Trustee so that during her lifetime she would retain almost total control over the assets and never need to request assets from someone else.
Over the years, we have amended these client’s documents to comply with changes in the laws that affect their relationship. But while times and laws are changing, and more states, as well as the Federal government, are treating same and opposite-sex couples equally, until Michigan law does the same it is important for us as professionals to provide guidance to our clients so that they are aware of the ability to control their situation. It is also important to remember that each situation is unique and calls for an analysis of what the partners want, and not presuming that every same-sex couple’s needs will be met with the same plan. 

Wednesday, October 16, 2013

Planning to Meet the Client's Goals and Limit Estate Tax Liability

Last week we profiled a client and the strategies used in his estate plan to protect his loved ones after doctors diagnosed him with a likely fatal disease. While we did a great deal of planning in his final months, as with many endeavors, planning prior to discovering problems leads to greater success. When we began working with this client, we immediately recognized that he faced significant potential issues related to estate planning, tax planning, and family dynamics.
After analyzing his situation, we found three areas of potential concern. First, due to the scope of business and invested assets, as well as his real estate holdings there was likely to be a substantial estate tax liability at both the client’s death and the death of his wife. Second, because he wanted to provide that some of his assets went to his daughters from his first marriage if he predeceased his current wife, we were unable to set up the traditional marital/residuary strategy to eliminate taxes on the first death. Finally, we knew that the value of his real estate holdings continued to increase and increased the potential estate tax liability.
We first discussed the potential estate tax liability and the effect it would have on his business if he died suddenly and a significant tax liability arose. He recognized that while his assets generated significant annual income, most of his assets were illiquid and would not provide cash for taxes without adversely affecting the business itself. Without planning, we would have to "kill the golden goose" to provide sufficient assets to satisfy tax liability. To address this issue we recommended a number of Irrevocable Trusts to own life insurance on the client’s life and on both the client and his wife’s lives jointly.
One Irrevocable Trust held a policy on his life alone, which matured at his death and provided the funds to pay the estate tax liability at that time. Since we could not know at that time if the client or his wife would die first, the second Irrevocable Trust held a second to die policy, which would mature in any event on the second death and provide funds to pay any additional tax liability at that time. After years of continued success and an increasing estate, we also later set up an Irrevocable Trust to own a policy on his wife's life, to provide additional protection against tax liability whenever she passed away. In addition to providing liquidity to the estate to offset potential tax liability, these Trusts freed up estate assets for other family planning. As an added benefit to the client, premiums paid were a fraction of the policy face value, so the client was able to pay estate taxes at his death with cheaper dollars.
When it came time to address the matter of the client’s evermore-valuable real estate holdings, the client indicated that he did not need the asset value or the income from these properties and was willing to gift the property to his five daughters, as long as he could maintain control of them. Using limited liability companies to own the property, we gave our client a 1% voting interest in the entities and gifted the 99% nonvoting interest to the daughters. While he was alive, the client maintained control of the properties with the voting interest and the LLCs held the rental income received for the benefit of the daughters. Eventually we entered into an agreement where the LLCs loaned money to the Irrevocable Trusts to pay life insurance premiums, which freed up a significant amount of cash flow for the client. In order to protect the children, we annually distributed a sufficient amount of money to pay taxes on the "phantom income" they received from the LLCs.
As you can see, while it is possible to complete some planning when emergencies arise, the best planning is done beforehand by anticipating issues and using strategies that protect the client and loved ones. It is important that we as planners anticipate our clients’ needs because they are often too busy to do so themselves.

Wednesday, October 9, 2013

Planning to Protect a Second Wife and Five Adult Daughters

Over the past year our goal in writing Plainly Legal was to discuss many of the technical legal issues in the area of estate planning that impact the practices of financial planners. Using this information as a basis, going forward we will be addressing specific situations raised by our clients and how we dealt with those situations. As we address these examples, we will do our best to link back to previous posts that address the technical issues. If any of you run across an issue or have a question on how to solve a client problem, feel free to e-mail us and we can address it in future posts.

A client of ours, diagnosed with cancer and given only a short time to live, was concerned about protecting his second wife during her lifetime, yet treating his five adult daughters fairly. The client owned a valuable business and also had significant personal assets, but was concerned that some of his daughters might create problems for his wife after his death. He was also concerned that he had not taught his daughters the value of money and worried they would not handle an inheritance well.
Initially, he wanted to leave everything in trust for his wife for use during her lifetime, with distributions to the daughters after her death. Knowing that the wife was somewhat younger than our client was and in good health, I raised the issue that it might be some time before the daughters received anything. To address this concern I suggested we carve out sufficient assets in a Marital Trust, including the residence and sufficient invested assets to maintain the wife's accustomed standard of living, for her use during her lifetime. Since the residence had significant value, we wanted to provide flexibility for the wife if she ever decided to sell the residence, and therefore we provided the Trustee with the power to sell the residence and use the funds to purchase a new residence for the wife, with any remaining funds added to the Marital Trust for the spouse. This power to purchase a new residence gave the wife the flexibility to downsize her residence or move to a different state for health or personal reasons if necessary. We also named the wife as a Co-Trustee of the Marital Trust set aside for her benefit, so that she had a say in the management of the assets held for her benefit.
To protect the daughters from their spending habits and maintain the value of the business, we placed the business and the remaining assets in a Children's Trust for the daughters benefit. The daughters received income automatically from their Trust each year, but principal distributions were totally discretionary until the oldest child reached the age of forty. At that point, the trust began distributing principal at the rate of 20% per year for the next five years. Our client felt comfortable that this would provide an income stream for each of the daughters, allowing them time to learn the value of money and how to manage the business, yet protect the value of the business so that disagreements among his daughters would not result in the sale of the business. To address the client’s concern that his daughters might cause his wife problems, we suggested that the wife be the Trustee of the Children's Trust, with a corporate fiduciary as a Successor Trustee in the event that the wife ever decided to resign as Trustee. Our client liked the idea because it gave the wife control over the children's future assets and distributions, which he felt would lessen the chance that the children would give her problems.
Fourteen years have passed and I am happy to report that the Marital Trust, with good investment advice, has provided sufficient income to maintain the wife's accustomed standard of living. She still lives in and enjoys the residence. Over time, the daughters received all their distributions and now jointly own the still successful family business. They learned the values of hard work and cooperation and the business provides each of them a good income. As an added bonus, some of them even enjoy a good relationship with their stepmother.
This is a good example of how planning can protect families and their assets following a client’s passing. While this particular client was in good health, we completed other planning that facilitated a smooth transition of other business assets and provided funds for payment of Federal Estate taxes when the client passed away. Next week we will address this planning in detail.

Friday, October 4, 2013

Coming Soon: Changes to Plainly Legal

For the past year we have provided you with a bi-weekly education in aspects of estate and tax planning. In the coming weeks we intend to build on that education to help clients and planners understand the value and importance of proper estate planning.

Stay tuned to see what comes next.

Tuesday, October 1, 2013

2014 Inflation Adjusted Tax Limits

     As you are aware, a number of tax figures are adjusted each year for inflation. The Government has released Inflation adjusted 2014 figures for Estate and Trust Tax brackets and other Transfer Tax items. The adjustments are based on the average Consumer Price Index (CPI) for the 12-month period ending the previous August 31. The August 2013 CPI has been released by the Labor Department, and using the CPI for August 2013, (and the preceding 11 months) some of the tax figure adjustments for 2014 are: 
  • Unified estate and gift tax exclusion amount. For gifts made and estates of decedents dying in 2014, the exclusion amount will be $5,340,000 (up from $5,250,000 for gifts made and estates of decedents dying in 2013).
  • Generation-skipping transfer (GST) tax exemption. The exemption from GST tax will be $5,340,000 for transfers in 2014 (up from $5,250,000 for transfers in 2013).
  • Gift tax annual exclusion. For gifts made in 2014, the gift tax annual exclusion will be $14,000 (same as for gifts made in 2013).
  • Determining 2% portion for interest on deferred estate tax. In determining the part of the estate tax that is deferred on a farm or closely-held business that is subject to interest at a rate of 2% a year, for decedents dying in 2014, the tentative tax will be computed on $1,450,000 (up from $1,430,000 for 2013) plus the applicable exclusion amount.
  • Increased annual exclusion for gifts to noncitizen spouses. For gifts made in 2014, the annual exclusion for gifts to noncitizen spouses will be $145,000 (up from $143,000 for 2013).
  • Kiddie tax. The exemption from the kiddie tax for 2014 will be $2,000 (same as for 2013). A parent will be able to elect to include a child's income on the parent's return for 2014 if the child's income is more than $1,000 and less than $10,000 (same as for 2013).
  • 2014 Estates and Trust tax rate brackets:
If taxable income is                                                                       The tax is:
Not over $2,500..................................................................................... 15% of taxable income
Over $2,500 but not over $5,800........................$375.00 plus 25% of the excess over $2,500
Over $5,800 but not over $8,900.................... $1,200.00 plus 28% of the excess over $5,800
Over $8,900 but not over $12,150...................$2,068.00 plus 33% of the excess over $8,900
Over $12,150..............................................$3,140.50 plus 39.6% of the excess over $12,150