2011 Tax Laws: Good News, Bad News

A First Look at the New "Temporary" Federal Estate Tax Law

Throughout 2010, several of our posts noted that the federal estate tax had expired but that under then-current law, the estate tax was due to come back in 2011 as a more onerous tax. We commented and provided links, for example, discussing the George Steinbrenner estate, some $600,000,000 that would not be subject to the federal estate tax because he died in 2010 instead of 2009 or 2011. Then, in the last days of 2010, a deal was cut between the President and Congress as part of a broader tax package. The estate tax came back but in a (relatively) more benign form.

At this point, we have been able to analyze at least some of the specifics of the new estate tax. It was an interesting compromise. First, the good news: estates worth up to $5,000,000 are excluded (are not taxed) and the highest bracket, at 35%, is significantly lower than the highest bracket of the old tax (45% in 2009 but once as high as 55%). More good news, the $5,000,000 exclusion amount is "portable" which means that a married couple can more easily shelter $10,000,000 from the tax (without the necessity of a special trust).

That "portability" provision is especially interesting. Congress was able to determine that you should be able to "port" only the unused portion of the exclusion of one spouse. You can't accumulate unused exclusions from serial marriages.

But, yes, there is some bad news. The new estate tax is also temporary and will expire in 2013. And, the new estate tax is retroactive - - in a way. Executors of decedents who died in 2010 may elect to have 2010's rules carried over to 2011. Why wouldn't all executors so elect? There is a complex interplay with the capital gains tax and the determination of the cost basis of assets. Some executors will have to perform a careful analysis before deciding how they want to proceed.

These changes apply only to the federal estate tax. States have their own estate tax laws. Connecticut taxes estates over $3.5 million. New York taxes estates over $1.0 million. In both cases, the tax rates are not anywhere near the federal rates but can apply to estates that are excluded from the federal estate tax.

The discussion above is somewhat simplified and we will return to each in future posts to explain these provisions in a little more detail. For now, here are some general takeaways:

• Most estates will not be taxed at all and the focus of most people's estate planning should be on what they want to accomplish with their assets, not on tax avoidance;
• The temporary nature of these provisions keeps the premium on flexibility for those estates that might be on the cusp of the taxable thresholds;
• As always, life insurance, 401(k) plans, jointly owned real estate and other "non-probate" assets can put an estate over the taxable threshold - - people tend to be unaware how "non-probate assets" can build up their taxable estate;
• It may be a good time to review your asset and your will with an estate planning attorney - - if you haven't done so in the last three to five years, it's probably overdue.
 

Million-Heirs Cashing in on the Estate Tax Lapse

George Steinbrenner passed away earlier this week. The man left behind an extraordinary legacy, a controversial reputation, and an estate estimated at more than $1.3 billion by Forbes Magazine.

With the estate tax lapsed this year, Mr. Steinbrenner’s heirs may not have to pay hundreds of millions of dollars in taxes on what they’re about to inherit.

According to the Wall Street Journal, wealthy people who die before 2011 will spare their heirs a hefty 45% tax fee. This situation has all the makings of a potentially great homicide novel (someone hastens the death of a rich uncle), not to mention a plethora of legal and ethical quandaries.

It’s never wise to make life and death decisions based on finances and estates. But when the New Year is rung in, the Journal reports, the top tax rate will jump to 55%, and the federal estate tax exemption amount will shrink from $3.5 million per individual in 2009 to just $1 million.

In the meantime, we’ll watch the Steinbrenner situation play out. “The Boss” is survived by his wife and four children. The ABA Journal posts that a marital deduction likely would have applied if he had died in 2009 or 2011.  Under federal law, probate transfers among spouses are tax-free. But, according to Forbes magazine, “the absence of the estate tax could set up an intriguing scenario in which Steinbrenner’s spouse could disclaim a bequest, allowing assets to move to the next generation.” Of course, his estate is going to be very complex and not a guide for more typical situations.

For those of us not needing to worry about the millions or billions we leave behind for our loved ones, it’s best to consult an estate planning attorney who can help make decisions based on law (regardless of how confusing it may seem).
 

Yes, Virginia, there is an Estate Tax

According to Investment News, Virginia became the first state to pass a law requiring that estates be treated as if it is still 2009 -- unless Congress acts first.

Why would Virginia do that? Many wills include formulas that are based on the existence of an estate tax. This article points out how the formulas can distort the intentions expressed in someone’s will - - to the extent of leaving one’s children nothing instead of $3.5 million.

Of course the issue does not apply at all to most estates because they are too small to be taxed in the first place. There was no tax on small estates in 2009, and there is none in 2010.

In our practice, for estates that might have been taxable, we have been using “disclaimer” provisions that allow a surviving spouse to decide whether tax-minimizing steps are necessary. The “disclaimer” technique is not a cure-all for an uncertain tax environment, but it works in many cases.

It would be better if Congress simply decided to end the uncertainty and pass some kind of estate tax law.

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Reversal of Fortune: The Estate Tax Law Update

As of January 1, the federal estate tax went away for a year. Under current law, it’s scheduled to return at a higher rate next year. Personally, I’m surprised that Congress allowed the estate tax law to lapse, and I'm curious to see the ramifications.

According to the Wall Street Journal, families facing end-of-life decisions in the immediate future are finding that the change is making one of life's most trying episodes only more complex. Beneficiaries stand to inherit a lot more for a death this year than a death after December 31, 2010. The ethical dilemma is clearly significant.

Of course, what Congress giveth, Congress can taketh away. As discussed in the Journal article, the repeal of the federal estate tax is accompanied by reinstatement of the capital gains tax on property passing to beneficiaries.  Previously, when property passed to beneficiaries, the property received a “step up” in basis, wiping out the capital gains tax. The net result is that many estates, including smaller estates, will be taxed anyway but it just won’t be called an estate tax.

The Journal says that the uncertainties of the new tax law (will it be changed? will it be retroactive?) are “forcing family legal advisers to craft various provisional financial-planning strategies that can be undone later if the rules do change.” According to the article, at least one person has added the prospect of euthanasia to his estate-planning mix.  That might be a little extreme.

For a more conventional planning environment, we look forward to some kind of retroactive resolution.
                                                                

Follow-Up Info: Inheritance Tax

As we have mentioned before, under current law, the federal estate tax is scheduled to temporarily disappear next year before returning in 2011 at an even higher 55 percent rate. During the year without an estate tax, all estates would be subject to capital gains taxes that they now avoid.

The House approached a vote Thursday on permanently extending a 45 percent inheritance tax on estates larger than $3.5 million, canceling a one-year repeal of the tax set to begin next month.

According to an article in the Hartford Business Journal, under the House bill, estates smaller than $3.5 million would continue to be exempt from the tax, and married couples, with a little estate planning, could exempt a total of $7 million.

Under current law, the estate tax would return in 2011 with a $1 million exemption and top rate of 55 percent, unless Congress acts.

We will continue to keep you updated. 

Gift Tax Exclusion Remains $13,000 in 2010

The Tax, Trusts and Estates Law Monitor recently reported that the Gift Tax Exclusion Amount, indexed to the cost of living, will remain $13,000 in 2010.

As explained by TTELM: “The annual exclusion permits a taxpayer to gift $13,000 annually to any beneficiary without being required to use his or her $1 million lifetime gift exemption amount.”

The gift tax exclusion amount is an important estate planning tool since the amount can be doubled in the case of a married couple and applies to any number of persons. Less well-known, other excluded gifts may be made for tuition expenses and health care provided payments made directly to the educational institution or provider.
 

Estate Tax Update!

According to the Tax, Trusts and Estates Law Monitor, it appears increasingly likely that the imminent federal estate tax legislation this year will be a one-year “patch,” or a one-year freeze of the 2009 rules (a 45% estate tax rate and a $3.5 million exemption).

The Monitor states that the Association for Advanced Life Underwriting (“AALU”), an important trade and public affairs group, believes that permanent reform is less likely this year and that enactment of a one-year patch is the most likely outcome. The AALU predicts that the Senate debate on the estate tax will extend to mid or late December.

What this means: Under current law, estates of $3.5 million or more are subject to a federal estate tax which is scheduled to be repealed in 2010 but brought back in 2011 for estates of $1 million or more.  The "one year patch" extends the tax for estates of $3.5 million or more through 2010 while Congress decides what to do for 2011 and beyond.

We will continue to post updates regarding this legislation as they arise.

It's a Dog's Life - (as far as estate planning goes)

Connecticut pets can rest easy now.

The Ridgefield Press reports that Governor Jodi Rell signed a law ensuring that animals will be properly cared for if their owners die.

The new pet law, An Act Concerning the Creation of a Trust for the Care of an Animal, requires that the owner designate a “trust protector;” someone whose sole duty is to act on behalf of the animal, ensuring that the pet receives the proper care. In other words, when you’re making arrangements for your children, make them for Fido and Fluffy, too.

Prior to the new law, which went into effect October 1, pet owners could set up trusts for their animals but those arrangements were considered honorary since animal beneficiaries could not enforce them.

The new law complements a standing Connecticut law which states that pets are personal property. This particular legislation actually created a bit of an issue for a divorcing Connecticut couple, according to A Connecticut Law Blog. The couple encountered substantial veterinary bills after seeking treatments for their ill pets. The court ordered that the husband and the wife equally divide the costs of medical treatment for dogs. After all, they were just part of the marital debt.

As pet owners ourselves, Bev and I support the new legislation. Providing for a pet is a matter of personal preference and values and there should be some comfort in knowing such provisions are enforceable and not academic exercises or empty words in a will. But, the more important issue is whether one has gotten around to having an estate plan at all to provide for the objects of one’s affection and bounty, human or not.

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A Life Lesson From Charles Kuralt: Don't Put Off 'Till Tomorrow...

I used to enjoy watching Charles Kuralt on Sunday mornings. But a recent post in the Pennsylvania Fiduciary Litigation Blog shows his soothing voice and well written dialogues masked the real story in his personal life.

PFLB reports that when Mr. Kuralt died at age 62, his estate passed to his wife and his two daughters. However, after his death, it was discovered that Kuralt had a second, “secret” family for over 30 years. Kuralt’s will stated that his wife was the beneficiary of his estate, but before he passed away, Kuralt wrote a letter to his companion stating his desire to have her inherit the 90 acres of land he owned in Montana. A court found that the letter was considered a codicil, and was acceptable under Montana law.

 In New York, where Mr. Kuralt’s original will was probated (declared to be genuine by a court), a codicil must be executed with the same formalities as the original will- - you can’t just write a letter to amend your will. However, if Mr. Kuralt executed the codicil with the requisite formalities but the format just happened to be that of a letter, then it is truly a codicil in almost any state.

Interestingly, change the facts a little and the situation is not so unusual: a prior marriage and divorce . The estate plan would have to provide for the children from a prior marriage, a spouse and children from the second marriage. Conflicts abound.

There were also tax issues associated with the Montana land. Wills are often written with the provision that taxes are paid from the residuary estate. The taxes paid on the Montana property that went to his “secret family” came out of funds that were left to Mr. Kuralt’s known family. A complicated life requires a complicated plan, or inequities like this may ensue.


According to the PFLB report, Mr. Kuralt had other plans in mind but was suddenly stricken ill. This sad and unfortunate aspect of the story offers a valuable life lesson - - don’t put off your planning. Who knows what events may intervene?

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"Cliff Notes" on Connecticut's Estate Tax Changes

Connecticut has eliminated the “cliff” from its estate tax. The Danbury News-Times, along with other media and legal blogs, reports that this change to Connecticut’s estate tax law, along with other significant changes, will go into effect for decedents who die on January 1, 2010 or later.

The aforementioned “cliff” refers to the fact that under prior tax law, an estate of $2,000,000 was exempt from taxation. However, add one more dollar to that, and the entire $2,000,001 was taxed, resulting in a tax liability of $101,700. With the new law, estates of $3,500,000 or less will not be taxed. This is similar to the federal estate tax threshold (or at least this year it is).

Under current law, the federal estate tax will be abolished next year, only to come back in 2011 with a threshold of only $1,000,000. The expectation is that the federal estate tax will be modified. On the other hand, that expectation has existed for some 8-10 years.  A clear explanation of the status of the federal estate tax is provided by this recent Wall Street Journal article.

In New York, the state estate tax threshold is a mere $1,000,000. But, in either Connecticut or New York, the federal tax takes a far bigger bite, with a marginal rate up to 45%. That’s right, 45%.

Here’s some good more news for Connecticut: estate tax rates are now being reduced by 25 percent, with a new maximum rate of 12%. But the estate tax and a return will be due six months after date of death instead of the current nine months.

In all three jurisdictions, (federal, Connecticut and New York), your “estate” for tax purposes includes almost everything you own: property, IRA’s, 401(k)’s, pension plans, the proceeds of life insurance and “In Trust For” accounts.

And one more point of potential confusion, specifically with respect to life insurance: the fact that beneficiaries do not pay income tax on the proceeds does not mean that the estate won’t pay estate tax.  A substantial life insurance policy can be enough to "tip: an estate into a taxable bracket.

A final piece of advice: take care of yourself and your loved ones.

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We Know Not What Tomorrow Will Bring: Estate Planning

The ubiquitous media coverage of Michael Jackson’s death last week mentioned the plight of his children and the state of his financial assets and woes. This unfortunate situation should serve as a reminder that careful estate planning is not just for the wealthy or Hollywood Elite. Taking care of your affairs now ensures that your loved ones are cared for in the manner you wish once you pass.

Many people believe their estate automatically passes onto the spouse, when in fact the spouse may actually receive less than intended.  In Connecticut and New York, the laws of "intestacy" (estates without a will) provide for fractional shares for the spouse if there are children.  By contrast, many married couples who write wills give all to the other and only at the death of both do assets pass to the children.  Without legal planning, how an estate will be distributed or who the administrator will be is determined by impersonal laws without considering individual circumstances..

Although there are no laws that require the assistance of an attorney in estate planning, we highly recommended  it. A "do-it-yourself" will or generic trust may actually be more expensive than consulting a lawyer. Generic forms often do not address the legal requirements of New York or Connecticut. They also will not take into account individual wishes. And then, of course, there may be tax issues that will need to be resolved.

The death of a loved one is always difficult, but with no estate plan, the loss can be compounded by family squabbles and feelings of betrayal -- not to mention an overwhelming amount of paperwork.

Visit some of our archived blog entries for more information.

Image:  Last will & testament of Alfred Nobels, dated November 27th, 1895.  Courtesy Wikimedia
 

Annual Gift Tax Exemption Increased to $13,000

The Utah Business, Real Estate and Estate Planning Blog, in a post by Matt Fanhauser, has alerted us to an increase in the federal annual gift tax exclusion, effective January 1, 2009, to $13,000 or, when a spouse joins in the gift, $26,000.

Federal tax law provides that the exclusion amount increases with inflation but only by $1,000 increments. Thus, it does not increase every year but only when the formula for the increase results in a $1,000 increase.

 

The annual gift tax exclusion is important for small business owners because lifetime, tax-free gifts provide a way to reduce the federal tax bite on estates that potentially would be taxable at a rate of 45%. 

 

We have always included within our mandate to discuss litigation issues the discussion of appropriate steps one may take to reduce the likelihood of often bitter litigation by one’s beneficiaries. That means a developing a good estate plan which, in part, may include a plan for making tax-free or discounted gifts during one’s lifetime.   

Connecticut's Probate Court System Losing Money

Legal Blog Watch brought to our attention last week the curious fact that the State of Connecticut’s Probate Court system is losing money - - according to reports, $20,000 each day (“Connecticut Probate Court on the Verge of Bankruptcy”). The report was also carried by Hartfordbusiness.com.

The story seems odd since you would think that a court system could always raise fees. Hartfordbusiness.com suggests a partial explanation in that courts in wealthier suburbs and make money on estates but subsidize the cities where the courts deal mostly in guardianships which don’t make money (and possibly insolvent estates). According to Legal Blog Watch, the courts bear the expense of paying outside counsel to represent indigent children and the mentally disabled.

 One wonders, given the title of the Legal Blog Watch, can the probate court go to bankruptcy court? 

 

In any case, this story is a little “off topic” for us since on the surface it has little to do with managing or learning from litigation. But, we can learn strategic management lessons from the plight of the probate courts. Without claiming special expertise in the management of Connecticut’s probate courts, there are some obvious characteristics that we could question from a management perspective:

 

  • Probate courts are organized and spread out at the level of cities and towns, rather than consolidated at the county level or into more efficient and larger districts;
  • Probate courts are supposed to be self-sustaining but are also burdened with the mission to subsidize the indigent;
  • Apparently, there is subsidization across geographic lines with the consequence that the suburban towns now subsidizing the cities are not likely to support fee increases;

The overriding goal of the probate court system apparently is to be close to the individual cities and towns. Each town has its own probate court and judges are elected. The State will probably correct the current financial problem appropriately without much controversy. But, as a learning experience, this temporary glitch demonstrates how elements of the operating “model” of an organization can present challenges to its success.

Life Insurance Litigation: Actor's Death Within Contestabilty Period Leads to Lawsuit

The West Virginia Business Litigation Blog summed up the situation well when the Estate of the late actor Heath Ledger sued a life insurer for $10 million:

Not even the rich and famous (or their beneficiaries) are immune from the decisions of insurance companies.

 

The quote and post is by Jeffrey V. Mehallic and entitled “Actor’s Estate Sues Insurance Company for $10 Million Policy” and the case, with a link on the WVBLB post is LaViolette v. ReliaStar Life Insurance Company, Civil Action No. 2:08-CV-05514 (C.D. Cal. 2008).   

 

The Estate alleges “post-mortem underwriting, delaying payment on the policy while it investigates whether the death was a suicide within the “contestability period” and, therefore, not covered. In brief, the insurer is investigating whether there were misrepresentations about drug use on the insurance application. As reported by WVBLB, the actor’s death was ruled accidental although abuse of prescription medications was mentioned. The insurer claims that since the actor died within the “two-year incontestability period,” its investigation is legitimate.

 

Here’s our “takeaway” from this sad story: Clients should remember that the “incontestability clause” of life insurance policies creates a two-year period within which life insurance claims can be contested for the exclusion of suicide and fraud in making the application. This two-year period is a safeguard against “adverse selection,” for example, against the possibility that an individual contemplating suicide buys a policy and then commits the act. In addition, however, if the life insurance policy application was not completed accurately and with care, the company can investigate for other reasons why it should not be required to pay the claim if death occurs within the two years after the policy was issued. If a proper cause is found, it can return the premiums paid and deny the claim for the benefits of the policy.

 

Thus, it is important to complete the policy application carefully. When purchasing life insurance, one hopes it is never needed and certainly not needed within the first two years. Unfortunately, unexpected tragedies do occur.

 

Finding Opportunities in Uncertain Times: Develope a Longer Term Perspective

A recent blog post suggesting that decreasing asset values present opportunities did not get my full appreciation until I put it together with an unrelated experience in an estate litigation case to draw a broader lesson.

The post was in the Utah Business, Real Estate and Estate Planning Blog, by Matt Fankhauser and entitled “A Silver Lining in Decreasing Asset Values.” The point was that decreasing asset values present opportunities for high net worth individuals. With gift and estate taxes not likely to go away, individuals can make gifts at a discount (that is, at depressed values) to take maximum advantage of lifetime gift tax exemptions and annual exclusions. 

 

While seemingly unrelated, the idea brought to mind my experiences with the parties in a will contest that was resolved only after years of litigation.

 

Valuable investment property had been in the family 35 years with the decedent refusing to allow it to be sold in her lifetime. One party in the will contest fought to gain control of that property intending to keep the property from being sold and as a family asset even longer. The estate also happened to include overseas properties that may have been owned by the decedent for 50-60 years.

 

In holding properties 35, 50, 60 years, the decedent (and other family members) exhibited a distinct long-term mindset. Since they intended to hold on to the assets for the long term, this family might very well consider a period of depressed values to be an opportune time to make tax-saving gifts.

 

More generally, a longer-term mindset, even in an uncertain economic environment, may identify opportunities that would otherwise be overlooked. That is as true of personal financial issues, such as estate and gift tax planning as it is of core business issues.

Avoiding Litigation You Can't Manage: Planning Your Estate and Talking About It

You will not be around to manage any litigation that might arise over your estate. 

That’s why we took notice of a recent New York Times article by David Cay Johnston which made an excellent case for informing your beneficiaries about the particulars of your estate plan. (“Learning to Share”). 

Essentially, the point of the article is that being up front about your plans may be difficult but will serve you well in the long run. Quoting Mitchell Gans, a law professor at Hofstra University, the Times points out the particular problem that occurs when the plan is not an equal distribution among the beneficiaries and the less favored beneficiaries react with anger:

 

Kids do get angry at being cut off, but if you say nothing their anger will be directed not at you, but at the favored child. You need to ask yourself, ‘Why should this kid be the target of the anger?’ Why would you do that to them?

 

I recommend the entire article. When we talk about the “long run” here, we are talking about a run so long that you are no longer there to smooth things over or straighten things out.

 

In our experience, estate and trust litigation is quite likely to occur where there is an unequal distribution and the beneficiaries do not find out about it until the will is offered for probate or a trustee takes charge after death has occurred. Estate and trust litigation tends to be especially bitter. We know of cases where the parties lose all perspective and dissipate large portions of the estate.  Most attorneys who practice in this field will have had similar experiences.   The majority of cases eventually settle but getting to a settlement can be a long, expensive effort.

 

We include trust and estate matters in the general category of “business litigation” (although many would not) because most of our small business clients do not create an artificial boundary between their business and their personal finances. And, it is possible to extract “better practices” from litigation developments for personal financial issues, such as estate matters, just as it is for business issues.

 

In this case, the Times article rightly suggests that the better practice, although difficult, is to communicate openly with your intended beneficiaries.

Litigating Against the IRS: Taxpayer Wins One, Loses One

A taxpayer both won and lost against the IRS in a case involving a Family Limited Partnership (FLP). The case, Holman v. Commissioner is reported and very-well summarized in a post (“Another FLP Fact Pattern: Holman v. Commissioner”) by Kimberly Martinez Lajarza in the Florida Estate Planning Blog

We sometimes comment on estate planning issues in this blog because of our broad interpretation of “business litigation.” Our business clients and readers have a very strong and personal interest in transferring the fruits of a lifetime of hard work to their chosen beneficiaries.   

Lifetime gifts are commonly used to reduce the size and tax liability of an estate large enough to be taxable. But, gifts are subject to the gift tax.

FLP’s provide a way to discount the value of the gifts made in one’s lifetime for gift tax purposes. The discount is important because it allows the taxpayer to take greater advantage of the annual exclusion (now $12,000) and the lifetime exemption (now $1,000,000) from the gift tax. For example, a 20% discount allows assets to be nominally worth $15,000 within the $12,000 annual exemption.

We have not seen the Holman case and rely on the FEPB post for the facts. Apparently, the mainstream elements of the plan (marketability and control discounts) survived the litigation but, the transfer restrictions pushed the envelope a little and did not. Another key element, in favor of the taxpayer, was that the assets were transferred to the limited partnership before gifts were made, even if only by a matter of days. 

General lessons to derive better practices: (1) leading-edge planning techniques will be scrutinized and may involve litigation so the potential returns (even larger tax savings) should justify the added risk, (2) careful planning is always in order – - consider how important the timing of the gifts was in this case.

Estate Plan By Substituted Judgment Cannot Be Contested After Death - A First from California

An appellate court in California has ruled that an estate plan created by a conservator under a substituted judgment order cannot be contested after the death of the estate owner.

The case is reported by Law.com in an article (“In Appellate First, Attacks on Wills Barred After Estate Owner Dies”) by Pamela A. MacLean of the National Law Journal.

We normally would not comment on a California case but there seem to be some general principles at work here. First, though, we should agree on terminology. While Connecticut uses the same term, “conservator,” in New York, a “guardian” would be involved, more specifically one appointed for an adult under Article 81 of the New York Mental Hygiene Law.

In general terms, someone (conservator or guardian) legally appointed to make decisions for a person who lacked capacity for decision-making created an estate plan. Substituted judgment means, generally, the plan was believed to be what the incapacitated person would have done if that person had not lacked capacity.

Most important in forming our point of view: it was done after a hearing, on notice, with an opportunity for interested parties to be heard and in accordance with a court order.

On these limited facts, one wonders why, as Law.com reports, it would be the first such decision in the nation.  I acknowledge not being able to read the entire case and reacting only to these limited facts. 

But, it seems to me a matter of common sense that if the parties had the opportunity to contest the estate plan before it was approved by the court, the same parties should not be permitted to wait until the death of the incapacitated person and then raise issues that could have been heard and determined in the earlier proceeding.

Will contests or, as is the case here, a challenge to a living trust, can be nasty affairs and can wastefully diminish the estate. There is no reason to give a potential objectant a second opportunity after failing to raise appropriate issues at a first hearing to approve the estate plan. It appears to be common sense and applicable in any state.

Estate Planning Advice for the Some of the Ten Million Millionaires in the World

HartfordBusiness.com reports that the world now has ten million millionaires (“World now has 10 million millionaires, report says”). The story, by Associated Press Writer Candice Choi, is based on a report issued by Merrill Lynch & Co. and consulting firm Capgemini Group. It also reports that one third of the millionaires are located in the United States.

I will suspend my skepticism at anyone’s ability to overcome differences around the world related to, among other factors, differences in currency, property valuations and customs of confidentiality to derive an accurate number. The exact number, after all, is not that important.  We like milestones so let's consider the number to be 10 million. 

Whatever the exact number, a lot of people are millionaires and multi-millionaires without realizing it. We can credit the growth of IRA’s, 401(k)’s, 403(b)’s, and even life insurance (and allowing for the current dip) home values.

But, the HartfordBusiness.com story also reports that a million dollars isn’t what it used to be. Today, millionaires can be people of fairly modest means.   

This story drew our attention because we interpret our "business litigation" mandate broadly.  We include in our commentary issues related to estate planning, in particular, avoiding litigation among beneficiaries and the unpleasant surprises associated with unexpected estate tax liabilities and disputes with tax authorities. 

We counsel clients to think about and make plans for their entire estate. Pension assets (which include IRA’s, 401(k)’s, 403(b)’s), the proceeds of life insurance and any jointly owned assets (such as homes, bank accounts, securities) do not necessarily pass by will but by separate beneficiary designations or operation of law. In legal terminology, these are “nonprobate assets.” Writing a will without also carefully coordinating the separate beneficiary designations, for example, may lead to unpredictable distributions of assets and the potential for disputes and litigation among the beneficiaries.

On the other hand, nonprobate assets are included in considering whether an estate becomes taxable and could put a modest estate over the top to a taxable level. We counsel clients to be aware of the way asset values may have grown over time and to do the appropriate planning.

For more on this subject, we invite you to view an earlier post, with link to our video program, My Financial Journal.

Irrevocable Life Insurance Trusts (ILITs): Avoiding Litigation with the IRS

The Utah Business, Real Estate and Estate Planning Blog, in its article, “ILTSs as an Estate Planning Tool” by Matt Frankhauser, provides a clear and succinct summary of how an Irrevocable Life Insurance Trust (ILIT) may be used to keep the proceeds of life insurance policies out of the gross estate of the insured. We don’t want to try to improve on the summary and offer the entire article here. But, we offer a few comments to supplement it.

First, as a point of clarification for our readers who are not lawyers, it is widely known that the proceeds of life insurance policies, the death benefits, are not taxed as income to the recipient. It is less widely known that the death benefits are counted as part of the gross estate of the insured and subject to estate tax if the estate is large enough to be taxable. The life insurance proceeds, by increasing the size of the gross estate, can push the estate across the threshold from a nontaxable to taxable estate.

The focus of our blog is generally on litigation and, whenever possible, avoiding litigation. One type of litigation our business clients will definitely want to avoid, although it will affect their beneficiaries, not themselves (who are gone at that point), is litigation with the IRS over whether millions of dollars in life insurance death benefits ought to be taxed at a marginal rate of 45% or so. Thus, Mr. Fankhauser’s article notes that “if properly constructed and managed,” ILITs can be effective estate planning tools (emphasis added). His article does a nice job of communication elements of proper construction and management.

One aspect that is especially difficult to communicate, however, concerns the process of paying the premiums. Although covered in the Utah blog article, some elaboration may help to further understanding. The issue arises because premiums paid by the insured for policies owned by this artificial entity (the ILIT) are gifts.

Now, in addition to keeping the future proceeds of the life insurance out of the gross estate, a further goal is added, not to pay gift tax on the current gifts of the premiums to the trust. As mentioned, in the Utah blog article, this is often done by taking advantage of the annual gift tax exclusion (currently $12,000). Unfortunately, the tax code and the IRS have established two governing principles: (1) the annual gift tax exclusion may not be used for a gift of a future interest and (2) money given to the trust to pay premiums that may not result in death benefits for many years are future interests.

But, if someone can exercise the option to receive the gifts now, then the gifts are considered present (and not future) interests. The result is the procedure of the “Crummey Letters,” named after a court case that established the procedure. The beneficiaries of the trust are given the option, limited for a short period of time, to immediately demand the money intended to be used by the ILIT to pay premiums. The existence of this option establishes that the gifts to the trust (for premiums) are “present interests” and the annual gift tax exclusion does apply.

Video: Estate Planning Discussed on My Financial Journal

If you have a compulsion to be involved in truly contentious litigation and are tired of matrimonial cases, try a will contest. For this reason, we include the identification of “best practices” in the area of Estate Planning as falling within the overall mission of our blog. Acquisition, preservation and, ultimately, disposition of assets are activities t, in our way of thinking, that are appropriately categorized as business activities that can be managed so as to avoid unnecessary and costly litigation.   

Because we consider Estate Planning such an integral part of our mission and practice, our firm’s two partners were excited to be invited and to actually appear last year to talk about Estate Planning on the public access television program My Financial Journal hosted by Andrew Rose. In all modesty, our audience was probably small. More important, we believe our audience, whatever its size, was treated to a fast paced, interesting and informative program.

With special thanks to Andrew Rose the program can be seen by clicking here.

If you don’t have time for the half hour program or the technical resources to download it, I offer a few bullet point highlights.

  • The discussion of death is definitely uncomfortable for many people but others find a source of satisfaction and accomplishment in knowing they have taken care of their families and addressed some difficult issues.
  • In particular, the care of minor children and financially dependent adult family members is a concern.
  • The complexity of an estate plan can depend on the variety and nature of your assets but two other factors include the extent to which income tax qualified assets are included in your estate and whether, because of size, the estate is exposed to federal and state taxation.
  • The status of estate tax laws is in flux because federal law, while temporarily increasing the size of exempt estates, is scheduled to be repealed absent another act of Congress and states have enacted their own estate tax laws “decoupling” or becoming independent from federal estate tax law.
  • Revocable Trusts can be effective planning tools if real estate is owned in multiple states or to provide an added layer of disincentive to contest the plan.
  • But, often revocable trusts are set up without actually transferring assets to them, nullifying some of the advantages.
  • Planning for non-traditional families and families with children from prior marriages requires an added level of sensitivity and a concern for fairness.
  • Similarly, gay and lesbian couples need to explicitly address their particular needs through effective planning because some useful provisions of law are inapplicable to them.
  • Women, traditionally tending to be caregivers, may have difficulty putting their own needs first, but upon establishing a relationship can proceed expeditiously in facilitating the family’s estate plan.
  • Single women and single men, in our experience do not tend to differ in the fundamental nature of their estate planning needs; one aspect is that often their concern is for more remote family members or even friends.

We hope you have the time to view the entire program. Whether you do or not, we hope you make the time for your own estate planning. You may not be around to experience it yourself, but for your beneficiaries the disputes, among themselves or with tax authorities, can be costly and debilitating.