A Further Look at Portability

As we discussed last week, there are benefits to the concept of portability in estate planning. However, portability has several limitations.

1. The unused Generation Skipping Tax (GST) Exemption of the spouse dying first is not portable and will be lost if not used. A client who wants to leave assets in trust for the benefit of future generations more remote than the first generation below the client’s will want to use a trust to take full advantage of the GST exemption.
2. Assets passing outright to the surviving spouse likely are subject to the claims of creditors of the survivor, including any subsequent spouse in a divorce. Placing property in trust provide better protection from such claims.
3. A trust provides independent management of the assets, protecting them from the unwise decisions of the beneficiaries. Even clients who believe that their spouse and children are competent managers may want to consider this benefit, because it avoids the potential adverse influence of unwise friends and in-laws.
4. As discussed previously, to secure portability the surviving spouse must file an estate tax return, even if one otherwise would not be due, and that may increase the costs of administering the estate of the first-deceased spouse.
5. The DSUE (Deceased Spousal Unused Exemption) amount is not indexed for inflation. Property passed via credit-shelter trust instead of relying on portability, may appreciate at a rate equal to or greater than inflation, allowing a greater amount of assets to pass free of estate tax when the surviving spouse dies.

        When counseling married couples who expect their combined wealth to fall well below the combined sum of two estate tax exemptions it may take several conversations to reach a decision about whether to use a credit-shelter trust or to rely on portability. In this situation, one option some may choose is to leave the entire estate to the surviving spouse but provide that to the extent the survivor disclaims the bequest, it will pass into a credit-shelter trust for the surviving spouse and, perhaps, for the couple's descendants.        Disclaimer planning that arguably does not save taxes may be a tough decision for a surviving spouse. Counting on the surviving spouse to disclaim in this situation and give up control of the assets may prove foolish.  In client discussions, consideration must be given to the benefits of a basis step-up on the second death.

Most Wills for married couples should now address the question of whether the executor should be required to elect portability, or be given discretion to elect portability. The document should reflect who should pay for the cost of the estate tax return, if it is filed solely to elect portability.  A married taxpayer who plans to use portability should direct his or her executor in his or her Will to file an estate tax return and make the election. Otherwise, the executor may decide not to incur the cost of filing the return

Portability also may become an important discussion for a provision in a prenuptial or postnuptial agreement, to ensure that the surviving spouse is required to use portability to minimize estate taxes on the first death, maximizing estate tax savings on the second death.

As with all estate planning options, the use of portability should be carefully reviewed with clients to make sure that the client takes into account not only estate tax savings, but also their own needs and desires. 

Alan Ferrara

Pros and Cons of Portability

     The most recent tax legislation made the concept of "portability" a permanent fixture in estate tax planning. Portability is the ability of a surviving spouse to use the deceased spouse's unused exemption amount (DSUE) and thus protect greater amounts against estate tax on the second spouse's death. Portability has the potential to be both a blessing for clients and a curse, if not used properly.

     Generally, estate planners used the credit-shelter (non-marital portion) trust to exclude an amount equal to the first deceased spouse's unused applicable exclusion amount from the gross estate of the surviving spouse, together with any appreciation and undistributed income on that share. This insured that on the death of the first spouse an amount equal to that person’s entire applicable exemption went into one trust, while any additional assets went into the marital portion and passed to the surviving spouse free of any estate tax. Now that portability is permanent, practitioners need to consider whether using a credit-shelter trust continues to be appropriate or whether reliance on portability is preferred.

     The conventional non-marital trust is a superior vehicle for reducing estate tax than is a portability election, because it avoids estate taxes not only on the initial value of assets allocated to the non-marital share, but also the appreciation and accumulated income in the non-marital share between the deaths of the two spouses. 

Portability, however, can be a superior technique in cases where

• The couple hold most of their assets in a form that cannot be used to fund a non-marital share, such as joint tenancy with a right of survivorship or contractual rights (such as life insurance and retirement benefits); 
• The estate consists largely of retirement benefits that will make funding a non-marital share less effective as a means of avoiding estate taxes; or 
• The decedent dies without having an estate plan that includes a non-marital trust. 

       Portability has a number of other significant benefits, the largest of which is simplicity. On the death of the first spouse, the entire estate can pass outright to the surviving spouse, giving that person total control over all assets. The Personal Representative of the deceased spouse's estate can file a timely Form 706 and elect to allow the surviving spouse to be able to use the DSUE amount and no part of the exemption of the first-deceased spouse is wasted. As an added benefit, the surviving spouse receives a automatic basis adjustment ("step up") when the surviving spouse dies for assets received from the first deceased spouse which are later included in the surviving spouse's estate

     Additionally, portability preserves the entire unused exemption of the first spouse to die, even if that spouse's estate was too small to use the entire exemption. A deceased spouse's estate that is valued at zero may still leave to the surviving spouse a DSUE amount equal to the entire unused applicable exclusion amount, if a timely estate tax return is filed and an election is made.

       Portability is especially useful when the first-deceased spouse's assets are largely items of income in respect of a decedent, such as retirement benefits (e.g., an IRA) and deferred annuities. Such assets are poor choices to fund a non-marital share, because they will be reduced by income taxes when they are received.

       Finally, portability is available when the assets of the first deceased spouse pass outside of the will or revocable trust, and are therefore unavailable to fund the non-marital share. This could occur if much of the decedent's assets are held jointly with the surviving spouse with a right of survivorship, or are contractual benefits, such as life insurance. Portability is still available in such circumstances.

     The permanence of portability brings many interesting planning opportunities, but it is not without its pitfalls. Next time we will discuss the drawbacks and potential traps of using portability.

Alan Ferrara

Unexpected Effects of the $5,000,000 Exclusion

     Now that the applicable exclusion amount for determining when the federal government assess estate taxes is $5,250,000, many clients believe that they no longer need to worry about updating their estate plan because their estate will never be large enough to pay estate taxes. However, the majority of estate plans prepared when the applicable exclusion amount was much lower than the current $5,250,000 never contemplated the exclusion reaching such a high value. Plans drafted as late as 2010 expected the exclusion to remain at $3,500,000 and plans drafted prior to 2001 were written when the exclusion was less than $1,000,000. Practitioners must now revisit these plans in light of the higher applicable exclusion amount, to determine whether the non-marital and marital shares created will leave the surviving spouse with sufficient assets on which to live comfortably. 

     There may be no need to amend a Living Trust that creates separate marital deduction and non-marital deduction shares if the provisions of the two shares provide the surviving spouse sufficient flexibility. This is particularly true where the clients have only common descendants and believe that the surviving spouse may need their entire combined wealth to maintain his or her accustomed standard of living. The increased applicable exclusion amount will have little effect on the surviving spouse in such an estate plan, because allocating the first $5,250,000 to the non-marital portion with little or none going to the marital portion will have little actual economic effect on the surviving spouse. Still, with the applicable exclusion now at $5,250,000, most if not all of the assets of most Living Trusts will be allocated to the non-marital share, leaving little flexibility for the spouse. Faced with this reality on the death of the first spouse, the surviving spouse will likely be very unhappy to be told that she is only entitled to income automatically and principal within the discretion of the trustee. 

     However, the increased applicable exclusion amount can create a serious problem if the marital and non-marital deduction shares do not both benefit the spouse or if they both benefit the spouse, but substantially different ways. An estate plan that creates a non-marital deduction share that benefits family members other than the surviving spouse can produce a particularly unfortunate result under the current law. If the trust provides that the non-marital share is equal to the available applicable exclusion amount and the total estate is less than that applicable exclusion amount, it will create a non-marital share that will disinherit a surviving spouse to a degree that the client never intended. 

     Even if the non-marital share benefits the surviving spouse, if the distribution provisions only allow for distributions of income to the spouse, with principal distributions only made within the discretion of the trustee then the surviving spouse has very little flexibility. Provisions such as these were common with a lower exclusion because the thought was that assets allocated to the Marital Portion would provide for more flexible distribution provisions, such as all income and all principal within the discretion of the spouse. Because the prior applicable exclusions were only $1,000,000, or at most $3,500,000, there would be sufficient assets allocated to the marital portion to provide the spouse with sufficient flexibility. 

     In our next post we will suggest some strategies that can protect the surviving spouse even considering the new law, yet protect family members after the death of both spouses.

Alan Ferrara

Planning to Pass Values along with Valuables

     As estate planning attorneys, we spend a considerable amount of time with clients discussing estate taxation, probate avoidance, and beneficiary selection. We worry about the value and type of assets in the estate and the titling of those assets. We work with the clients to determine those loved ones who are to receive a portion of the estate and the manner in which they are to receive it. In short, we worry about their "tangible valuables".

     Sometimes, as part of the discussion, clients' concerns about their beneficiaries' lifestyles creep into the conversation. Are the beneficiaries mature enough to handle large sums of money? Do they have problems of their own, whether it is a rocky marriage, creditor issues, or even a dependency issue? Some conversations go even deeper, to an area where most attorneys, and perhaps other professionals, are wary of treading. Clients start to question whether their beneficiaries have developed values and beliefs similar to the client’s that makes the client comfortable with passing on tangible valuables. As these concerns become more prevalent, we as planners need to be aware of how we can assist our clients in addressing them. 

     Jim Stovall, author of "The Ultimate Gift", a book in which the main character passes on 12 life lessons to his grandson, has said "Giving second- or third-generation family members resources without a mental, emotional and informational foundation is like giving them a loaded weapon without instruction or caution." More of my clients are starting to feel the same way. When a client expresses these concerns, it is a good idea to take a holistic approach to estate planning and introduce them to the concept of an “Ethical Will” which they can use to pass on their "values" as well as "valuables.” 

An Ethical Will is a document that can transmit a client's core values and principles. It is not legally binding, but rather an expression of the beliefs, opinions,and cherished memories a person does not want forgotten. An Ethical Will may contain of some or all of the following,

     Things you learned from your grandparents or other relatives that you want your children to remember;

• Important events in your life;
• Things learned from an experience that you want to pass on; or
• An expression of the values you want to pass on to your beneficiaries.

     A simple Google search of the words "ethical will" will provide more than enough information and examples if one wants to consider writing an ethical will. It need not be something larger or formal, and may begin with simple thoughts jotted down from time to time. The website, www.ethicalwill.com, suggests some tips for writing an ethical will, such as:

1. Over time, write down ideas, a few words, or a sentence or two about things like: 

• Your beliefs and opinions 
• Things you did to act on your values 
• Something you learned from others 
• Something you learned from experience 
• Something you are grateful for 
• Your hopes for the future 

1. Write about important events in your life
2. Save items that articulate your feelings, e.g., quotes, cartoons, etc.
3. Review what you have collected after a few weeks or months and arrange paragraphs in an order that makes sense to you.

     While an ethical will may be beyond what many clients are willing to prepare, it is becoming more critical that people pass along their values before they pass along their valuables. I once had a discussion with a bank trust officer who said to me that he thought third-generation money was the most useless. The first generation worked hard to earn the money. The second generation saw how hard their parents worked and therefore had an appreciation of the money. However, the third-generation had no idea how hard it was to earn, had no appreciation for the money, and therefore rarely put it to good use. While leaving one's tangible estate is important, it can be even more impactful to leave an "intangible legacy" to your loved ones.

Buy Sell Planning As an Important Part of Estate Planning

When assessing a client's estate planning needs, it is important consider any business interests owned by the client. Business interests are frequently one of the client’s most valuable assets and absent other planning, pass according to the provisions of a client's Will or Living Trust. Unfortunately, often a direct transfer of the business interest to beneficiaries is not optimal for the operation or continuation of that business after the death of the client.

For example, if the surviving spouse or children have not been active in the business, their lack of operational experience can cause reduce the business’ value quickly or even cause the business to collapse completely, rendering it valueless. If the business is a large part of the client's assets and provides a good income stream, this scenario will pose a serious problem for the spouse and minor children if the business is lost. Another potential issue arises when only some, but not all, of the client’s children, are active in the business. If all the children receive equal shares of the business, the non-active children may try to manage the business without knowledge, again causing the value the business to decrease significantly. Alternately, the non-active children may demand the purchase of their interest by the children active in the business, creating substantial cash-flow problems.

However, by engaging in Buy Sell planning it is possible to significantly reduce the likelihood that such problems will arise. Buy Sell planning is also important when the client is not the sole owner of the business. In situations where a portion of the business is owned by a nonfamily member, but the deceased client's interest now goes to beneficiaries a Buy Sell Agreement can protect the nonfamily member and the business from new owners who,

• Have no interest in being a part of the business;
• Want to be part of the business but have no idea how to run it; or
• Are unrealistic about the value of the business.

All of these situations can decrease the value of the business, create cash flow problems if the beneficiaries demand a salary, or simply wish for cash in exchange for their interest.

All of these situations are common, however by executing a Buy Sell Agreement the business owners can proactively limit the chance that a sudden change of circumstance for one owner can bring down an entire business.

The primary benefit of a buy sell agreement is the protection provided to the health of the businesses. A Buy Sell Agreement typically provides that under certain circumstances, 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 typically provides for specific events, such as death, disability, desire to sell, or retirement that trigger the parties’ obligations to one another. Additionally the Buy Sell Agreement provides provisions for determining the value of the business interest and terms for the payment of the price over a fair time span to all the parties. Further, beneficiaries can receive fair value for their business interest over a reasonable period, without adversely affecting the health of the business. It is important to review and update the buy sell agreement periodically as the situation changes.

In circumstances where the potential for conflict exists between siblings or with non-family owners, the parties will "fund" the agreement with life insurance, to be paid in the event of the death of one of the parties. The life insurance proceeds pay the deceased's estate for the deceased’s share of the business and beneficiaries involved in the business operation or the non-family owner are free to run the business without interference. To the extent that the value of the business exceeds life insurance, the Agreement provides for the payment of the remaining value over a reasonable time, with reasonable terms.

I often meet resistance when I discuss a buy sell agreement with some of my business clients. That resistance usually melts away when faced with one of two questions:

1. "Do you want to be partners with your partner's spouse, if your partner passes away?
2. Will your children’s collective efforts result in the continued success of the business?

While client’s may like a partner’s family members, they are generally not interested in being partners with them and when they truly take the time to consider their children’s interests most clients acknowledge that ownership is better passed to particular children.

A business interest is often a large part of a client’s assets. A properly drafted Buy Sell Agreement is important to insure that beneficiaries benefit from that asset in the best possible manner. Having a Buy Sell Agreement allows a client's family to be treated fairly as part of the purchase agreement and allows the remaining parties to continue running the business with no management interference while purchasing the business interest for a fair price and at reasonable terms. This is why any complete discussion of estate planning issues is not complete without addressing the client’s business interests.

Talking About an Estate Plan

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

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

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

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

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

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

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

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

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

Providing Loved Ones with a Postmortem Checklist

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

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

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

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

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

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

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

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

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