Planning Ahead for an Unexpected Event

     A short time ago a client of mine passed away unexpectedly. A few days after the memorial service I got a panicked call from his widow who said, "I am sitting in the middle of a circle of papers and documents, I have no idea what to do, or how I am supposed to pay the bills!" 

     While this couple saved, invested well, and kept their estate planning documents up to date, he handled the financial issues and never communicated to his wife where anything was or how to handle the day-to-day financial obligations. I calmed her, assured her that because of their good savings and spending habits she would have no financial issues, and then set an appointment to meet with her and her financial planner to explain to her the extent of her assets and her ability to access them.

     This got me to thinking about preparing for the unexpected and how some clients do a good job of this and some do not. A little preparation can save family members much time and stress at a time when they are already grieving. It is a good idea for both spouses to be familiar with monthly bills and how they handled, and where investment accounts are and how they can be accessed.

     Over the years, to help our clients with this preparation, we have built a list of information we have found useful or important to know when a loved one passes away. This list, or at least its location, should be shared with spouses and children, and updated regularly. 

     We included our list at the end of this post, please feel free to use it and add to it were necessary. Also, feel free to let us know if there is other important information that you feel we should include on the list.   

     It is also a perfect opportunity to remind everybody to "live life to its fullest, but plan for the unexpected.” The planning is obviously more important for those left behind.

Inventory and Location of Legal Documents:

Will:______________________________________________________________

Trust:_____________________________________________________________

Power of Attorney:__________________________________________________

Living Will:_________________________________________________________

Patient Advocate Designation:_________________________________________

Important Contact Numbers:

Attorney:__________________________________________________________

Accountant:________________________________________________________

Broker:____________________________________________________________

Financial Planner:___________________________________________________

Life Insurance Agent:________________________________________________

Property Insurance Agent:____________________________________________

Doctors:___________________________________________________________

Spiritual Leader:____________________________________________________

Funeral/Burial Arrangements Desired

__________________________________________________________________

__________________________________________________________________

Close Family and Friends to Notify

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

__________________________________________________________________

Location of Assets

Deeds to property:___________________________________________________

Bank Accounts and PIN #s:___________________________________________

__________________________________________________________________

__________________________________________________________________

Brokerage Accounts #s and Passwords or PINs:___________________________

Certificates of Deposit:_______________________________________________

Mortgages:________________________________________________________

Safety Deposit Box Location:__________________________________________

Retirement Plans and IRAS:___________________________________________

Annuities:__________________________________________________________

Life Insurance Policies and Beneficiary Designations:

__________________________________________________________________

__________________________________________________________________

Vehicle Titles:______________________________________________________

Collectibles:________________________________________________________

Stock Certificates:___________________________________________________

Service Providers

Gas:______________________________________________________________

Electric:___________________________________________________________

Cable:____________________________________________________________

Internet:___________________________________________________________

Landscaping:_______________________________________________________

Telephone:_________________________________________________________

Newspapers/Magazines:______________________________________________

Plumber:__________________________________________________________

Heating and Cooling:_________________________________________________

Electrician:_________________________________________________________

Handyman:________________________________________________________

Important Passwords

Computer:_________________________________________________________

Email:____________________________________________________________

Router:____________________________________________________________

Creditors

Mortgages on Real Estate:____________________________________________

Other Borrowing:____________________________________________________

Credit Cards to Pay and Cancel:_______________________________________

__________________________________________________________________

__________________________________________________________________ 

Protecting Business Assets Through Buy-Sell Planning

In our last few blogs, we have discussed issues that arise following the death of a spouse. A significant concern for surviving spouses during this time is the impact of the death on the operation of a family business, especially when that business is a primary source of income.  This can be an especially thorny problem for the surviving spouse if they were not active in the operation of the business, because they may then be at the mercy of key employees, business partners, or even family members whose interests are very different from their own. The possibility of a surviving spouse facing this situation is the best reason for a business owner to consider Buy-Sell planning. 

    

     Business interests are frequently one of a client’s most valuable assets, so it is important to consider how to handle such assets following the client’s death. A direct transfer of the business interest to a surviving spouse or children, according to the provisions of a client's Will or Living Trust, has the potential to cripple the operation of the business and significantly reduce its value especially if the surviving spouse or children have not been active in the business. Lack of operational experience, conflicts with staff and business partners, or lack of interest in running a business can all reduce the business’ value quickly or even cause the business to collapse completely, rendering it valueless. This is where a well-drafted Buy-Sell Agreement can assist in making a smooth transition following the client’s death 

     The purpose of a Buy-Sell Agreement is to establish how business interests transfer following the death of a business owner. Buy-Sell Agreements can be made between co-owners, between parents and children, and even between a business owner and their key employees. Typically, a Buy-Sell Agreement provides that one of the parties has the right or obligation to purchase the interest of the other party for whom a “triggering” event occurred. The agreement also defines what constitutes a “triggering” event, including death, disability, desire to sell, or retirement, to eliminate questions about when a party’s obligation arises. Additionally the Agreement provides a method for determining the value of the business interest and the terms for the payment of the sale price over a time span fair to all the parties. This ensures that following a death, the people active in the operation of the business know what will happen, allowing them to continue operations uninterrupted, and maintain the value of the company. 

     Often the parties to the Buy-Sell Agreement purchase insurance on the life of the business owners in order to provide funds for the purchase of that owner’s interest at their death. This is especially useful when there are non-family co-owners who may be put in an untenable business situation if the family members have no interest or knowledge in running the business, or want cash now and are unrealistic about the real value of the business. Life insurance proceeds can also be used to ensure that surviving spouses, or other children, receive fair value for the business when only some of the client’s children are active in operations. This allows the active-children to continue running things, without worrying about their surviving parent’s welfare or non-active siblings creating problems with the operation of the business. 

     A well drafted Buy-Sell Agreement takes into account the myriad of unexpected circumstances that may arise following the death of a business owner and attempts to foster a situation where that death has a minimal impact on operations. This allows survivors to either continue operating the business as usual or easily transition of ownership of the business, for a fair price, to those people the client chose as the next owners. 

     As always, it is important to remember that engaging in business planning should not be done without having good advice. A Buy-Sell Agreement is a binding legal contract and thus it is important to discuss Buy-Sell planning with an experienced attorney who can explain the substantial operational, tax, and planning impacts that the Agreement imposes on a client’s business.

The Unexpected Results of Probate Distributions

Last week’s blog discussed the process of probating an estate. This week we will continue that theme and discuss the distribution of an estate when the decedent has and has not left a Will. Later this week we will continue discussing estate administration with a look at the benefits of establishing a buy sell agreement for clients with interests in small (and not so small) businesses.

     As we previously discussed, the probate process can be both lengthy and expensive, but eventually the appointed personal representative is able to make distributions from the estate to the designated beneficiaries. If the decedent left a Will, those beneficiaries are the people named in the Will. If the decedent died without a Will, then state law dictates the distribution of the estate.

     After giving effect to the statutory allowances that we discussed in last week's blog, the personal representative first makes distributions to the decedent's surviving spouse. The size of the share distributed to the surviving spouse depends on the decedent’s other surviving relatives. The spouse is entitled to:

• The entire intestate estate if no descendant (child or grandchild) 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.

For individuals with estates under $150,000.00, the law provides the surviving spouse is entitled to all of the assets. However, for larger estates, the intestate distribution statutes may result in distributions, to parents or children, which the decedent would not have intended.

     Speaking of unintended distributions to children, it is important to note that if an asset in the probate process passes to a minor child, that asset must be held in trust until the minor child reaches age 18, at which point the child, whether mature enough or not, receives the remainder of that asset outright and free of trust. In addition to the potential problem of providing a lump sum of money to an 18-year-old, the probate court requires that the personal representative provide an annual accounting of those assets to the court until the child turns 18. As with every other aspect of the probate process filing these accountings takes more of the personal representative’s time and has a financial cost.

     Clearly, there are potential problems that arise when a decedent does not have a Will. Some of these, such as unintended distributions to parents or children as opposed to the surviving spouse, and large distributions to children upon reaching age 18, may be avoided by executing a. However, other problems such as the financial costs and reporting burdens exist as long as the Probate Court remains involved in the administration of an estate.

     As we have advocated in our writings on this blog and in our practice, clients can avoid almost all of these issues through proper planning and the use of a Living Trust. The Living Trust ensures that the decedent’s decisions govern the distribution of their assets and does not rely on a one size fits all approach that can result in unanticipated consequences. Additionally, because a Living Trust is a private agreement there is no involvement of the probate court, which can expose the decedent's assets and distribution decisions to public scrutiny. Furthermore, the Trust's private nature allows for greater ease in making distributions following death and avoids the costs associated with long-term administration of an estate through the Probate Court if the client desires to hold assets in trust until such time as their beneficiaries can handle those assets responsibly.

     Keep in mind that each individual's needs are different and estate planning should not become a one size fits all commodity. It is important for clients to meet with experienced experts in planning fields and discuss their desires regarding assets after their death so that the client can receive advice best suited to their particular situation.

Introduction to Probating an Estate

As we discussed last week, the death of a loved one can be very trying. In addition to the emotional weight of the loss, survivors must also contend with the burdens of administering the decedent’s estate. 

     The first step in administering the estate is determining whether there are any assets that must pass through the Probate process. Under Michigan Law, any assets owned by the decedent alone, as well as IRAs and life insurance policies without valid beneficiary designations, must go through the probate process before passing to their new owners. The probate process can be lengthy and is very public. The probate is opened in the county in which the decedent resided at the time of death and a personal representative is named to administer the estate. Unless the decedent executed a Will naming a person to act as personal representative, the Probate Court will appoint someone to that role. Upon appointment, the personal representative receives "letters of authority" which gives them the power to act on behalf of the estate. 

     The personal representative is charged with gathering all of the assets of the estate and protecting them, which includes covering assets with insurance where appropriate, maintaining assets such as real estate, and protecting any other valuables. The personal representative must value the assets in order to file an inventory and regular accountings with the probate court, showing what is being done.

     The personal representative also has a duty to notify all actual creditors and potential creditors of the estate. Once notice is given, the creditors have four months to file a claim against the estate. The personal representative must then determine which claims are valid and then pay those claims, as well as any expenses or obligations of the administration of the estate. 

     The personal representative must also determine the beneficiaries of the estate, either by looking at the terms of the Will or, if there is no will, the state intestacy statute. The beneficiaries must be given information regarding the assets of the estate and their entitlement.

     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.

     After completing all of these steps the personal representative can then begin to distribute the remainder of the estate to the heirs. On Thursday we will discuss the factors that impact the portion of an estate each heir receives. 

Working Together to Assist Clients

Today’s blog begins a series focused how attorneys and financial planners can work together to assist clients following the death of a loved one. Over the coming month we will address a variety of areas where clients benefit when their advisors work together as a team to make a very difficult time in their lives a little easier. We invite and encourage our readers to send us their thoughts on these issues so that we can take them into account as we tackle this complex subject.

     The loss of a loved one is one of the most emotionally difficult experiences a person will ever face. Sadly, during our careers as planners and advisors, we face the loss of a client, with unfortunate regularity. When those clients leave behind a surviving spouse or children, it is important to be prepared to assist those survivors while being mindful of their grief over their own loss. This is a perfect opportunity for the attorney and the financial planner to work together for the maximum benefit of their client.

     There are a wide variety of issues that arise after a death, including the administration of the decedent’s estate and trust, updating estate planning documents for surviving spouses, and making financial decisions that take into account their changed circumstances. Some of these decisions must take priority over others and it falls to attorney and planners, who handle these matters with more regularity, to keep clients from becoming overwhelmed by the decisions that must be made, even as the client still grieves for their loved one. 

     Immediately following a death it is important to quickly determine if there are any documents showing the deceased client wished to make anatomical gifts, had a prepaid funeral, or left specific instructions for funeral or memorial services, as well as a specific burial request. This is important first because such instructions elevate the need for survivors to make certain decision, but also because discovering these instructions after the survivors take other contrary actions can be devastating. 

     After addressing matters related to the disposition of the decedent’s remains, the personal feelings of the client are paramount and their mourning should take precedence over meetings with planners and advisors, but when they are able, it is important to begin the process of administering the estate and trust. A first step in the process is to determine a list of assets and values held in the estate of, or a living trust of, the deceased spouse. The client's planner often as this information and is the best person to assist in developing a list of assets. Documents should be reviewed to determine ownership of assets and beneficiaries of any insurance policies or IRAs. A review of estate planning documents will indicate whom beneficiaries are, what are the terms of distribution, and who are the persons chosen to help administer the estate, the personal representative and the successor Trustee.

     In this stage of the process, the attorney can assist the client in determining whether any probate of assets is necessary and whether it is necessary to file a federal estate tax return. If a business was part of the deceased's estate, it is important that the surviving spouse and successor Trustee continue to handle the management of that business appropriately. It is also important to determine if any Buy-Sell Agreements exist to govern the transfer of the business to surviving partners. Finally, if there are any assets outside of the state of Michigan these will also have to be administered. 

     With their more complete knowledge of the assets, the planner is invaluable at this point in the process for determining what assets remain available for the spouse, revising  the surviving spouse’s investment plan and providing a strategy for cash flow for both the short-term and long-term to assist the client in maintaining his or her lifestyle.

     This only begins to scratch the surface of the choices that face clients at this difficult time in their lives. Over the coming weeks we will address a variety of issues in greater detail, paying special attention to how attorneys and financial planners can work together to assist clients in managing these issues. As we continue to explore this topic we must remind ourselves that as important as this planning is to our clients, we must always balance the need to make decisions with the client’s need to mourn their loved ones.

Federal Estate Tax: Onerous & Unfair or Much Ado About Nothing?

     A common worry for nearly every adult is the impact of taxes on their lives. This is especially true for estate planning, where clients worry about the taxes their beneficiaries will be liable for at their death. The good news for all of these clients is that their beneficiaries generally are not liable for any amount of taxes on their inheritance, because the tax liability is the primary responsibility of the estate prior to distributions, and not the beneficiary. In addition, clients are relieved to learn that because of the most recent estate tax changes, they are unlikely to have any estate tax liability at all. 

     The estate tax, is a tax on the transfer of assets from one person to another at death. People tend to understand the requirement of paying income taxes or sales tax, but feel differently about the estate tax because of the perception that taxes already been paid on the assets to be transferred at death and should not be taxed again with the estate tax. While this is a common belief today, estate taxes have existed in various forms around the world for hundreds of years. Only recently has the perception that such transactions are different from other exchanges gained popularity. 

     A reason for this change of perception can be traced back to as early as the 1940s when opponents of the tax began to refer to it as a "death tax," but the most recent push against the tax began during the late 1990s when Newt Gingrich served as Speaker of the House. Since that time, rarely has a federal legislative session passed without someone proposing a complete repeal of the estate tax. In the current Congress, Senator John Thune recently proposed such a repeal. Like many others who attempt to raise the population’s ire towards the estate tax, Sen. Thune takes liberties with the facts about the law. In his most recent statements on the proposed legislation, Sen. Thune attempted to garner support from small business owners and farmers by stating that one-third of businesses who owe estate tax will owe more in taxes than the assets of the business. Unfortunately for Sen. Thune is incorrect, based on the law as it stands today. The Senator’s office later confirmed that Sen. Thune was quoting from a more than decade old report from a time when the estate tax exemption threshold was $675,000, and also omitted the fact that the statistics he cited only referred to liquid assets of the business and not the total value of the business. These sorts of distortions are precisely the reason that a tax that affects so few people presents such a common concern for clients.

     The truth is that the estate tax has almost no impact on the vast majority of people. This is because there are two major exemptions to the estate tax that result in almost no one paying any tax. The first major exemption is the Marital Exemption, which allows the spouse of a deceased individual to inherit any amount of money without paying any estate tax. This means that no matter how large an estate may be, if it passes to the decedent’s spouse there will be no tax liability. With the Supreme Court's 2014 Windsor decision, this exemption applies to both legally married opposite sex and same-sex couples.

     The second major exemption, known simply as the Estate Tax Exemption, creates a threshold under which an estate will not have any tax liability. Currently that threshold is $5,430,000 for a single individual and the decedents surviving spouse may roll over any unused portion of the exemption at their death. This means that a married couple must have an estate larger than $11,860,000 before they will pay even one dollar of estate tax. As a matter of fact, in 2013, 2.6 million people died in this country and only 4,700 of them had to pay any estate taxes, less than .2%. 

     A benefit of this very high threshold for taxation is once clients understand that their estate is not subject to the estate tax it frees them up to focus on what is really important in estate planning--. designing a plan to distribute their assets to their loved ones in a manner that is in the beneficiaries' best interests without requiring any complex legal maneuvering to mitigate taxes. 

Gifting $5 Million Without Using $5 Million Worth of Lifetime Exemptions

A few weeks ago we discussed the concept of using limited liability companies ("LLC's") for gifting purposes. We have been working with clients using such a strategy and this gives us an opportunity to explain how the concept works.

     Among other assets, John and Jane have commercial buildings valued at $10,000,000, which are likely to double in value over the next 10 years. The clients also have two children and six grandchildren, all of whom are adults. They were not opposed to lifetime gifting to remove assets and the future appreciation from their estates, but they wanted to maintain control of the assets.

     We suggested that John and Jane transfer the buildings to an LLC, in exchange for a 2% voting interest in the LLC and a 98% nonvoting interest in the LLC, which they then divided equally between themselves. We then discussed what portion of the interests they wanted to gift to their children and grandchildren. Since one goal was to ensure that John and Jane maintained control of the buildings, they will definitely retain ownership of the voting interests. They also wanted to enjoy some of the annual income generated by the buildings, so they will need to retain a portion of the nonvoting interests. Ultimately, John and Jane chose to gift 50% of the nonvoting interests to their children and grandchildren.

     Since John and Jane gifted nonvoting interests, which do not give the owner of that interest control of the business, the IRS will allow a discount of the value of the interest gifted for gift tax purposes. Thus, even though John and Jane gifted an equivalent of $5,000,000, because of the discount (conservatively at 20%) the deemed gift was only $4,000,000. John and Jane each used their annual exclusion gifts of $14,000 to make gifts to each of the children and grandchildren, for a total of $224,000 ($14,000 x 2 grantors x 8 descendants). The remaining gift of $3,776,000 was divided equally between John and Jane's lifetime exemptions against estate tax and we filed a gift tax return providing the IRS with a record of the transaction.

    As an additional protection against creditors and any potential divorce, we also established irrevocable trusts for each of John and Jane’s children and grandchildren to hold the gifted nonvoting interests. These trusts have flexible provisions regarding the distribution of income and principal to the beneficiaries, while also creating a nest egg for later in their lives. 

     The net result of this strategy is that John and Jane maintain control of the buildings during their lifetime and removed assets presently valued at $5,000,000 from their estates using only a portion of their lifetime exemptions. In addition, the transfer removes all of the appreciation on the gifts from John and Jane's estates, saving approximately $2,000,000 of estate taxes at their deaths (appreciation of $5,000,000 x 40% estate tax). In addition, income earned by the gifted interests is now reported on eight different income tax returns and presumably taxed at lower tax rates.

     In this situation, an estate tax savings was one of the desired results. However, even if clients do not have an estate tax issue, gifts of LLC interests to irrevocable trusts can provide children and grandchildren with an income stream, while protecting the interests from creditors or possible marital issues. This strategy is not without additional cost, as appraisals of both the asset value and the minority discount must be completed by a qualified appraiser. In addition, attention must be paid to the administrative requirements and tax filings of both the LLC and the irrevocable trust. As always, clients should seek the advice of a qualified professional before engaging in the strategy.

Honesty in Estate Planning

     Of all of the reasons to begin the estate planning process, one of the most important for many clients is gain the peace of mind that comes from knowing a plan exists to care for their loved after the client’s death. For some people that means having guardians and trustees who will see to it that their children grow into responsible adults. For others, that plan is as simple as making sure that someone will organize their assets and divide them equally between the beneficiaries. These clients have common situations and it is easy for them to express their concerns for the future. Generally, the client is forthright and open about their desires and therefore we are able to establish a plan to meet those goals.

     For other clients, this process is not as simple. These clients find themselves in a position where they know that their children or other loved ones, for a variety of reasons, are incapable of managing assets for themselves and will need additional assistance. Some of these beneficiaries may have substance abuse problems, others may simply be bad at managing money, and others still may be in relationships that the clients feel are not in the beneficiary's best interest. In all of these circumstances, it is possible to craft an estate plan that addresses the clients concerns, but only if the client is willing to be open and willing to discuss the situation truthfully. 

     For clients with more complex situations, we find that problems often arise due to the clients desire to keep their private lives private. No one enjoys admitting that everything is not perfect, and often clients who need more complex planning will not open up about their concerns, despite our best efforts, until well into the planning process. While this delay is understandable, it is important to remember that attorneys and financial planners can only provide good advice if our clients give us access to all of the pertinent information. 

     There are many tools and techniques which we can use to help a client create a plan that will care for their loved ones’ needs, but only when the client communicates those problems. We cannot talk about options for long-term trusts designed to provide for a loved one's needs without directly providing that person with access to assets if we do not know that a son has spendthrift issues. We cannot prepare documents that take into account the need for substance abuse counseling and testing before making distributions if we are unaware that these issues exist. We cannot prepare documents that address the disparate needs of different children, who may not have good relationships with one another, if we are unaware of these family dynamics.

     For clients in these unique situations there are two pieces of good news. 

1. Your privacy is secure. The things that you discuss with your attorney are privileged and will not be shared with anyone else. We are aware that these are difficult issues and want to help you address them. Therefore, you can open up and discuss your concerns about loved ones without worrying that this information will ever reach their ears. 
2. This is not the first time we have dealt with your situation. While each client’s circumstance is unique, any given client is unlikely to be the only one with these types of concerns, and it is unlikely that their story is something we have never heard before.

     Clients come in all varieties, with all manner of concerns, but regardless of those things they all want to create a plan that protects their loved ones and our goal is to help reach that goal while maintaining their privacy.

      It is important to remember that when you come to an attorney, the advice you receive is only as good as the information you provide the attorney. Like any other professional who provides counsel and advice, an attorney is limited to what the client chooses to share. Therefore, it is important that clients come prepared to discuss all of their concerns in order for them to receive the best representation. When consulting any new professional, take the time to get to know the person and make sure that you can be comfortable sharing all of your concerns with them, so that they can provide you with the level of care that your deserve.

Funding: the Next Step in Estate Planning

     When clients finish signing their estate plans, they often have a look of relief on their faces. They realize, after putting off planning for many years, they now have a plan that will make things much easier for their loved ones if something unexpected happens to them. Of course, signing the documents is not the end of the estate planning process. In order to minimize probate delays, unnecessary costs, and gain the maximum benefit from a Living Trust, clients must take the time to fund their assets to the Trust.
     Clients should retitle major assets, such as real estate and business entities, to ownership by the Trust. This allows the client to retain complete control of the asset during their lifetime and ensure that the successor Trustee can easily administer the property within the Trust, in total privacy, after death. Real estate transfers should include residences, vacation homes, vacant land, and commercial buildings. Business interests should include stock in corporations, and ownership interests in limited liability companies and partnerships.
     It is equally as important to transfer broker, bank, and privately managed investment accounts to the Trust. Again, there is no loss of control during the client’s lifetime and the assets will escape probate costs, time delays and publicity.
     For other assets, clients will need to update their beneficiary designations. For life insurance policies, the primary beneficiary of the policy should be the changed to the name of the Trust. This allows the successor Trustee to immediately access the proceeds for the beneficiaries benefit without worrying what happens if beneficiaries get large sums of money without restrictions, or if a beneficiary dies and there are no alternate beneficiaries. Depending on the terms of the trust, clients may also want to name the trust as a contingent beneficiary on their retirement accounts.
     While you are in the organizing mood, you may also want to give attention to the following:

• Notify those you have named to make decisions under your Power of Attorney and Patient Advocate Designation, and provide them with a copy of those documents.
• Make a list of assets, including account numbers and passwords, and keep copies of statements, deeds and business ownership documents in a specific place.
• Consider having children over the age of 18 execute a Power of Attorney and Patient Advocate Designation so you will be able to make decisions for them should they get into an accident or suffer a debilitating illness.
• If you are traveling and leaving minor children with grandparents or others, provide the caregivers with an Authorization for Medical Decisions, so they can give guidance to medical personnel in the event of an emergency.

     These steps can provide you with peace of mind, knowing that things are in place the event of an emergency. Remember to keeps all of these things up to date, then store them somewhere safe, presuming they will not be needed for many years.

The Importance of Personal Property

Today's blog examines an often overlooked part of estate planning. Clients often presume that their children will simply sort out personal property, without considering the potential pitfalls of leaving such decisions up to others. Including a Personal Property Memorandum as part of an estate plan is an excellent way to limit those issues. 

     One aspect of estate planning frequently overlooked by clients is the distribution of their tangible personal property. "Tangible personal property" includes all of the clients possessions that do not otherwise have a title or ownership designation. As part of our estate planning we use an Assignment to designate the Living Trust as the owner of all of these items. We also provide the client with the ability to leave a list of specific gift of tangible personal property.This Personal Property Memorandum may be changed at any time, without amending the Trust, and is read as part of the Trust after the client’s death. Unfortunately, when we bring this to the client’s attention, they often give it short shrift, indicating that they do not have anything of value or that they believe their children will not care about the personal property.

     Treating tangible personal property as an afterthought or unimportant is a common source of discord in the administration of a client’s estate or trust. Clients fail to account for the their loved ones attaching significant emotional value to items that lack significant monetary value. As an example, children may fight over which of them inherits their mother’s KitchenAid mixer because one of them has a strong emotional attachment to the mixture as a reminder of all the times he and his mother baked together for the holidays, while the client’s daughter simply would like a mixer for her own home. It never occurs to either sibling to explain to the other why they place such a high value on their mother’s mixer, thus resulting in misunderstandings and hurt feelings.

     Whenever our clients indicate that they feel their tangible personal property is not significant in their estate planning we encourage them to take time to sit down with their loved ones and discuss which items may hold emotional significance. This conversation, as much as any other conversation, can alleviate surprises and problems after the client’s death. In addition, it allows the client and their loved ones to begin a discussion about what will happen after the client’s death without focusing on difficult matters to discuss, such as illness and the money. Not only do clients gain a better understanding of what their children value, they also have the ability to limit any unnecessary conflict that otherwise might have arisen after their death.

     Tangible personal property often carries the most emotional significance to a client’s loved ones after their death. For a client concerned about maintaining familial harmony and ensuring the smooth administration of their estate, taking time to prepare a personal property memorandum can significantly reduce the chance of problems after their death. 

     It is important to remember that while the personal property memorandum is a common tool in estate planning is not universally included in every document. Different documents will treat the memorandum differently, some give it different priority from the other terms of the trust, and some trusts omit this option entirely. Clients should consult an experienced professional to determine under what terms they can make use of a memorandum in their planning.

Keeping Family Vacation Homes in the Family

A warm day like yesterday often triggers thoughts of summer and good times at the family cottage. With these thoughts in mind, clients often wonder how to structure the transfer of ownership of a family vacation home to their children and grandchildren either during lifetime or at death.

     Gifting or bequeathing a family vacation home is not an easy matter and requires significant planning in order to treat all family members fairly. Clients need to balance their desire to make a well-intentioned gift with the possible unintended burden on beneficiaries, which may cause strife among loved ones. Additionally, the transfer of such high-value assets brings with it potential estate and gift tax implications. While a client certainly must consider tax issues and the possibility of an increase in property taxes because of the transfer, we will leave these for another time and focus primarily on the family issues. 

     While a parent may hope that common ownership of a vacation home will keep their family together, it is entirely possible that not all of their children have the same warm memories of summers at the lake. In addition, those children’s spouses and children may have different ideas on how to spend family vacations. Add to all of this the fact that many adult children have moved away to pursue their careers (or avoid sometimes harsh Michigan winters) and may not be able to enjoy the use of a vacation home. It is important to discuss these issues with all of the family members to determine which children are interested in owning a part of the "family cottage".

     While there is not enough time to discuss all of the issues, important points to consider when transferring the vacation home include:

• What will the ownership structure be? This could include ownership jointly, as tenants-in-common, by a trust, or by an LLC?
• Who will manage the property? Family dynamics are important - not all of the family members may want to get involved in the day-to-day decisions.
• How will use of the vacation home be determined?  A plan should be in place for fairly selecting weeks of use for each of the family members.
• How are repairs and improvements, including cost, dealt with? Some family members may always be looking to upgrade the facilities while others may be happy to keep things simple and inexpensive.
• Should there be rules about allowing guests to use the cottage, especially without a family member present?  Allowing many non-family guests to use the cottage can cause considerable wear and tear on it and create friction among family members.
• Is there a procedure for allowing a family member to sell or gift the ownership interest?  Either during lifetime or at death, family members often desire to transfer their interest to a spouse, or children. If not planned for, this can result in a significant fractionating of a family member's interest and increasing the total number of "owners" for purposes of use and expenses. It might also result in pieces of the vacation home being owned outside the intended family.

     While continuing family ownership of vacation property is a laudable goal, much thought should be put into the process to make sure that the intended result of family harmony does not actually result in disharmony. As with any other tax or gift planning strategy is important to understand each client individual circumstances and consult with their professionals to ensure that the planning will not have unforeseen consequences.

Using LLCs to Expand Lifetime Gifting

So far, our discussion regarding the use of gifting an estate plan has revolved primarily around cash gifts, it is important to understand that gifts can consist of any type of property, including interests in real estate and business entities. A family owned Limited Liability Company is an excellent tool for transferring a variety of assets from one generation to the next, often at a reduced value, while allowing parents to retain control of the assets during their lifetime.

     While the use of cash gifts provides clients with a tool for reducing their potential estate tax liability, clients may be able to gain greater benefits through by using a Limited Liability Company (LLC) in their estate planning. The client can establish an LLC with two classes of Membership Interest, voting and nonvoting, and can retain control over assets by keeping the voting interests and gifting the nonvoting interests to beneficiaries..

     To make use of this gifting strategy, clients first establish a LLC (or modify an existing LLC) with a 1% Voting Member Interest and a 99% Nonvoting Member Interest. This allows the owner of the 1% Voting Member Interest to control the company regardless of who owns the 99% Nonvoting Member Interest. Clients then transfer ownership of other assets, such as real estate or business interests, to the LLC. Now the client is able to make gifts of the Nonvoting Member Interest, without giving up control of the assets. This allows clients to begin transferring highly appreciating assets during their lifetime, reducing any potential estate tax liability because the appreciation of the assets is now out of the Estate, and providing a potential source of income to their loved ones. Clients can transfer these  Nonvoting Member Interests in the LLC using either their lifetime estate exemption and/or their annual gift tax exemption, further reducing potential tax liability. These nonvoting member interests can be given to adult children as well as minor children and grandchildren, with trust holding the interest for these minors. These trusts can then be used to provide funds for education for the minors as income is distributed from the LLCs

     Another benefit of including an LLC in an estate plan is the potential to receive a valuation discount when making gifts of Nonvoting Member Interests. The IRS recognizes that a member interest in an LLC which does not allow the owner control over the company and which restricts the owner's ability to sell or transfer the member interest has less value than an unrestricted interest. Thus, a properly structured LLC may allow clients to transfer larger portions of the Nonvoting Member Interest as part of an annual gifting plan. While using an LLC in this manner is a well-established practice, it is important to acknowledge that without proper appraisals and planning, and such transfers may be subject to IRS scrutiny.

     In order to comply with the law and IRS regulations is important to manage and operate the family-owned LLC as a separate entity, and not just an extension of the client’s own affairs. The LLC should not contain all of the client assets, especially not the client’s residence, because the IRS argues that the LLC is necessary to maintain the client’s lifestyle and therefore, under estate tax rules, the IRS may deem the LLC's assets part of the client’s estate.

     For many clients the use of an LLC as part of their estate planning is an excellent strategy to increase the value of annual gifting. It is also an excellent tool for transferring ownership of family-run businesses to the next generation while ensuring that the clients retain control of the business operation. It is important to remember that this is a complex planning technique that clients should not attempt without consulting qualified professionals for assistance in reviewing the tax and legal implications.

The Changing Role of the Irrevocable Life Insurance Trust

Today we look at an advance trust, the Irrevocable Life Insurance Trust, whose role in the the estate planning process continues to evolve in response to changes in the tax code.

     With the Estate Tax Exemption now over $5,000,000 for an individual and $10,000,000 for a married couple, the Irrevocable Life Insurance Trust (ILIT), a once common tool for offsetting estate tax liability, is used less often. While the benefits of an ILIT as a tool to offset the estate tax liability have decreased for the majority of individuals, there are other situations where an ILIT can still be a very useful tool in estate planning.

     An ILIT is designed to own a life insurance policy, normally on the life of the Grantor, without the proceeds from that policy being included in the Grantor’s estate for the purposes of estate taxes. The premiums for the insurance policy are paid by the Trustee, most often with contributions made to the trust by the Grantor using the Annual Gift Tax Exclusion. In order for these contributions to qualify for that exclusion, they must be what the IRS regulations refer to as "present gifts". This means that the recipient of the gift must have the ability to take the gift outright and free of trust if they so choose. The terms of the ILIT require the Trustee to give the trust beneficiaries written notice of a limited window of time during which they may withdraw their gift from the trust. After that time period passes, the gift becomes a trust asset and the Trustee can use it to pay the premiums on the insurance policy owned by the trust. This notice is often referred to as a "Crummey Notice", and is named after a tax case named Crummey vs Commissioner.

     A keen observer might ask what is to keep the ILIT beneficiaries from simply withdrawing their gifts immediately and leaving the Trustee without any assets to pay the policy premiums. The answer to this question lies in the beneficiaries' understanding that not withdrawing this gift from the trust in the short term will result in a larger benefit in the long term. If that logic fails, the Grantor can simply refuse to make gifts subject to the Crummey withdrawal rules, not providing the beneficiaries with the ability to withdraw gifts. The negative of this strategy is that the gifts do not qualify for the annual exclusion.

     An ILIT's benefit is that the proceeds from a life insurance policy owned by the trust is not considered to be in the estate of the grantor and therefore not counted for calculation of estate tax liability. For those couples with estates in excess of the $10,000,000 estate tax exemption this means a pool of assets that can offset the portion of an estate used to pay the tax bill. For those clients who do not have a taxable estate, there are also benefits.

• For clients who own small, or not so small, businesses that they intend to leave or sell only to children active in the business, an ILIT allows them to create a pool of assets that can pass to the children who will not inherit the family business, creating equity among children and minimizing interfamily squabbles after death, without increasing the size of the client’s estate and risking potential estate taxes. 
• An ILIT also can be used to provide assets for the benefit of a second spouse, protecting client's other assets for the benefit of children of a prior marriage 
• If a client has substantial charitable inclinations, an ILIT can be used to provide children or other loved ones with a certain amount of inheritance while leaving the remainder of an estate to the client’s favorite charities, creating a charitable estate tax deduction. 
• As with other trusts,  for those clients who want to make gifts, but retain some control over the gifted assets, an ILIT allows them to provide and additional benefit to their loved ones while retaining control over the circumstances under which those loved ones may receive distributions from the trust.
• The ILIT also can leverage the grantor’s generation skipping transfer (GST) tax exemption because the grantor’s GST tax exemption can be allocated to an ILIT holding a life insurance policy that may substantially increase in value. As a result, numerous generations may benefit from the trust assets free of federal estate and GST tax.

     While the value of using an ILIT has been reduced by the current ever-growing Lifetime Estate Tax Exclusion, there are still circumstances where an ILIT may be useful to clients. Like any other tax and estate planning strategy, it is important to consult with experienced professionals before deciding to make use of the technique in order to ensure that clients do not expose themselves to unintended consequences.

The Benefits of Intra-family Lending

With this blog, we return to the subject of gift planning. Clients like the idea of reducing taxes with gifting, but the problem is they actually have to give away an asset. When the client expresses an interest in gift planning, We ask them "What amount of assets do you have to own to feel comfortable giving away something?" The answer is usually "just a little bit more!”

     A common issue that arises when we discuss gift planning with a client is the desire to assist their children without giving up control of the assets. One strategy used in this situation, which allows clients to provide funds for family members' use while still protecting the client’s own interests, is intra-family lending. 

     An intra-family loan works much like any other loan, parents loan money to a child for a specific amount of time and at a specific interest rate. For example, a client agrees to lend $200,000 to her son to help finance a business purchase. The son signs a promissory note with specific repayment terms and a mortgage on the new business as security for repayment of the loan. This intra-family loan allows the son to purchase a business he could not otherwise afford and begin securing his own financial future. The client, over time, will get an annual interest payment as well as a return of her principal. If the child's business earns more than the principal and required interest, the child benefits from the loan, and the client has effectively transferred wealth to her son that he would not otherwise have had. 

     While the annual interest payment and opportunity to run their own business are clear benefits to the client and her son, the benefits of an intra-family loan, as opposed to a bank loan, also include:

1. The parents' ability to set an interest rate far lower than any interest rate available through a bank. While the Internal Revenue Service regulations require that the interest rate of the loan equal a minimum rate set by the IRS each month, the current annual rate is just 2.19% for loans with a duration of more than nine years and significantly lower for shorter loans. If the parents desire, they can charge an interest rate greater than minimum rate but lower than current bank savings rates, increasing the parent’s benefit and still give a benefit to the child.
2. The parents give the child the opportunity to have access to an eventual inheritance much earlier, with much less risk. The parents can also assess the child's abilities to handle the money and perhaps modify the distribution provisions of their estate plan. 
3. In the event parents want to provide their child with an additional benefit, they can use their Annual Gift Tax Exemption to provide their children with the funds to reduce the principal of the loan, without the worry that the child will frivolously waste such gifts.

     To protect the client and avoid potential problems, it is important that clients document any intra-family loan's amount, term, interest rate, and repayment schedule in a formal written contract. This is important not only to ensure a return of the parent's money, but also for protecting the client against an IRS claim that the transaction was a gift, not a bona fide loan.  Courts have held that the existence of a written document evidencing the debt, the charging of a specific interest rate, the existence of a set repayment day, and proof of actual repayment of the loan are all criteria that favor the position of a transfer was a bona fide loan.

     Intra-family lending is a very useful technique for clients who want to provide gifts to their children, while retaining control of their own assets. As with all tax related strategies, clients should seek the advice of a qualified professional before engaging in an intra-family loan. Proper planning can provide benefits to both the borrower and the lender.

Private Information, Security, and your Estate Plan

Locating and gaining access to a loved one's assets during an emergency or after their death can be one of the biggest challenges. Today's blog addresses how clients can provide their loved ones with access to this information without risking identity theft. 

     We often mention, to our clients, and in this blog, the importance of maintaining a record of important information. This list can include the location of accounts, login information and passwords for online accounts, contact information for planners and advisors, and other sensitive personal information to avoid creating problems for loved ones attempting to administer the client’s affairs in the event of an emergency or their death. However, we rarely discuss how the client can safely maintain a collection of information, which, in the wrong hands, can lead to significant financial hardship. We recommend a combination of high-tech and low-tech solutions to maintain security while also making information accessible in the event of an emergency.

     First, we provide our clients with a worksheet designed to assist them in documenting much of the important information someone would need to administer their affairs in the event of their death or an emergency. On this worksheet, we recommend that our clients provide their loved ones and designees with important, but not private, information. This includes the names and contact information for planners and advisors, a list of utility providers, nonfinancial online accounts (including social media and shopping sites), and a list of known creditors. This is the information loved ones will need in order to handle the client’s day-to-day affairs. We encourage our clients to inform their loved ones of the location of this information so that it is easily accessible in the event of an emergency. 

     Second, with respect to information that in the wrong hands creates a risk of identity theft or loss of assets, including specific account information, passwords for online access to financial accounts, and private personal information, we encourage our clients to prepare a secure document containing this information, the location of which the client guards more closely. While the increased security makes accessing this information more difficult, it primarily impacts information that a loved one would only need if it became necessary to manage the client’s affairs in the long term.

     There are increasingly complex ways to protect private information, while still making it available in the event of an emergency. The simplest, but least secure, way is for the client to prepare a written list of the information and provide their designee with the location of that list. Using technology to increase security, the client can prepare a document containing the information, save that document to a flash drive and store the flash drive in a location known to their designee. For even more security, the client may use an online password management service, designed to provide a high degree of protection for all of their online accounts and private information. Using this method, the client will store the important information using the service and provide their designee with the secure password needed to access client’s information.

     Regardless of the method employed to secure all of this information, the underlying important concept we are attempting to convey is the importance of client preparation for emergencies. By taking the time to prepare lists like the ones we have discussed in this blog will allow clients to minimize the stress and inconvenience to their loved ones in the event of an emergency.

Planning for Vacation

Today’s blog takes a break from the complex gifting and tax issues we addressed in the past few posts to talk about aspects of estate planning that arise while preparing for a vacation. We will return to our discussion of gift issues next week. 

     With the unrelentingly cold weather and impending “Spring Break” weeks for many school districts, our thoughts turn to vacation, many of which involve trips to warmer climates. However, upcoming trips should prompt people to think about their current estate plans and some of the possible changes they have been putting off.

Here are a few tips to think about before setting off on vacation:

• Do you have a Grandparent/Caregiver Power Of Attorney? If you are vacationing but leaving your minor children home with a grandparent or caregiver, do you have a written document giving the caregiver authority to make medical or other decisions in your absence. This document can be crucial in the event of an accident, and can provide you comfort knowing that caregivers can handle emergencies even while you are relaxing and enjoying your trip.
• Do you have a list of assets, passwords, and important contacts? Many people manage most or all of their financial assets online and it is important to have a record of your accounts and passwords so that those you have named to act on your behalf for the benefit of your family can easily locate this information. This information should be part of the list of assets and advisor contact information you keep with your important estate planning documents. While this may require some time on your part, it can save your family significant time and money if misfortune should befall you. 
• Are your disability documents current and available to those you have named? In Michigan a Durable Power of Attorney, for financial decisions, and a Patient Advocate Designation, for medical decisions, are essential to allowing another to act on your behalf in the event you become incapacitated. Before vacationing, you should be sure the documents are up-to-date and that those designated know where to locate these documents. You may even want to discuss your wishes with your designated agents.
• Are your beneficiary designations are up-to-date? With proper designations, assets such as retirement accounts brokerage accounts and life insurance can pass directly to designated beneficiaries and avoid probate. If you have a Trust, these assets can be designated the beneficiary and allowed distributions pursuant to the provisions you have set forth in your Trust.
• Are there any changes you have been contemplating making in your Will and Trust? While we usually suggest you review and update your estate planning documents every 3 to 5 years, while planning for a big trip you also may want to review your documents to make sure that provisions for your family, and those you have designated to fulfill those provisions, are still as you want them.

     Time spent on these issues will allow you to relax and enjoy your vacation knowing that your estate planning is in good order.

The Grantor Retained Annuity Trust as a Tool for Wealth Transfer

     We often discuss the benefits of Living Trusts as part of an estate plan, but there are other types of trusts that may provide our clients with significant benefits as part of a larger estate plan, depending upon the client’s particular situation.

     A Grantor Retained Annuity Trust (GRAT) is one method for wealthy clients to maintain an income stream yet transfer property (often which is highly appreciating) to a child with minimal Gift or Estate Tax. A GRAT allows the client to transfer assets into an irrevocable trust and retain the right to annuity payments for a fixed term of years or their lifetime. When the set duration ends, the remainder of the trust, including any appreciation, can go to a named beneficiary. Alternatively, it is possible to structure the GRAT to return the principal and a certain amount of income to the grantor, and distribute the excess income to the remainder beneficiary. While it is possible that the trust will earn insufficient income to cover the required annual payment and thus the Trustee must make that payment from the principal, with proper planning the GRAT is a powerful tool for wealth transfer.

     When using a GRAT to transfer assets, the gift tax value of the assets is determined at the time of trust creation and funding by subtracting the value of the annuity interest from the fair market value of the assets transferred to the trust. The value of the annuity interest will depend on the interest rate used, the value received by the grantor, and the value of the remainder beneficiaries’ interest. The IRS Regulations set rules for determining what interest rates may be used in the calculation of valuations, especially when family members are involved.

     As an example, if a 60-year-old client sets up a GRAT to last two years and uses the following provisions:

• Contributed Asset Value: $1,000,000, 

• The §7520 interest rate required by IRS Regulations: 2%,  

• The asset earns 5% per year 

• The asset appreciates at 5% per year 

Over the term of the Trust, the client will receive two annual payments of approximately $515,000 and the remainder beneficiary will receive approximately $130,000 at the termination of the GRAT. Since the value of the annuity interest exceeds the fair market value of the assets transferred into the GRAT there is no Gift Tax liability to the client, nor do they use any of their Lifetime Gift Tax Exemption. If the client funds their GRAT with assets anticipated to appreciate faster than 5% per year, the benefit to remainder beneficiaries is even greater

     Since the GRAT permits payment of both income and trust principal to satisfy the annuity payments, it is important to treat the GRAT as a grantor trust for income tax purposes. This means the client retains liability for taxes on income and realized gains on trust assets even if these amounts are greater than the trust's annuity payments. This further enhances this tool's effectiveness as a family wealth-shifting and estate tax saving device because the client pays the income tax, thus reducing the their estate.

     In the right circumstances, the GRAT can be a powerful tool to transfer assets with minimal gift or estate tax consequences, but clients should carefully review their financial situation with both an experienced attorney and financial advisor before entering into such a transaction.

Gifting Strategies for Medical and Education Expenses

     As we touched on in our last blog, many strategies exist for using gifting as part of an estate plan. Today’s blog addresses some of the simpler planning opportunities available through gifting. In future blogs we will focus on the more sophisticated strategies.

     Tuesday’s blog discussed the Annual Gift Tax Exclusion, but it is important to note is that there is another, unlimited Gift Tax exclusion permitted for amounts paid by one individual in two circumstances:

1. On behalf of another individual directly to a qualifying educational organization as tuition for that other individual.
2. On behalf of another individual directly to a provider of medical care as payment for that medical care.

     A "qualifying educational organization" is one that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where it regularly carries on educational activites. It can be a primary or secondary school, including a vocational high school, college, university, or a normal, technical, mechanical school and similar institutions. . The Internal Revenue Code (the "Code") permits an unlimited exclusion for tuition expenses of full-time or part-time students paid directly to the qualifying educational organization providing the education. The Code does not permit an unlimited exclusion for amounts paid for books, supplies, dormitory fees, board, or other similar expenses that do not constitute direct tuition costs.

     "Qualifying medical expenses" are limited to those expenses defined in Code §213(d), but include expenses incurred for the diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body or for transportation primarily for and essential to medical care. In addition, the unlimited exclusion from the Gift Tax includes amounts paid for medical insurance on behalf of any individual. The unlimited exclusion from the Gift Tax does not apply to reimbursement for amounts paid for medical care by an individual. 

     While contributions to a qualified tuition program, such as a §529 plan do not qualify for the tuition exclusion above, they do enjoy treatment as a "present gift" that can qualify for the gift tax annual exclusion (currently $14,000 per year). The rules also allow the taxpayer electively to spread the contributions made in a single year over a five-year period. This means that grandparents can make a gift of $70,000 each ($14,000 times 5 years) to a §529 plan for a grandchild, for a total of $140,000 in one year, essentially "frontloading" a grandchild's education and allowing for a greater appreciation of the account. These gifts remove funds from the grandparents' estates, saving estate taxes on their deaths.  

     By using these gifting strategies, individuals can help their loved ones currently and reduce possible future estate taxation. Next week we will start discussing some of the sophisticated strategies used to increase the benefits of lifetime gifting in estate tax planning. 

Understanding the Estate and Gift Taxes

     One of the most misunderstood areas of estate planning involves the impact of Federal Estate and Gift Taxes. While most people understand they pay Federal Estate Tax on inherited assets and Federal Gift Tax on gifts made, few people truly understand what creates liability for these taxes and who is responsible for paying them.

     The first point to understand is that Federal Gift and Estate taxes are integrated into a single transfer tax under a unified rate schedule and with a unified credit that imposes a single tax on transfers during life and at death. The Internal Revenue Service group gifts and inherited assets together for purposes of determining total tax owed and the amount of assets excludable before payment of either Federal Gift or Estate taxes

     Let us begin with the Estate Tax. The estate of a deceased individual pays Estate Tax on the assets transferred to non-spouses at the individual's death. The estate tax rate is a sliding scale that tops out at 40%.  The Tax Code includes an Exclusion, which currently allows an estate to transfer $5,430,000.00 before incurring any Estate Tax liability. In addition to this large Exclusion, the Tax Code provides that any assets transferred to a surviving spouse are exempt from tax liability. In addition, any portion of the Exclusion that the estate of the first to die of a married couple does not use can be used by the surviving spouse's estate at his or her death. This ability, commonly known as Portability, means that a married couple will need to transfer nearly $11,000,000.00 at death before paying any Estate Tax. The Tax Code ties the Exclusion amount to the cost of living and therefore each year the Exclusion grows allowing ever-greater tax-free transfers.

     A person can choose to make gifts during lifetime instead of making bequests at death, making Gift Tax an important consideration. The person making the gift is liable for paying the Gift tax, if any is due. As indicated above, Gift and Estate taxes are integrated into a single transfer tax, so that the exclusion from tax becomes a "lifetime exclusion" rather than an exclusion at death. Any exclusion used during lifetime against Gift taxes will reduce the exclusion available against Estate taxes. 

     As noted above, we offset any Gift Tax against the Lifetime Exclusion before any tax becomes due. There is also another exclusion against Gift Tax--the "Annual Exclusion. A The Annual Exclusion on Gift Taxes allows any person to give up to $14,000 to any number of people, each year without creating any Gift tax liability. This means that a husband and wife together can give the each of their three children and their spouses $28,000 each year, reducing the parents' taxable estate by $168,000 each year without paying any tax on those transfers, and without using the Lifetime Exclusion. If our couple wanted to give their children additional amounts in a year, every dollar over $14,000 per beneficiary then reduces the parent’s Lifetime Exclusion.

     As an example, if the parents want to make a $200,000 gift to each of their three children so that the children can purchase a home, the parents can give a total of $28,000 to each child and $28,000 to each child’s spouse tax-free using the Annual Exclusion. The remaining $432,000 in gifts to the children and their spouses will reduce each of the parent's Lifetime Exclusion by $216,000 and reduce their remaining Estate Tax Exclusion by the same amount.

     In estate planning, we employ strategies that can increase the benefit of each of these Exclusions for people able to make substantial gifts. We will discuss some of these in our next blogs. 

Adding Additional Protections for Inherited IRAs

     Last year the Supreme Court of the United States unanimously held that Inherited IRAs do not qualify for protection during a bankruptcy. Stating that the term "retirement funds" refers to money set aside for time when a person is no longer working, the Court stated that three characteristics disqualify the funds held in an Inherited IRA from the status of "retirement funds.” 

1. The owner of an inherited IRA cannot add additional funds to the account. 
2. Holders of Inherited IRAs must take distributions from those accounts without regard to the number of years until the account owner reaches retirement. 
3. The owner of an Inherited IRA may make penalty-free withdrawals from the account, up to the entire balance of the account, at any time without triggering the 10% withdrawal penalty found in the Internal Revenue Code.

     This important for any client who expects their retirement accounts to make up a large part of their estate, because this decision means that those inherited retirement assets do not enjoy the usual protection from creditors and will be at risk if one of their beneficiaries files for bankruptcy after receiving their inheritance. Presumably, those assets will also be at risk if a beneficiary divorces a spouse.  Thankfully, we already have a tool that addresses this concern and provides protection for beneficiaries. A standalone IRA Trust named as the beneficiary of a client's IRA can make distributions to the beneficiaries of the IRA Trust without exposing the inherited IRA to creditors. I

     Normally only an individual can be a "designated beneficiary" under an IRA, but if a Living Trust meets certain requirements it is considered a "see-through" trust and the Internal Revenue Code and Regulations treat the beneficiaries of the trust as the "designated beneficiaries" of the IRA. This allows those beneficiaries to stretch their distributions to receive the minimum required distributions over the life expectancy of the oldest beneficiary. In the event that it would be more advantageous for each beneficiary to take distributions over their own life span, it is possible to create specific sub trusts for each beneficiary under the IRA Trust to stretch distributions over the individual beneficiaries' lifespans. 

     For years, we have been using standalone IRA Trusts to assist clients who wished to place different restrictions on the distribution of their retirement and nonretirement assets or to protect beneficiaries from misusing the benefits of an inherited IRA by taking large lump sum distributions, or as protection against possible creditors or loss of assets in a divorce action. With this recent decision from the Supreme Court, a standalone IRA trust provides clients with the peace of mind that in the event one of their loved ones becomes one of the nearly 1,000,000 people who file for bankruptcy in the United States each year, their inherited IRA assets will remain protected.

     The law and regulations governing "inherited IRAs" and the use of IRA Trusts is expansive and complex. Before a client begins designating a trust as the beneficiary of a retirement account they should consult with a legal expert in that area. Additionally at the death of the account owner, it is important to seek additional advice as to the best way to retitle accounts or distribute the assets. If you or your clients have specific questions regarding this or any other planning matter please do not hesitate to contact us and we will be happy to provide you with an understanding of the consequences of any actions.