Succession Planning in Uncertain Times

These are challenging times for analyzing potential estate tax burdens. Last year, individuals could pass $3.5 million in assets upon their death free of federal estate taxes. Now in 2010, there is no federal estate tax whatsoever (maybe). Next year, current law would revert the exemption back to $1 million.

The impact of a $1-million estate tax exemption is significant. Many more Americans will potentially be faced with a maximum estate tax rate of 55%. Whether the law will change at this point is uncertain. A bill was recently introduced that would increase the exemption to $3.5 million retroactively back to Jan. 1. Unfortunately, the reality is that we simply do not know what will happen.

Whether a new estate tax law is enacted, or we revert to a $1 million exemption, the best approach is to put a sound, well thought-out estate plan in place now. This article outlines various tools available to reduce or even eliminate the estate tax burden, regardless of the exemption amount.

1. Properly drafted living trusts

Living Trusts have become an increasingly popular technique for avoiding lengthy, expensive and public court processes such as probates and conservatorships in the event of a person’s death or mental incapacity. Probate avoidance alone can mean large savings in the cost of estate administration.

Beyond saving estate administration costs and maintaining privacy, a properly drafted Living Trust can also mean substantial estate tax savings. For example, suppose Husband and Wife, with a taxable estate of $2 million, have a simple Living Trust that directs the transfer of all of their property to the other upon the first spouse’s death, and equally to their children thereafter. Assume Husband dies first, leaving everything to Wife. On Husband’s death, no estate tax will be owed because of the unlimited marital deduction, which defers estate taxes until a surviving spouse’s death. When Wife dies, however, she will only be able to pass the exemption amount in the year of her death before triggering an estate tax. Therefore, assuming an exemption of only $1 million when Wife dies, the children would receive approximately 50 cents on the dollar for all assets in excess of $1 million.

A better plan for Husband and Wife would have provided that an amount up to the exemption would be left in a tax-sheltered trust, frequently referred to as a “bypass trust,” for Wife’s benefit. Wife could then use the bypass trust to support herself during her lifetime, with the bypass trust going to the children free of estate taxes upon Wife’s death.

2. Planned gifting beyond the living trust

For wealthier individuals, basic Living Trust-based tax planning is not enough. In those situations, consider reducing the size of the estate through techniques such as those discussed below.

A. Irrevocable Life Insurance Trust

Suppose Husband and Wife were unable to totally avoid estate taxes despite the use of a bypass trust. In those cases, serious consideration should be given to preparing a specially designed trust commonly known as an Irrevocable Life Insurance Trust, or “ILIT.” If an ILIT is used to purchase life insurance, death benefits are kept out of the estates of both Husband and Wife (and therefore not subject to estate tax). The difference between having Husband or Wife own the policy, as opposed to having it owned by an ILIT, is staggering. For example, a $1 million life insurance policy kept out of the parents’ estates can prevent the children from having to pay roughly $500,000 of those proceeds for estate taxes. That means the full $1 million can pass to the children income and estate tax free.

B. Family Limited Partnerships (FLP’s) and Family Limited Liability Companies (FLLC’s)

Think of these entities just as you would any business, except they are owned by members of the same family. Parents initially contribute certain assets into a partnership or LLC in a manner that allows them to retain full control over those assets (just as any general partner or managing member would). The power for estate tax reduction comes from giving interests in these entities to the next generation during the parents’ lifetime. Since the gifts typically involve minority interests, the gift tax value can be discounted to reflect lack of marketability and control.
In many cases, these types of gifts have been discounted 40% or more. A 40% discount on a family entity could potentially provide for a gift-tax-free transfer of over $1.3 million more than could be achieved without the use of such an entity. Further, all income and appreciation flowing from the gifted property escapes both income and estate taxation at the parents’ generation. It may be important to act quickly with this type of gifting strategy, as there is a significant threat of legislation greatly reducing or even eliminating these discounts.

C. Charitable Giving

Where one has true donative intent, charitable contributions through gifts made outright or in trust may reduce the taxable estate. Private foundations are also becoming a popular tool for charitable giving. These arrangements are beyond the scope of this article, but merit consideration for the charitably inclined.

Conclusion

Planning for the worst in these uncertain times is critical. Regardless of estate size, proper planning will reduce both time and expense in estate administration, and leave loved ones with the clarity they deserve.

Celebrity Deaths Remind Us of the Need for Estate Planning

Funny how the "unthinkable" gets a bit closer to home when we learn about celebrities who fail to properly plan. This video points out how these issues impact all of us. It also explains the difference between a will and a trust with a nice twist that helps it make sense.

Estate Planning to Protect the Kids

This Wall Street Journal video highlights a couple of reasons why parents with minor children need a will, and should consider a trust. It also provides support concerning the need for life insurance as income replacement to fund the children's needs through young adulthood. Excuse the brief commercial at the beginning.

Eliminating Capital Gain on Real Estate Owned By Married Couples: A Simple Yet Critical Strategy

The article below (authored by yours truly) was recently posted on Matt Freeman's (impressive) blog. He is a dear friend and top-tier mortgage professional.

"California Home Strategies is happy to bring you the first in our series of featured business partners. Brian Qualls, Esq. is an attorney who specializes in Estate Planning. What he has brought to California home strategies is invaluable information. Enjoy the first in the series of many great guests to come.

How do you hold title to your home? Odds are, if you are married and purchased real estate with your spouse, you elected to hold the property as Joint Tenants. This has been the common practice recommended by many real estate agents, lenders, and attorneys for quite some time. The advantage to holding property in Joint Tenancy is that when the first spouse passes away, the deceased spouse’s one-half interest in the property automatically passes to the surviving spouse with little to no transfer cost. Provided that such a transfer of ownership was the couples’ objective upon the first spouse’s death, holding property as Joint Tenants seems like a no brainer.

Here’s the downside: If you hold real estate in Joint Tenancy with your spouse, you are missing out on significant tax benefits that are available under another method of holding title (which has all of the benefits of Joint Tenancy discussed above) that we’ll discuss in just a moment. First however, we need to understand the basics of calculating capital gain for tax purposes under the traditional Joint Tenancy method. Here’s how it works … when the first spouse passes away, the surviving spouse receives a “step up” in cost basis equal to 50% of the market value of the property at the time of the first spouse’s death (cost basis is, essentially, what you paid to purchase the property). The remaining 50% of the property retains the surviving spouse’s original basis. This concept is best illustrated through an example:

Max and Marge bought a house and took title as Joint Tenants. They paid $200,000 for the home (their cost basis for the purposes of calculating capital gain is therefore $200,000). Thirty years later, Max passes away. At the time of Max’s death, the property has increased in value to $1,150,000 (this assumes an annual appreciation of 6% over a 30 year period). Since Marge gets a “step up” in cost basis to 50% of that amount ($575,000), her new cost basis is $775,000 (her initial basis of $200,000 + Max’s stepped up basis of $575,000). Assuming that Marge chooses to downsize and sell the family home immediately, she will have capital gain in the amount of $375,000 ($1,150,000 sales price – her new $775,000 cost basis). At best (assuming Marge had lived in the home for 2 out of the last 5 years), she will have $250,000 of that $375,000 exempt from capital gains tax. But she’s still left subject to capital gains tax on $125,000 when she sells. This will result in a pretty hefty tax bill.

Fortunately, there is a better option. Since July 1, 2001, married couples have been able to take title to real estate as Community Property with Right of Survivorship. The “Community Property” designation will entitle the surviving spouse to a “double step up” in cost basis equal to 100% of the market value of the property at the time of the first spouse’s death. Therefore, in the example above, Marge’s new cost basis will be the full market value of $1,150,000, and she will be able to sell the property for zero capital gain. Moreover, if she chooses to remain in the residence (or even rent it out for a few years), she will still be able to rack up an additional $250,000 in appreciation and sell it tax free down the line.

It is important to note the significance adding the of the “with Right of Survivorship” language to the Community Property designation. That is what enables the surviving spouse to automatically inherit the deceased spouse’s one-half interest in the property with little to no transfer cost (the same benefit of Joint Tenancy that is often so appealing to married couples). If the property were only taken as Community Property without the “with Right of Survivorship” language, a court process would be required to transfer the deceased spouse’s one-half interest over to the surviving spouse. Therefore, if the couples’ objective is for the survivor to receive full ownership and control over property, opting for the “with Right of Survivorship” designation makes perfect sense.

If you are buying a new home or refinancing and would like to take advantage of taking title as Community Property with Right of Survivorship, it is as simple as checking the appropriate box in your closing documents. If you already own a home in Joint Tenancy and would like to change how you hold title, no problem. You can simply sign a new deed transferring your property from yourselves as Joint Tenants, to yourselves as Community Property with Right of Survivorship. Ask your title company or a competent attorney to assist you.

About the Author: Brian Qualls is an estate planning and trust attorney who assists families throughout California in protecting their loved ones (and their hard earned assets) through well designed estate plans that work. He firmly believes that everyone should at least have a basic plan in place, and therefore guarantees that every client who consults with his firm will walk away equipped with a simple will, power of attorney for finances, and advance health care directive for a nominal consultation fee. The fee itself is refundable at the end of the consultation in the event the client is not fully satisfied with the experience. If more comprehensive planning is requested by the client, the consultation fee is applied accordingly. Brian can be reached by email at Brian@BrianQualls.net, and his educational blog is available for the public at http://www.planyourestate.net/."

What is Estate Planning?

Let me start by describing what estate planning is not. I was having lunch with a financial advisor last week, who shared with me a great story about an event that occurred during his career in the military. Before troops were being deployed into hostile territory, they were summarily interviewed by a base attorney who filled in Will documents for them. The substance of the discussion was getting a response to the question, “How do you want to leave your stuff?”

Although that story certiainly (and bluntly) illustrates one element of one of the issues addressed in developing an estate plan, proper estate planning accomplishes so much more than just that.

Essentially, proper estate planning is taking responsibility for your finances, your person, and the well being of your loved ones at three critical times:

(1) Now, During Your Lifetime:

• What do you own? All that “stuff” (along with everything that you acquire in the future) is “your estate.” However you perceive the size and nature of your estate is irrelevant to whether or not planning should be done. It is simply a factor to help determine what type of plan will best suit your present situation and future goals.

• Is your estate exposed to unnecessary financial liability by the way that you hold title to real estate and other important assets?

• Who is on your team? Do you have an attorney you can trust to guide you through these important matters? How about complimentary professionals like insurance, financial and tax advisors? Bottom line, are you receiving the service that you need and deserve?

(2) If You Become Physically or Mentally Disabled:

• Who will manage your finances (i.e. pay expenses, endorse a check, withdraw funds, reallocate investments, sell property, etc) if you cannot do it yourself? Someone else must have legal authority to do it on your behalf.

• Who will make medical decisions for you if you can’t communicate? Will they have legal authority to do that? Will medical information privacy laws like HIPPA put them in a “catch 22” by preventing them from accessing medical information they might need?

• Who will take care of minor children if you (or a spouse) cannot? Again, someone else must have legal authority to act as a guardian. You have two choices here: You can name someone that you want, or you can leave it for a court to determine. Who knows your children and the people closest to you the best .... you, or a judge you have never met?

(3) When You Pass Away:

• What will happen to your property if you do no planning?

• What if you write a Will? Does that cover all of your assets? Hint: It probably controls very few of them.

• Do you want a court to have to approve the transfer your assets, or would you prefer to keep matters private?

• Who will be given the authority to care for minor children?

• How should you leave property to your children and other loved ones?

As you can see, estate planning involves very real and delicate issues that affect everything that you have, and everyone you love most. This planning is not automatic. You must choose to take control. If you are working with the right people, it’s a process that will empower you.

Where Do I Start?

You start by simply making a decision to complete your estate plan. Give yourself a firm deadline that you believe you will stick to. Make sure the deadline is early enough to cause you to stretch, as doing so creates urgency that will propel you through your planning.

• Educate yourself by learning a bit about the task at hand through materials like the Estate Planning Bullets posted on this blog, or by attending quality local workshops. Do-it-yourself estate planning products (while typically falling short in terms of quality of documents produced) can provide some valuable background and a framework to build upon. Whatever you do, the point is not to become an expert, it is to plant seeds as to what issues you'll be resolving as you create your plan.

• Decide which estate planning attorney you'd like to work with. You should meet and feel a sense of trust and rapport with your attorney before you ever get "on the clock." In fact, you should be able to get a flat-fee quote during your initial meeting (i.e. there is no "clock"). Fees quoted may or may not be indicative of the attorney's ability or quality of service (you have to trust your gut and / or your referring source's endorsements). In any case, you'll want to hold the initial meeting with your attorney about three to four weeks before your deadline. Beware: Not all attorneys will have your documents prepared for signature in a prompt manner. Some attorneys and firms let files "sit in the office" for months before something is actually done with them (long after the details of the plan have faded in memory or been passed on to an associate to piece together). Our documents are guaranteed to be prepared within four weeks, and its usually more like two or three. The details of your plan are arranged in our drafting system within 48 hours of meeting with you.

• Show up to your meeting having prepared in advance. Request a questionnaire from your attorney early on, and set yourself up to have it filled out and submitted to the law office three days before the meeting. You don't need to provide account numbers if you aren't comfortable doing so. Just the name of the financial institution, who's name it's in, and the approximate balance will suffice. You don't need to provide us with a copy of the deed to your home, but you should bring in a property tax statement to show the legal description. In other words, just get a bit organized. It's good for you.

The fact that you are reading this means you were referred by a family member, personal friend, or advisor. Suffice it to say that we are available to serve you.

Estate Planning Should be an Easy Process

Today has been a good example of why I like what I do:

• I had a meeting with Jesse Lichaa this morning, a Fresno realtor I've come to know and respect this year. In the meeting, when he asked me an open ended question about my business, I responded (pretty much instinctively) that I have a passion for making estate planning easy for people.

• My afternoon primarily involved preparing for and attending a meeting with a new client. At the end of the meeting, one of the spouses said "thank you for making this process easy and enjoyable."

Estate planning is not a complex animal when broken down into its core components. It truly is rewarding to see people engage in the process and feel so much peace of mind as a result.

Wills in 4 Minutes (Video)

You've probably heard that everyone needs a will. Here is an explanation of what wills do, and why they are important.

Trusts in 4 Minutes (Video)

The video below provides a helpful overview of using trusts in your planning. It also includes the basics on estate taxation.

Estate Planning Video for Parents

This interview with a colleague of mine was featured on the Today Show last spring. It is a worthwhile 4 minutes for any parent.



Nicely done Alexis!

LegalZoom, Etc. Can You Do It Yourself?

The short answer is, yes. There are numerous products and online services available to create your estate plan in a do-it-yourself type of fashion. In most, if not all cases, you can create documents that will be legally binding. That is actually where the concern comes in. I've experimented with many of the big name document generation programs available including LegalZoom, Nolo, Rapidocs, US Legal Forms, Suze Orman, and Living Trusts on the Web. In my opinion as an estate planning attorney, the processes in these programs (and consequently, the documents they produce) all contain one or more of the following challenges:

• The questions posed in the interviews can be ambiguous and confusing
• There are few options provided
• The wheels can fall off the wagon on the issues of contingent beneficiaries (if the person you named passes away before you) and trustee selection
• The issue of afterborn or adopted children is ignored in the interview process
• Poor incapacity planning (although that was less of an issue than I'd expected)

As a result of the flaws noted above, I do not recommend using any do-it-yourself program currently available as the only source of counsel you receive when creating your estate plan. They can, however, create a good starting point to build upon when you meet with your attorney, which might save you money. In all cases, they are good learning tools, and all of the programs noted above have their individual strengths and weaknesses. If I had to pick a winner, I would definitely say that Living Trusts on the Web produces the best state specific documents available. The options on the program are also more robust than the other candidates. That process, however, should not be completed without an attorney consultation and review.

Technology has not made it far enough to replace the need for advice, which is what all these programs specifically disclaim. In fact, it may take some consultation to make it through the interview confidently (as is the case with all programs). In general, I'd say most people are much better off meeting and developing a relationship with a qualified estate planning attorney. See the"Where do I Start" posting for further direction.

A Trust is Like a Business

For many people (and myself for a period of time), understanding the concept of a trust can be difficult. It need not be. Think of a trust as being a business. You are creating a new legal entity. If you create it during your lifetime, you don't even have even get a separate tax id number for your trust. Instead, much like a sole proprietorship or partnership, your trust will be treated as an extension of you as an individual (or individuals in the case of a joint trust).

• Business Plan: Your trust document will contain your business plan. This plan will include important components to ensure its success both now and into the future. For example, your plan will probably provide that you will be in full control of your property while you are alive and well. It will also provide for a seamless transfer of control over your affairs should you become disabled at any point in your life (and that trasnsfer should be structured in a way that excludes lengthy and expensive court involvement). Finally, you'll have instructions that give whatever property you have in your trust to whom you want, when you want, and in the way you want. Some people even take the extra step of documenting some of the key values and principals they want to pass on, including how they feel about their loved ones.

• Finances & Management: Once your trust is established (either now by signing it in front of a notary in the case of a living trust-based plan, or upon your death upon order of the probate court in the case of a will-based plan), you start funding your trust with of all of your assets (except for retirement accounts). For example, your trust will own the interest in your your house, land, bank accounts, investments, and life insurance. Again, remember that while you are alive and well you have full control to manage your trust assets just as you're used to doing right now. You can also change the terms of your trust document (or business plan) anytime that you want to while you are alive and well. Regardless of whether or not you make any changes, it is important to briefly review your plan every year to make sure it stays on track with your life situation.

• Succession & Transfer: If you become disabled during your life, your successor trustee (the person you named in your business plan to succeed you) will be able to manage your affairs on your behalf. When you pass away, your trust doesn't die, but lives on to provide for the transfer of your assets in any way or over any length of time that you desire. Children's inheritances are protected from creditors as long as their property stays in the trust as opposed to being owned in their own name (kind of like a corporation or an LLC). My trust by the way, provides that my children's shares will remain in their trusts until they are 40 years old. I've drafted many that gave it all outright, and many that included lifetime trusts for each child. There is no right or wrong way to do it, just find the way that suits your values and your personality.

That's pretty much all there is to it. Trusts are really pretty simple creatures when compared to a well organized business.

Asset Protection For Your Loved Ones

There are two ways to leave property to your loved ones. You can leave it: (1) Outright; or (2) In Trust.

• When you leave property outright to your spouse or children, you leave it to them with "no protection" from: Creditors (a lawsuit brought against them or a business partner, a bankruptcy), Predators (a divorce), or Themselves (youth, lack of financial responsibility, etc.).

• The best way to provide creditor protection for your loved ones is to leave your property to them in a trust. These trusts can be structured to be very simple and flexible (leaving the beneficiary with full control), can contain significant detail to accomplish certain legacy goals (such as helping children learn to manage money well by providing them with structured distributions), or do just about anything in between.

• Trusts can be created through will-based estate planning, or living trust-based estate planning. There are advantages and disadvantages to both types of plans, and a qualified estate planning attorney will assist you with finding the right fit based on your individual situation. The only wrong decision is the decision not to plan.

Our 60 minute introductory meetings and group workshops are the most effective tools to discover the plan that you'll feel right about. Contact us for details.