FIVE ESTATE MISTAKES
Understanding key concepts can help you save you
from a bad estate plan
Every reader of this article has an estate plan, whether or not they know it. Some have taken a proactive approach and retained counsel to create a plan and draft appropriate documents that express their wishes. The rest — perhaps unknowingly — rely on the laws of the state in which they reside. The laws affecting seniors have become increasingly complex, and it is up to the client to seek appropriate advice at an early date.
Power of attorney
Some may be tempted to download a power of attorney form from the Internet. Anyone can search the Internet for the term “power of attorney” and find Web sites with standardized forms for sale or immediate download. This might sound like a simple solution, but don’t be misled.
The basic power of attorney documents found on the Internet often do not cover the very specific issues you may need addressed. Medical powers of attorney are not always included, nor are clauses about gifting, real estate transactions or the ability to make asset transfers to affect Medicaid eligibility. These are important parts of your estate plan that require case-by-case consideration.
Tax allocation clause
One of the most important provisions in a will is the tax allocation clause, which allocates a decedent’s estate or inheritance tax burden among the estate beneficiaries by specifying the source or fund from which the death taxes are to be paid. The allocation of taxes among beneficiaries of an estate is generally governed by the terms of a testator’s will, a nontestamentary instrument passing nonprobate property or the default rules under applicable state law.
Despite the importance of tax allocation clauses, which can dramatically alter the dispositive provisions of a client’s estate plan, many practitioners rely on general boilerplate tax clause provisions for all clients without fully examining the impact that such clauses have on the plan. Generally, a tax clause contained in a will charges the estate’s tax burden to the residuary estate or apportions the tax burden among the estate beneficiaries in proportion to their share of the estate tax liability. Often, a boilerplate tax allocation clause commonly found in wills charges the testator’s residuary estate under the will with the burden of all taxes imposed on both probate and nonprobate property. An example where a tax allocation clause resulted in a presumably unintended result involved the estate of Charles Kuralt. His 1994 will provided that all estate, inheritance and other death taxes imposed by reason of death would be paid, without apportionment, by his residuary estate. The residuary beneficiaries included his surviving spouse and two children. Shortly before his death, he prepared a handwritten codicil (which was ultimately admitted to probate) that devised his Montana ranch to his longtime companion. Since the terms of Kuralt’s will provided that the taxes were to be paid from the residuary estate, the residuary beneficiaries (his wife and kids) bore responsibility for payment of taxes attributable to the property that passed to the companion.
Special needs trust
Consider establishing a special needs trust if one of your potential beneficiaries is entitled to government benefits such as Supplemental Security Income or Medicaid. Direct receipt of funds will cause the individual to be disqualified, which means the funds will need to be spent down before requalifying for the benefits. This result is particularly harmful for those who incur substantial medical expenses each month.
Consider a situation in which Mom and Dad have three children, one who is disabled. The parents are killed together in an accident and don’t have wills. In most states, the children will be entitled to receive the inheritance in equal shares. Since the disabled child’s share is not diverted to a special needs trust, the result will be disqualification from the entitlement program that he or she may have been otherwise eligible until the funds are spent.
Another situation I handled involved a client in a nursing home, the costs of which are being covered by Medicaid. A family member dies, leaving the ill person an inheritance. Again, the ill person is disqualified from Medicaid. This means that he or she must pay the nursing home bill directly (at a rate of $5,000 to $9,000 per month, depending on the locale) until only $2,000 remains.
State estate tax
Since the state death tax credit was repealed at the federal level through the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), many states have imposed their own estate tax. (It’s important to know that an estate tax differs from an inheritance tax. Some states have both, and some states have neither.)
The planning focus is often on the federal estate tax, and many erroneously believe that tax planning is no longer necessary in light of the current federal estate tax exemption of $2 million. The state estate tax can be avoided in many cases; therefore, you need to take a proactive approach with respect to this issue. In New Jersey, the exemption is $675,000.
Updated documents
When important changes occur in our lives, we need to revisit our wills and beneficiary designations to make sure that our current intent is expressed. The following are major events that might motivate individuals to take a second look at their will:
• Marriage or new life partner
• Divorce
• Birth of a child
• Change of who will inherit your assets
• Change of who should handle your estate after your death
Many have failed to update their documents since the enactment of EGTRRA in 2001. This mistake has caused many surviving spouses to unnecessarily incur state estate tax liability at the death of the first spouse.
Don’t allow your estates to suffer unintended consequences. Become more familiar with the laws affecting you by seeking the advice of an attorney with expertise in this complex area of law.
Thursday, October 15, 2009
Wednesday, September 30, 2009
Laws May Cause Issues for Owners In Civil Unions
When civil unions became legal for same-sex couples in New Jersey last year, the lesbian, gay, bisexual and transgender community celebrated a hard-won victory. But conflicting laws for LGBT partners at the state and federal levels have some business owners who live with same-sex partners worried about how the conflict may affect their estate planning.
Kimberlee Williams and Tamara Fleming-Cooper are co-owners of Newark-based marketing firm Femworks LLC and are both in civil unions. If both owners were to die and their respective partners were each to receive half the business, it would become “difficult on the federal level to transfer our assets to them without an estate tax being paid,” says Williams.
Femworks, which has five part-time employees besides the owners, specializes in reaching African Americans in the LGBT community.
Neither Williams nor Fleming-Cooper have children, but both want to have everything figured out before they do because their business makes up a large portion of their personal assets.
Each member of a civil union must file separate federal tax returns because federal law doesn’t recognize civil unions. Williams says there is a burden on small business owners because of the time spent on all the paperwork.
Stephen Hyland, a Westmont attorney who specializes in LGBT couples law, says that under federal law one member of a civil union who gives the other more than $12,000 in one year as a gift will eat into a $1 million lifetime gift-tax exclusion.
“Let’s say a business owner [in New Jersey] in a same-sex civil union and his partner buy a house and the business owner puts down the entire down payment,” he says. “Later in the same year, the business owner gives his partner a $50,000 stake in the company. The business owner would have given his partner a reportable gift of half the down payment plus the $50,000 investment minus the $12,000 annual gift exclusion.”
Hyland notes that the $1 million lifetime federal gift-tax exclusion counts toward the federal estate-tax exemption, a tax levied upon death that is currently capped at $2 million but scheduled to jump to $3.5 million next year.
“So if I used up $500,000 of my gift-tax exclusion, I’ve really reduced the amount of my estate I can leave tax-free to $1.5 million” under the current cap.
Meanwhile, members of a traditional marriage can gift each other unlimited amounts of money without being federally taxed, and can take federal-tax deductions on all assets left to each after death, says Hyland. But gay and lesbian couples don’t have that right, notes Hyland.
For state taxes such as the inheritance-transfer tax and the estate tax, same-sex partners in civil unions get the same exemptions as married couples, he says.
In New Jersey, an estate in excess of $675,000 is subject to the state’s estate tax, however civil-union couples and married couples pay no tax on assets they leave to their spouse. Same-sex couples in domestic partnerships are exempt from the state’s inheritance-transfer tax but not from the estate tax.
“What it comes down to is that anytime an [LBGT] business owner is doing something that would be non-taxable federally if he were married, it has tax implications either as a gift or income,” Hyland says. “Unfortunately, that’s the effect of the federal law.”
Stephanie Canas Hunnell, a lawyer in Belmar, says same-sex partners in civil unions should create what is called a dummy form with the state when filing their federal estate taxes because the federal government doesn’t recognize same-sex unions.
“One form is a real form filed with the federal government to pay taxes, as if the estate was being left to a stranger,” she adds.
“The other is a dummy form filled out as if the estate was being left to a spouse. You would use dummy form in New Jersey to get the same tax benefits as a married couple,” says Canas Hunnell.
“Because the federal government doesn’t recognize same-sex marriages or civil unions as having the same rights and responsibilities as opposite-sex married couples, they’re not going to give any [tax] benefits,” she says. “So you’re not any kind of relation according to the [federal] government and you’re going to pay a higher tax.”
Both Hunnell and Hyland advise LGBT business owners in New Jersey to assemble a team comprised of a lawyer, an accountant and a financial adviser who are familiar with the laws surrounding same-sex couples.
Kimberlee Williams and Tamara Fleming-Cooper are co-owners of Newark-based marketing firm Femworks LLC and are both in civil unions. If both owners were to die and their respective partners were each to receive half the business, it would become “difficult on the federal level to transfer our assets to them without an estate tax being paid,” says Williams.
Femworks, which has five part-time employees besides the owners, specializes in reaching African Americans in the LGBT community.
Neither Williams nor Fleming-Cooper have children, but both want to have everything figured out before they do because their business makes up a large portion of their personal assets.
Each member of a civil union must file separate federal tax returns because federal law doesn’t recognize civil unions. Williams says there is a burden on small business owners because of the time spent on all the paperwork.
Stephen Hyland, a Westmont attorney who specializes in LGBT couples law, says that under federal law one member of a civil union who gives the other more than $12,000 in one year as a gift will eat into a $1 million lifetime gift-tax exclusion.
“Let’s say a business owner [in New Jersey] in a same-sex civil union and his partner buy a house and the business owner puts down the entire down payment,” he says. “Later in the same year, the business owner gives his partner a $50,000 stake in the company. The business owner would have given his partner a reportable gift of half the down payment plus the $50,000 investment minus the $12,000 annual gift exclusion.”
Hyland notes that the $1 million lifetime federal gift-tax exclusion counts toward the federal estate-tax exemption, a tax levied upon death that is currently capped at $2 million but scheduled to jump to $3.5 million next year.
“So if I used up $500,000 of my gift-tax exclusion, I’ve really reduced the amount of my estate I can leave tax-free to $1.5 million” under the current cap.
Meanwhile, members of a traditional marriage can gift each other unlimited amounts of money without being federally taxed, and can take federal-tax deductions on all assets left to each after death, says Hyland. But gay and lesbian couples don’t have that right, notes Hyland.
For state taxes such as the inheritance-transfer tax and the estate tax, same-sex partners in civil unions get the same exemptions as married couples, he says.
In New Jersey, an estate in excess of $675,000 is subject to the state’s estate tax, however civil-union couples and married couples pay no tax on assets they leave to their spouse. Same-sex couples in domestic partnerships are exempt from the state’s inheritance-transfer tax but not from the estate tax.
“What it comes down to is that anytime an [LBGT] business owner is doing something that would be non-taxable federally if he were married, it has tax implications either as a gift or income,” Hyland says. “Unfortunately, that’s the effect of the federal law.”
Stephanie Canas Hunnell, a lawyer in Belmar, says same-sex partners in civil unions should create what is called a dummy form with the state when filing their federal estate taxes because the federal government doesn’t recognize same-sex unions.
“One form is a real form filed with the federal government to pay taxes, as if the estate was being left to a stranger,” she adds.
“The other is a dummy form filled out as if the estate was being left to a spouse. You would use dummy form in New Jersey to get the same tax benefits as a married couple,” says Canas Hunnell.
“Because the federal government doesn’t recognize same-sex marriages or civil unions as having the same rights and responsibilities as opposite-sex married couples, they’re not going to give any [tax] benefits,” she says. “So you’re not any kind of relation according to the [federal] government and you’re going to pay a higher tax.”
Both Hunnell and Hyland advise LGBT business owners in New Jersey to assemble a team comprised of a lawyer, an accountant and a financial adviser who are familiar with the laws surrounding same-sex couples.
Monday, August 17, 2009
BUSINESS SUCCESSION LEGAL PLANNING
By Parag Patel, Esq.
If the U.S. Government is your favorite charity, rest assured, it will find a way to use your donation. But wouldn't it be better to give your money to your children?
Studies show that 60% to 70% of all family-owned businesses, including hotels, have no business succession plan in place or no one to take over the reins. This leaves third-party sales, family limited partnerships and buy-sell agreements as the most likely methods of transfer if a business is to continue.
Proper business succession planning will protect you from a potential liquidity shortfall and intervention by the IRS, and will ensure your successor (i.e., your son, daughter, nephew, etc.) receives the maximum value upon transfer of your business.
Gifting and Family Limited Partnerships:
A substantial portion of the estimated $6 trillion to $8 trillion of personal wealth that will transfer over the next 10 years consists of family business interests, including hotel properties. Unlike publicly traded securities, no ready market exists for closely held private interests. Each business therefore represents a unique and challenging valuation problem to the IRS with respect to estate and gift taxes. One way to deal with this problem is gifting. With a new IRS ruling allowing for gifts of minority shares to family members at a discount, individuals considering a transfer of shares of a family business should gift the shares now. The formation of a family limited partnership holding all shares of your business interests is a common and popular way to maximize gifts and still maintain control of your businesses until you are ready for your successor to takeover the business.
Valuation of Your Business:
Disputes over business value are a leading cause of tax challenge between the IRS and business owners. The transfer must be well-documented by an independent expert. The valuation process has been around since 1959 and has been well-treated by the courts. It carries stiff penalties for over-under valuation, hence strict adherence is mandatory.
Buy-Sell Agreements:
A family business should have a buy-sell agreement in place that specifies terms of ownership and price of transferred shares between family members in the event one of the them retires, leaves the business, becomes disabled or dies. Of course, the lower the specified share price, the lower the estate and gift tax value of the shares. The specific mechanism for setting the price of the shares in the agreement has been a subject of controversy for many decades.
Regardless of your method of planning, you have worked too hard to build up your business to have it lose value or fall apart when you can no longer run the business. I have had too many clients that simply fail to do any business succession planning and ultimately give the U.S. Government more in taxes. The time is now to think about tomorrow.
If the U.S. Government is your favorite charity, rest assured, it will find a way to use your donation. But wouldn't it be better to give your money to your children?
Studies show that 60% to 70% of all family-owned businesses, including hotels, have no business succession plan in place or no one to take over the reins. This leaves third-party sales, family limited partnerships and buy-sell agreements as the most likely methods of transfer if a business is to continue.
Proper business succession planning will protect you from a potential liquidity shortfall and intervention by the IRS, and will ensure your successor (i.e., your son, daughter, nephew, etc.) receives the maximum value upon transfer of your business.
Gifting and Family Limited Partnerships:
A substantial portion of the estimated $6 trillion to $8 trillion of personal wealth that will transfer over the next 10 years consists of family business interests, including hotel properties. Unlike publicly traded securities, no ready market exists for closely held private interests. Each business therefore represents a unique and challenging valuation problem to the IRS with respect to estate and gift taxes. One way to deal with this problem is gifting. With a new IRS ruling allowing for gifts of minority shares to family members at a discount, individuals considering a transfer of shares of a family business should gift the shares now. The formation of a family limited partnership holding all shares of your business interests is a common and popular way to maximize gifts and still maintain control of your businesses until you are ready for your successor to takeover the business.
Valuation of Your Business:
Disputes over business value are a leading cause of tax challenge between the IRS and business owners. The transfer must be well-documented by an independent expert. The valuation process has been around since 1959 and has been well-treated by the courts. It carries stiff penalties for over-under valuation, hence strict adherence is mandatory.
Buy-Sell Agreements:
A family business should have a buy-sell agreement in place that specifies terms of ownership and price of transferred shares between family members in the event one of the them retires, leaves the business, becomes disabled or dies. Of course, the lower the specified share price, the lower the estate and gift tax value of the shares. The specific mechanism for setting the price of the shares in the agreement has been a subject of controversy for many decades.
Regardless of your method of planning, you have worked too hard to build up your business to have it lose value or fall apart when you can no longer run the business. I have had too many clients that simply fail to do any business succession planning and ultimately give the U.S. Government more in taxes. The time is now to think about tomorrow.
Friday, July 17, 2009
15 IRS Audit Tips
1. In an audit, you must convince the IRS that you reported all of your income and were entitled to any credits, deductions and exemptions that are questioned.
2. Delaying the audit usually works to your advantage. Request more time whenever you need it to get your records in order or for any other reason.
3. Keep the IRS from holding the audit at your business or home. Instead, go to the IRS or have your tax attorney handle it.
4. Give the auditor no more information than she is entitled to, and do not talk any more during the audit than is absolutely necessary.
5. Do not expect to come out of the audit without owing something, the odds are against you.
6. Do not give copies of other years' tax returns to the auditor; if you do and she sees something she does not like she will make adjustments in these years too.
7. The IRS must complete an audit within three years of the time the tax return is filed, unless the IRS finds tax fraud or a significant underreporting of income.
8. If the audit is not going well, demand a recess to consult a tax attorney.
9. If you are still unclear about the tax law or how to present your documents to an auditor, consult a tax attorney before the audit.
10. If you are missing receipts or other documents, you are allowed to reconstruct records.
11. Do not bring to an audit any documents that do not pertain to the year under audit or were not specifically requested by the audit notice.
12. If the subject of tax fraud comes up during an audit, do not try to handle it yourself.
13. Field audits are more intensive than office audits. They are used mainly when there is business income; consult a tax attorney before a field audit.
14. When you get the examination report, call the auditor if you do not understand or agree with it. Meet with her or her manager to see if you can reach a compromise.
15. If you ca not live with an audit result, you may appeal within the IRS or go on to Tax Court.
2. Delaying the audit usually works to your advantage. Request more time whenever you need it to get your records in order or for any other reason.
3. Keep the IRS from holding the audit at your business or home. Instead, go to the IRS or have your tax attorney handle it.
4. Give the auditor no more information than she is entitled to, and do not talk any more during the audit than is absolutely necessary.
5. Do not expect to come out of the audit without owing something, the odds are against you.
6. Do not give copies of other years' tax returns to the auditor; if you do and she sees something she does not like she will make adjustments in these years too.
7. The IRS must complete an audit within three years of the time the tax return is filed, unless the IRS finds tax fraud or a significant underreporting of income.
8. If the audit is not going well, demand a recess to consult a tax attorney.
9. If you are still unclear about the tax law or how to present your documents to an auditor, consult a tax attorney before the audit.
10. If you are missing receipts or other documents, you are allowed to reconstruct records.
11. Do not bring to an audit any documents that do not pertain to the year under audit or were not specifically requested by the audit notice.
12. If the subject of tax fraud comes up during an audit, do not try to handle it yourself.
13. Field audits are more intensive than office audits. They are used mainly when there is business income; consult a tax attorney before a field audit.
14. When you get the examination report, call the auditor if you do not understand or agree with it. Meet with her or her manager to see if you can reach a compromise.
15. If you ca not live with an audit result, you may appeal within the IRS or go on to Tax Court.
Wednesday, June 17, 2009
Top 7 Costly Estate Planning Mistakes and How To Avoid Them
1. Where There Is A “Will” Is There Is A Way? The biggest mistake is the failure to plan, having the wrong plan or even having an outdated plan. Everyone can benefit from a will or some other form of estate planning. Avoiding or reducing estate taxes, saving estate administrative costs, specifying who will receive your estate and protecting your family are just a few of the benefits a will can achieve.
2. Understanding the Death Tax System. If you are married, with proper planning you and your spouse can shield double the state and federal exemption amount ($3.5 million federal and $675,000 for New Jersey) from estate tax. The mistake occurs when the first spouse dies and leaves their entire estate to the surviving spouse thereby in effect losing the deceased spouses individual exemption amount. Instead, it is often beneficial for the spouse to leave all or a portion of their estate to a simple trust called an exemption trust (also know as a credit shelter trust).
3. Should Assets be Jointly Titled? Joint assets often have a right of survivorship which transfers ownership at death to the joint owner by operation of law. This bypasses the will. Since probate in New Jersey is relatively straightforward, instead of being an advantage, joint ownership can interfere with an estate plan.
4. What Are The Benefits Of Beneficiary Designations? IRA And Retirement Plan Distributions. A well thought out estate plan can be undermined by an incorrect beneficiary designation. The most common error is naming minor or irresponsible beneficiaries. A trust may be a better designation. Also consider a “Stretch IRA”.
5. Can Life Insurance Be Improperly-Owned? Life insurance death benefits are not subject to income tax. However, they are subject to estate taxes if the policies are owned by the insured at death. A way to avoid this is to have life insurance owned by an irrevocable life insurance trust.
6. Gifting When You Shouldn't And Not Gifting When You Should. When properly applied, gifting can be an extremely effective way to reduce estate taxes. However, many individuals incorrectly assume that gifting is simple and fail to obtain competent advice.
7. Hiring A Generalist. When hiring a doctor, attorney, mechanic or any type of service profession, I strongly recommend hiring a specialist. Almost without exception, the specialist will have more experience and skill in their area of specialty than will a generalist. This usually translates into higher quality services provided in the most cost effective manner possible.
2. Understanding the Death Tax System. If you are married, with proper planning you and your spouse can shield double the state and federal exemption amount ($3.5 million federal and $675,000 for New Jersey) from estate tax. The mistake occurs when the first spouse dies and leaves their entire estate to the surviving spouse thereby in effect losing the deceased spouses individual exemption amount. Instead, it is often beneficial for the spouse to leave all or a portion of their estate to a simple trust called an exemption trust (also know as a credit shelter trust).
3. Should Assets be Jointly Titled? Joint assets often have a right of survivorship which transfers ownership at death to the joint owner by operation of law. This bypasses the will. Since probate in New Jersey is relatively straightforward, instead of being an advantage, joint ownership can interfere with an estate plan.
4. What Are The Benefits Of Beneficiary Designations? IRA And Retirement Plan Distributions. A well thought out estate plan can be undermined by an incorrect beneficiary designation. The most common error is naming minor or irresponsible beneficiaries. A trust may be a better designation. Also consider a “Stretch IRA”.
5. Can Life Insurance Be Improperly-Owned? Life insurance death benefits are not subject to income tax. However, they are subject to estate taxes if the policies are owned by the insured at death. A way to avoid this is to have life insurance owned by an irrevocable life insurance trust.
6. Gifting When You Shouldn't And Not Gifting When You Should. When properly applied, gifting can be an extremely effective way to reduce estate taxes. However, many individuals incorrectly assume that gifting is simple and fail to obtain competent advice.
7. Hiring A Generalist. When hiring a doctor, attorney, mechanic or any type of service profession, I strongly recommend hiring a specialist. Almost without exception, the specialist will have more experience and skill in their area of specialty than will a generalist. This usually translates into higher quality services provided in the most cost effective manner possible.
Thursday, May 28, 2009
Six Estate Planning Myths
The most time-consuming aspect of estate planning is educating clients and dispelling common misconceptions that most people have regarding Wills, Trusts, Estate Taxes and Probate. Over the years, we have identified six recurring misconceptions which many of our clients carry with them into our first conference:
MYTH #1 - "I DON'T HAVE A WILL"
New Jersey law provides a Will for people who die without one. "New Jersey's Will" provides for the following:
The manner in which your property will be distributed among your surviving relatives.
The designation of an administrator who will be responsible for settling the estate.
Guardians for minor children.
MYTH #2 - "I DON'T NEED A WILL"
See Myth #1; do you want the state to dictate:
The manner in which your property is distributed?
Who will be responsible for administering your estate?
Who will be guardians for your minor children?
A Will may also be necessary to minimize Death Taxes. (See Myth #3.)
MYTH #3 - "I HAVE NO FEDERAL ESTATE & GIFT EXPOSURE"
Federal Estate & Gift Tax is generally a concern only where assets (including the face value of life insurance) exceed the "Applicable Exclusion Amount". The Applicable Exclusion Amount is $1,500,000 for 2004 and 2005; $2,000,000 for 2006-2008; and $3,500,000 in 2009. The Federal Estate Tax is repealed in 2010 under current law, but scheduled to be reinstated in 2011 absent further Congressional Action. The Applicable Exclusion Amount in 2011 would only be $1,000,000.
For married couples, there is no Federal Estate Tax exposure at the first death, regardless of the amount of their assets, as long as everything passes to the surrvivor. However, Estate Tax will be due at the second death to the extent assets exceed the survivor's Applicable Exclusion Amount (discussed above). For Example, if Ricky and Lucy have assets valued at $3,000,000, the Federal Estate Tax and New Jersey Estate Tax (discussed below) due when neither is surviving could exceed $840,000. This is the case even though Ricky and Lucy each have a $1,500,000 Applicable Exclusion Amount ($3,000,000 combined).
Married couples need Wills to implement a "Bypass Trust" for the benefit of the survivor in order to preserve the decedent's (i.e., the first person to die) Applicable Exclusion Amount. A Bypass Trust is a trust established under the decedent's Will for the benefit of the survivor. Notwithstanding the survivor's enjoyment of the Bypass Trust assets, none of those assets are exposed to Estate Tax in the survivor's estate. In Ricky and Lucy's case, a Bypass Trust would have eliminated all Federal Estate Taxes, saving the family almost $660,000. However, as a result of recent changes to the New Jersey Estate Tax, fully funding the Bypass Trust would generate a New Jersey Estate tax upon Ricky's Passing.
Effective January 1, 2002, the State of New Jersey will impose an Estate Tax on assets which exceed the New Jersey "Applicable Exclusion Amount". Under old law, the New Jersey Applicable Exclusion Amount was the same as under Federal Law. However, the New Jersey Exclusion is now fixed at $675,000. Accordingly, New Jersey Estate Tax can be due even where no Federal Estate Tax is due. For example, if an individual dies in 2004 with a taxable estate of $1,500,000, there would be no Federal Estate Tax due, but the New Jersey Estate Tax would be $64,400. Moreover, the extent to which Bypass Trusts (discussed above) are funded when one spouse dies must be reassessed in light of the new law. In the example set forth above relating to Ricky and Lucy, setting aside $1,500,000 in a Bypass Trust for Lucy's benefit would be the most advantageous planning technique for Federal Estate Tax purposes, but could potentially generate a New Jersey Estate Tax of $64,400 upon Ricky's passing. Accordingly, the new law greatly affects both estate planning documents and decisions made during the estate administration process.
MYTH #4 - "I HAVE NO NEW JERSEY INHERITANCE TAX EXPOSURE"
Even if there is no Federal Estate & Gift Tax exposure or New Jersey Estate Tax exposure, there may be New Jersey Inheritance Tax exposure. This tax applies to property transferred at death to the following individuals: brothers, sisters, nephews, nieces, cousins and friends. It does not apply to property transferred to children, grandchildren, step-children and parents.
Example: Ricky dies with assets valued at $1,000,000. His Will provides that all of his property will pass to his friend, Ethel. Federal Estate Tax - $0; New Jersey Inheritance Tax - $153,000.
The New Jersey Estate Tax would be $33,200, but Ricky's estate would only be liable for the higher of the Inheritance Tax or Estate Tax. The two taxes are not combined.
MYTH #5 - "I MUST AVOID PROBATE"
In New Jersey, Probate is neither an expensive, nor a time consuming process.
"Probate" is simply the legal process by which an individual's Will is proven as a valid legal document to dispose of that individual's property. This "process" usually consists of a thirty minute meeting at the County Surrogate's office.
Once the Will is "probated", or proven as valid, the decedent's (the person that has died) property can be distributed in accordance with the directions set forth in the Will.
MYTH #6 - "TRUSTS ARE JUST FOR THE WEALTHY"
A Trust is simply a vehicle for separating the legal title and beneficial ownership of property.
A "Trustee" is designated as the person or entity who has legal title to the property placed in that person or entity's "trust".
The "Trustee" must manage the trust property in accordance with the directions set forth in the trust document, for the benefit of the trust's "beneficiary".
Even the simplest Will should contain provisions for a trust to be established to hold property for the benefit of minors.
MYTH #1 - "I DON'T HAVE A WILL"
New Jersey law provides a Will for people who die without one. "New Jersey's Will" provides for the following:
The manner in which your property will be distributed among your surviving relatives.
The designation of an administrator who will be responsible for settling the estate.
Guardians for minor children.
MYTH #2 - "I DON'T NEED A WILL"
See Myth #1; do you want the state to dictate:
The manner in which your property is distributed?
Who will be responsible for administering your estate?
Who will be guardians for your minor children?
A Will may also be necessary to minimize Death Taxes. (See Myth #3.)
MYTH #3 - "I HAVE NO FEDERAL ESTATE & GIFT EXPOSURE"
Federal Estate & Gift Tax is generally a concern only where assets (including the face value of life insurance) exceed the "Applicable Exclusion Amount". The Applicable Exclusion Amount is $1,500,000 for 2004 and 2005; $2,000,000 for 2006-2008; and $3,500,000 in 2009. The Federal Estate Tax is repealed in 2010 under current law, but scheduled to be reinstated in 2011 absent further Congressional Action. The Applicable Exclusion Amount in 2011 would only be $1,000,000.
For married couples, there is no Federal Estate Tax exposure at the first death, regardless of the amount of their assets, as long as everything passes to the surrvivor. However, Estate Tax will be due at the second death to the extent assets exceed the survivor's Applicable Exclusion Amount (discussed above). For Example, if Ricky and Lucy have assets valued at $3,000,000, the Federal Estate Tax and New Jersey Estate Tax (discussed below) due when neither is surviving could exceed $840,000. This is the case even though Ricky and Lucy each have a $1,500,000 Applicable Exclusion Amount ($3,000,000 combined).
Married couples need Wills to implement a "Bypass Trust" for the benefit of the survivor in order to preserve the decedent's (i.e., the first person to die) Applicable Exclusion Amount. A Bypass Trust is a trust established under the decedent's Will for the benefit of the survivor. Notwithstanding the survivor's enjoyment of the Bypass Trust assets, none of those assets are exposed to Estate Tax in the survivor's estate. In Ricky and Lucy's case, a Bypass Trust would have eliminated all Federal Estate Taxes, saving the family almost $660,000. However, as a result of recent changes to the New Jersey Estate Tax, fully funding the Bypass Trust would generate a New Jersey Estate tax upon Ricky's Passing.
Effective January 1, 2002, the State of New Jersey will impose an Estate Tax on assets which exceed the New Jersey "Applicable Exclusion Amount". Under old law, the New Jersey Applicable Exclusion Amount was the same as under Federal Law. However, the New Jersey Exclusion is now fixed at $675,000. Accordingly, New Jersey Estate Tax can be due even where no Federal Estate Tax is due. For example, if an individual dies in 2004 with a taxable estate of $1,500,000, there would be no Federal Estate Tax due, but the New Jersey Estate Tax would be $64,400. Moreover, the extent to which Bypass Trusts (discussed above) are funded when one spouse dies must be reassessed in light of the new law. In the example set forth above relating to Ricky and Lucy, setting aside $1,500,000 in a Bypass Trust for Lucy's benefit would be the most advantageous planning technique for Federal Estate Tax purposes, but could potentially generate a New Jersey Estate Tax of $64,400 upon Ricky's passing. Accordingly, the new law greatly affects both estate planning documents and decisions made during the estate administration process.
MYTH #4 - "I HAVE NO NEW JERSEY INHERITANCE TAX EXPOSURE"
Even if there is no Federal Estate & Gift Tax exposure or New Jersey Estate Tax exposure, there may be New Jersey Inheritance Tax exposure. This tax applies to property transferred at death to the following individuals: brothers, sisters, nephews, nieces, cousins and friends. It does not apply to property transferred to children, grandchildren, step-children and parents.
Example: Ricky dies with assets valued at $1,000,000. His Will provides that all of his property will pass to his friend, Ethel. Federal Estate Tax - $0; New Jersey Inheritance Tax - $153,000.
The New Jersey Estate Tax would be $33,200, but Ricky's estate would only be liable for the higher of the Inheritance Tax or Estate Tax. The two taxes are not combined.
MYTH #5 - "I MUST AVOID PROBATE"
In New Jersey, Probate is neither an expensive, nor a time consuming process.
"Probate" is simply the legal process by which an individual's Will is proven as a valid legal document to dispose of that individual's property. This "process" usually consists of a thirty minute meeting at the County Surrogate's office.
Once the Will is "probated", or proven as valid, the decedent's (the person that has died) property can be distributed in accordance with the directions set forth in the Will.
MYTH #6 - "TRUSTS ARE JUST FOR THE WEALTHY"
A Trust is simply a vehicle for separating the legal title and beneficial ownership of property.
A "Trustee" is designated as the person or entity who has legal title to the property placed in that person or entity's "trust".
The "Trustee" must manage the trust property in accordance with the directions set forth in the trust document, for the benefit of the trust's "beneficiary".
Even the simplest Will should contain provisions for a trust to be established to hold property for the benefit of minors.
Thursday, May 7, 2009
Estate Planning for Non-US citizens
Estate Planning for Non-US citizens
By Parag Patel Esq.
Non-US citizens (greencard holders or H-1 visaholders) are severely discriminated against by US estate tax laws.
Since estate taxes are based on the size of your estate. It is estimated that without proper planning, you will lose 15 percent to 75 percent of your estate, because the government will take it. Estate taxes alone are 49 percent of an estate worth over $3 million.
For both US citizen spouses, a $2,000,000 exemption is available. If the estate plan is properly structured, a $2 million exemption is available per couple. H-1 visaholders have a smaller $60,000 exemption and a $120,000 exemption per couple.
Furthermore, a large number of people have non-US citizen spouses (either greencard holders or H-1 visaholders) and these couples are adversely affected by discriminatory tax laws.
US citizens distribute unlimited amounts of property to their spouses (through lifetime gifts and/or transfers at death) by reason of the unlimited marital deduction. The theory behind the unlimited marital deduction is one of tax deferral, not tax avoidance. This is because the marital deduction only postpones collection of the estate tax, with the assumption that property received by a spouse under the marital deduction will ultimately be included in the gross estate of the surviving spouse.
To prevent the loss of tax revenue from a non-US citizen, who may decide to "take-the-money-and-run" back to a foreign country and beyond the reach of the IRS after the death of their spouse, the tax law denies any estate tax marital deduction for property passing to non-US citizen spouses.
Thus, there are only three choices available:
- set up a Qualified Domestic Trust (QDOT), a trust that provides the non-US citizen surviving spouse with distributions of income from the trust assets.
- to pay estate taxes on first death
- to become a US citizen
In light of all of the above, sophisticated estate planning for non-US citizens is strongly recommended and a competent tax attorney should consulted.
By Parag Patel Esq.
Non-US citizens (greencard holders or H-1 visaholders) are severely discriminated against by US estate tax laws.
Since estate taxes are based on the size of your estate. It is estimated that without proper planning, you will lose 15 percent to 75 percent of your estate, because the government will take it. Estate taxes alone are 49 percent of an estate worth over $3 million.
For both US citizen spouses, a $2,000,000 exemption is available. If the estate plan is properly structured, a $2 million exemption is available per couple. H-1 visaholders have a smaller $60,000 exemption and a $120,000 exemption per couple.
Furthermore, a large number of people have non-US citizen spouses (either greencard holders or H-1 visaholders) and these couples are adversely affected by discriminatory tax laws.
US citizens distribute unlimited amounts of property to their spouses (through lifetime gifts and/or transfers at death) by reason of the unlimited marital deduction. The theory behind the unlimited marital deduction is one of tax deferral, not tax avoidance. This is because the marital deduction only postpones collection of the estate tax, with the assumption that property received by a spouse under the marital deduction will ultimately be included in the gross estate of the surviving spouse.
To prevent the loss of tax revenue from a non-US citizen, who may decide to "take-the-money-and-run" back to a foreign country and beyond the reach of the IRS after the death of their spouse, the tax law denies any estate tax marital deduction for property passing to non-US citizen spouses.
Thus, there are only three choices available:
- set up a Qualified Domestic Trust (QDOT), a trust that provides the non-US citizen surviving spouse with distributions of income from the trust assets.
- to pay estate taxes on first death
- to become a US citizen
In light of all of the above, sophisticated estate planning for non-US citizens is strongly recommended and a competent tax attorney should consulted.
Thursday, April 23, 2009
Introduction to Estate Planning
Estate planning is concerned with the use, conservation and disposition of a person's property and wealth. This involves two elements: (1) minimizing the gift or estate tax consequences that occur when a person's property is passed to another either during life or at death; and (2) provisions for taking care of the decedent's spouse and family.
Both elements can be enormously complex, interrelated and often operate inversely. For instance, the goal of providing more for one's children or grandchildren and less for a surviving spouse may cause adverse estate tax consequences. This summary describes the fundamentals of estate planning.
I. DEFINITIONS
There are four main methods by which property is transferred at death:
1. Will
A will is a written document that takes effect at the death of the person signing it (the "testator"). A will covers all property owned by the testator at death. A state court proceeding ("probate") is instituted and the provisions of the will are implemented under supervision of the probate court. Both the tax and family estate planning objectives of the decedent can be accomplished with a will.
2. Living Trust
A living trust (sometimes called an "inter-vivos" trust) is a document that is revocable at any time by the person signing it ("grantor"). Living trusts have become quite popular as a method to avoid probate. To avoid probate, the trust must be funded; this means that title to the assets which the grantor owns personally must be actually transferred to the trust -- real property is deeded to the trust; bank accounts are switched to the trust; and stocks, bonds, partnership interests and other holdings are assigned or transferred to the trust.
NOTE : The grantor is usually the trustee and beneficiary of the trust during his or her lifetime.
Use of a Will vs. a Living Trust : Generally, with either a will or a trust the same estate tax consequences occur, and the same opportunities for tax and family planning are available. The debate over the value of each often centers around the savings of the costs incurred in a probate proceeding which typically run between 2 to 4 percent of the value of the probate estate. While a living trust which is fully funded with the grantor's assets prior to his or her death will eliminate probate, there may be advantages to probate which are also lost. In addition, the initial cost and maintenance of the living trust must be considered.
A realistic assessment of the net savings in using a living trust would be approximately 1 to 2 percent of the gross estate; an estate of $1,000,000 should save between $10,000 and $20,000 by using a living trust instead of a will.
The savings must be counter-balanced by the administrative burden of maintaining the assets in the trust over the period of one's life. There are other, non-economic advantages for using a trust which merit consideration such as privacy (a trust is not probated in open court) and upon the incapacity or death of the grantor, the trust continues to operate without court intervention.
3. Joint Tenancy
Joint tenancy is a method of holding title to property when two or more people own property together, but the last survivor will own the property outright. When a joint tenant dies, his or her interest goes automatically to the survivor; there is no probate and a will or living trust has absolutely no effect on joint tenancy property.
There may be adverse tax consequences to the joint tenant who dies first. There is a presumption that the entire fair market value of the property is part of the decedent's estate for estate tax purposes, unless the surviving joint tenant can prove (through financial records) the amount of his or her share of the payments made towards the purchase, improvement or upkeep of the jointly held property. For instance, if the surviving tenant can prove he or she made a 30 percent contribution towards the purchase, improvement or upkeep of the property, then 70 percent of the property will be included in the deceased tenant's estate for estate tax purposes.
4. Community Property
California is a community property state which means that any earnings and assets acquired during the marriage belong equally to both spouses, regardless of who actually earned the income. Property acquired before marriage, or gifts and inheritances received by one spouse during a marriage, are generally the separate property of that spouse.
Upon the death of either spouse, the community property is split equally and the surviving spouse receives his or her share of community property outright. The deceased spouse's 50 percent share of community property is part of his or her estate and is subject to his or her will or living trust.
II. The Gift and Estate Tax Aspect To Estate Planning
There are five basic tax concepts to estate planning:
1. Gift Tax
A person may make a gift of $10,000 per year per recipient ("donee") without incurring a federal gift tax. There is no longer a California gift tax. For a husband and wife, the amount is $20,000 per year, per donee. In order to qualify, the gift must be completed presently; the gift cannot be placed in trust unless the beneficiary has the right to withdraw it within a reasonable period after the gift is made. In most circumstances, it is the person making the gift ("donor") who is taxed, not the donee.
2. Estate Tax
The federal estate tax is a tax levied on the property owned by the decedent at death. The tax is paid by the estate for the privilege of passing property to the donee(s). The tax is based on the fair market value of the property at the date of death or on the alternate valuation date (discussed below). California has eliminated a separate estate tax on the decedent's property.
3. Stepped-up Basis at Death
When a person dies, all assets owned by the decedent are valued at their fair market value, usually by appraisal, by the person (the executor of the will or trustee of the living trust) filing the federal estate tax return. The determination of fair market value is generally made as of the date of death, however, there is an alternative valuation date of 6 months after death available for estates that have decreased in value.
As a corollary to this rule, the tax basis of the decedent's property is "stepped-up" to the estate tax valuation amount. Tax basis refers to the value of the property for computing gain or loss. It is usually the cost of the property plus improvements and less any depreciation.
For example, if the decedent dies owning stock which he or she purchased for $5, but has a current value of $100, the full $100 value is used to determine the estate tax. The stock then receives a stepped-up basis of $100 in the hands of the donee. No income tax will be paid by the donee on the subsequent sale of stock for $100 or less; income tax will only be paid on the sale of stock for an amount in excess of $100 and only for that excess amount.
With community property, even though 50 percent passes outright to the surviving spouse, both portions of the community property receive a stepped-up basis at the death of the first spouse. If a married couple owns a house worth $500,000 which has a tax basis of $45,000, the tax basis for the entire house (both community property shares) is stepped-up to $500,000 upon the death of the first spouse, and a later sale of the house for $560,000 will result in only $60,000 in gain. A sale of the house for the same amount prior to the death of the first spouse would have caused a $515,000 gain.
The stepped-up basis rule does not apply to certain income the decedent earned prior to his or her death. This income is considered income in respect to a decedent ("IRD"). IRD includes income from property sold prior to death, unpaid compensation and retirement benefits.
4. The Unified Estate and Gift Tax Credit and the Credit Exemption Trust
Each person is entitled to a lifetime credit of $600,000 for gift and estate taxes called the "unified credit." This credit applies to gifts made over and above the $10,000 annual gift tax exclusion discussed previously. If a person makes an annual gift to a single donee of $50,000, then the additional $40,000 - which does not qualify for the annual gift tax exclusion - will reduce the unified credit from $600,000 to $560,000. The unified credit is phased out for estates over $10 million.
The unified credit may be used for property left to any donee, either outright or in trust. In a typical estate plan the unified credit amount is used by creating a trust for that amount for the surviving spouse during his or her lifetime. Upon the surviving spouse's death, the children would then become the beneficiaries of the trust. This trust is sometimes called an "exemption trust" or a "by-pass" trust since it is exempt from estate taxes and by-passes the surviving spouse's estate. The exemption trust may provide the surviving spouse with the following rights during his or her life without causing the trust to become part of the surviving spouse's estate for estate tax purposes: (1) all the trust's net income may be payable to the surviving spouse; (2) the trust's principal may be applied to the surviving spouse for his or her health, support, maintenance and education ("ascertainable standards"); and (3) the surviving spouse may have the noncumulative right to withdraw the greater of 5 percent or $5,000 of trust principal per calendar year for any reason ("5&5 power").
The unified credit plays a major role in estate planning because there is no estate tax for estates that are less than or equal to the unified credit. In most circumstances, there is no estate tax on estates of $600,000 or less.
5. The Marital Deduction and the Marital Deduction Q-TIP Trust
The decedent's gross estate is entitled to deduct all amounts passing to a surviving spouse which qualify for the marital deduction. The marital deduction can become extremely complicated, but it represents the most important deduction available to married couples. Property which passes to the surviving spouse under the marital deduction escapes taxation on the death of the first spouse, but that property then becomes part of the surviving spouse's estate for estate tax purposes. Oftentimes, because the surviving spouse is in a higher tax bracket, property passing under a marital deduction is taxed at a higher rate at the death of the surviving spouse.
The marital deduction applies to property that is left: (1) outright to a spouse; (2) in trust in which the spouse has the right to withdraw any or all of the property during his or her lifetime; and (3) property which is left in trust for the spouse's life under a Q-TIP ("qualified terminable interest property") trust.
A Q-TIP trust is an exception to the general rule that to qualify for a marital deduction, property must be left outright to the spouse or in trust in which all the principal may be withdrawn by the spouse. A Q-TIP trust may qualify for a marital deduction if the spouse is entitled to receive all the trust's income at least annually and during the spouse's lifetime, no person, including the spouse, is permitted to appoint any trust property to anyone other than the spouse. The person filing the estate tax return must properly elect to take a marital deduction for the Q-TIP trust.
The advantage of the Q-TIP trust is that the desires of the decedent spouse will control the ultimate disposition of the trust's assets, and the decedent's estate retains the benefit of the marital deduction. On the death of the surviving spouse, the assets in the Q-TIP trust are taxed in the surviving spouse's estate, but any increase in estate tax resulting from this inclusion is generally taken directly from the Q-TIP assets, not from the surviving spouse's other assets.
By prudently combining the unified credit with the marital deduction, the estate of the first spouse will pay no estate tax. The surviving spouse also has a unified credit that can be applied to any estate tax owing at his or her death. Therefore, for estates under $1,200,000 (2 x $600,000), assuming no increase in value during the time between the death of the first spouse and second spouse and assuming no reduction of the unified credit for either spouse, a properly structured estate plan eliminates taxation on both spouses' estates through the maximum use of the unified credit.
III. Using the Unified Credit in Estate Planning
Assume that:
1. a married couple has all their assets as community property;
2. the value of that community property is $1,000,000;
3. the husband is the first to die and the wife lives another 8 years;
4. the couple has two children; and
5. no gifts were ever made that exceeded the annual gift tax exclusion.
Upon the death of the husband, the husband's estate (50% ofthe community property) is worth $500,000 and his wife retains her 50% share of the community property ($500,000). The husband's estate will pay no estate tax since his unified credit is worth $600,000.
Example 1 : If the husband leaves all his property outright to this wife, then his wife will have an estate totaling $1,000,000. On the death of his wife, assuming no growth in her estate, she will now have a $1,000,000 estate subject to estate tax, but a unified credit worth only $600,000. This means her estate will be subject to estate tax on the balance of $400,000. The tax will be $153,000 according to the current tax rate schedule.
Example 2 : Same facts as Example 1 except husband left his property to an exemption trust, which permitted his wife the right to receive all the income from the trust during her life and certain other powers (such as the power to invade the principal under an ascertainable standard and the 5&5 power discussed previously). Upon her death the trust assets could then be divided between the couple's two children and the exemption trust would not be part of the wife's estate for estate tax purposes. Upon her death, her estate would be worth $500,000 and her unified credit worth $600,000 would eliminate any estate taxes.
If we assume a 4% growth rate during the 8 years she outlives her husband, then under Example 1, her estate will appreciate from $1,000,000 to $1,368,600 and the estate tax will be $255,000.
Under Example 2, her estate consists of her share of community property valued at $500,000 which will appreciate to $684,285 and the estate tax will be $19,400, a reduction of $236,150.
IV. Non-tax Aspects of Estate Planning
Couples with minor children need to carefully plan their estates, although the focus is usually on taking care of the children rather than saving estate taxes. The major assets are usually life insurance and the family home. In case of the deaths of both parents, provisions for the guardian(s) for the children and trustee(s) for the property must be carefully considered. While the funding of these trusts might follow the exemption trust and marital deduction trust pattern, the exemption trust is geared for the care and support of the children.
Also, decisions must be made such as: Should the trustee(s) save and conserve the trust estate for the college education of the children? At what ages should the children receive the trust principal and what amounts and when? All at 21? Half at 25 and the remaining principal at 35? What happens if the children die without having any children? Who then receives the property? The decedent's family, a specified charity or charities?
A carefully planned estate will cover a variety of remote contingencies, provide for the continuing personal and financial care and support of the decedent's spouse and family, and reduce or eliminate estate taxes.
Both elements can be enormously complex, interrelated and often operate inversely. For instance, the goal of providing more for one's children or grandchildren and less for a surviving spouse may cause adverse estate tax consequences. This summary describes the fundamentals of estate planning.
I. DEFINITIONS
There are four main methods by which property is transferred at death:
1. Will
A will is a written document that takes effect at the death of the person signing it (the "testator"). A will covers all property owned by the testator at death. A state court proceeding ("probate") is instituted and the provisions of the will are implemented under supervision of the probate court. Both the tax and family estate planning objectives of the decedent can be accomplished with a will.
2. Living Trust
A living trust (sometimes called an "inter-vivos" trust) is a document that is revocable at any time by the person signing it ("grantor"). Living trusts have become quite popular as a method to avoid probate. To avoid probate, the trust must be funded; this means that title to the assets which the grantor owns personally must be actually transferred to the trust -- real property is deeded to the trust; bank accounts are switched to the trust; and stocks, bonds, partnership interests and other holdings are assigned or transferred to the trust.
NOTE : The grantor is usually the trustee and beneficiary of the trust during his or her lifetime.
Use of a Will vs. a Living Trust : Generally, with either a will or a trust the same estate tax consequences occur, and the same opportunities for tax and family planning are available. The debate over the value of each often centers around the savings of the costs incurred in a probate proceeding which typically run between 2 to 4 percent of the value of the probate estate. While a living trust which is fully funded with the grantor's assets prior to his or her death will eliminate probate, there may be advantages to probate which are also lost. In addition, the initial cost and maintenance of the living trust must be considered.
A realistic assessment of the net savings in using a living trust would be approximately 1 to 2 percent of the gross estate; an estate of $1,000,000 should save between $10,000 and $20,000 by using a living trust instead of a will.
The savings must be counter-balanced by the administrative burden of maintaining the assets in the trust over the period of one's life. There are other, non-economic advantages for using a trust which merit consideration such as privacy (a trust is not probated in open court) and upon the incapacity or death of the grantor, the trust continues to operate without court intervention.
3. Joint Tenancy
Joint tenancy is a method of holding title to property when two or more people own property together, but the last survivor will own the property outright. When a joint tenant dies, his or her interest goes automatically to the survivor; there is no probate and a will or living trust has absolutely no effect on joint tenancy property.
There may be adverse tax consequences to the joint tenant who dies first. There is a presumption that the entire fair market value of the property is part of the decedent's estate for estate tax purposes, unless the surviving joint tenant can prove (through financial records) the amount of his or her share of the payments made towards the purchase, improvement or upkeep of the jointly held property. For instance, if the surviving tenant can prove he or she made a 30 percent contribution towards the purchase, improvement or upkeep of the property, then 70 percent of the property will be included in the deceased tenant's estate for estate tax purposes.
4. Community Property
California is a community property state which means that any earnings and assets acquired during the marriage belong equally to both spouses, regardless of who actually earned the income. Property acquired before marriage, or gifts and inheritances received by one spouse during a marriage, are generally the separate property of that spouse.
Upon the death of either spouse, the community property is split equally and the surviving spouse receives his or her share of community property outright. The deceased spouse's 50 percent share of community property is part of his or her estate and is subject to his or her will or living trust.
II. The Gift and Estate Tax Aspect To Estate Planning
There are five basic tax concepts to estate planning:
1. Gift Tax
A person may make a gift of $10,000 per year per recipient ("donee") without incurring a federal gift tax. There is no longer a California gift tax. For a husband and wife, the amount is $20,000 per year, per donee. In order to qualify, the gift must be completed presently; the gift cannot be placed in trust unless the beneficiary has the right to withdraw it within a reasonable period after the gift is made. In most circumstances, it is the person making the gift ("donor") who is taxed, not the donee.
2. Estate Tax
The federal estate tax is a tax levied on the property owned by the decedent at death. The tax is paid by the estate for the privilege of passing property to the donee(s). The tax is based on the fair market value of the property at the date of death or on the alternate valuation date (discussed below). California has eliminated a separate estate tax on the decedent's property.
3. Stepped-up Basis at Death
When a person dies, all assets owned by the decedent are valued at their fair market value, usually by appraisal, by the person (the executor of the will or trustee of the living trust) filing the federal estate tax return. The determination of fair market value is generally made as of the date of death, however, there is an alternative valuation date of 6 months after death available for estates that have decreased in value.
As a corollary to this rule, the tax basis of the decedent's property is "stepped-up" to the estate tax valuation amount. Tax basis refers to the value of the property for computing gain or loss. It is usually the cost of the property plus improvements and less any depreciation.
For example, if the decedent dies owning stock which he or she purchased for $5, but has a current value of $100, the full $100 value is used to determine the estate tax. The stock then receives a stepped-up basis of $100 in the hands of the donee. No income tax will be paid by the donee on the subsequent sale of stock for $100 or less; income tax will only be paid on the sale of stock for an amount in excess of $100 and only for that excess amount.
With community property, even though 50 percent passes outright to the surviving spouse, both portions of the community property receive a stepped-up basis at the death of the first spouse. If a married couple owns a house worth $500,000 which has a tax basis of $45,000, the tax basis for the entire house (both community property shares) is stepped-up to $500,000 upon the death of the first spouse, and a later sale of the house for $560,000 will result in only $60,000 in gain. A sale of the house for the same amount prior to the death of the first spouse would have caused a $515,000 gain.
The stepped-up basis rule does not apply to certain income the decedent earned prior to his or her death. This income is considered income in respect to a decedent ("IRD"). IRD includes income from property sold prior to death, unpaid compensation and retirement benefits.
4. The Unified Estate and Gift Tax Credit and the Credit Exemption Trust
Each person is entitled to a lifetime credit of $600,000 for gift and estate taxes called the "unified credit." This credit applies to gifts made over and above the $10,000 annual gift tax exclusion discussed previously. If a person makes an annual gift to a single donee of $50,000, then the additional $40,000 - which does not qualify for the annual gift tax exclusion - will reduce the unified credit from $600,000 to $560,000. The unified credit is phased out for estates over $10 million.
The unified credit may be used for property left to any donee, either outright or in trust. In a typical estate plan the unified credit amount is used by creating a trust for that amount for the surviving spouse during his or her lifetime. Upon the surviving spouse's death, the children would then become the beneficiaries of the trust. This trust is sometimes called an "exemption trust" or a "by-pass" trust since it is exempt from estate taxes and by-passes the surviving spouse's estate. The exemption trust may provide the surviving spouse with the following rights during his or her life without causing the trust to become part of the surviving spouse's estate for estate tax purposes: (1) all the trust's net income may be payable to the surviving spouse; (2) the trust's principal may be applied to the surviving spouse for his or her health, support, maintenance and education ("ascertainable standards"); and (3) the surviving spouse may have the noncumulative right to withdraw the greater of 5 percent or $5,000 of trust principal per calendar year for any reason ("5&5 power").
The unified credit plays a major role in estate planning because there is no estate tax for estates that are less than or equal to the unified credit. In most circumstances, there is no estate tax on estates of $600,000 or less.
5. The Marital Deduction and the Marital Deduction Q-TIP Trust
The decedent's gross estate is entitled to deduct all amounts passing to a surviving spouse which qualify for the marital deduction. The marital deduction can become extremely complicated, but it represents the most important deduction available to married couples. Property which passes to the surviving spouse under the marital deduction escapes taxation on the death of the first spouse, but that property then becomes part of the surviving spouse's estate for estate tax purposes. Oftentimes, because the surviving spouse is in a higher tax bracket, property passing under a marital deduction is taxed at a higher rate at the death of the surviving spouse.
The marital deduction applies to property that is left: (1) outright to a spouse; (2) in trust in which the spouse has the right to withdraw any or all of the property during his or her lifetime; and (3) property which is left in trust for the spouse's life under a Q-TIP ("qualified terminable interest property") trust.
A Q-TIP trust is an exception to the general rule that to qualify for a marital deduction, property must be left outright to the spouse or in trust in which all the principal may be withdrawn by the spouse. A Q-TIP trust may qualify for a marital deduction if the spouse is entitled to receive all the trust's income at least annually and during the spouse's lifetime, no person, including the spouse, is permitted to appoint any trust property to anyone other than the spouse. The person filing the estate tax return must properly elect to take a marital deduction for the Q-TIP trust.
The advantage of the Q-TIP trust is that the desires of the decedent spouse will control the ultimate disposition of the trust's assets, and the decedent's estate retains the benefit of the marital deduction. On the death of the surviving spouse, the assets in the Q-TIP trust are taxed in the surviving spouse's estate, but any increase in estate tax resulting from this inclusion is generally taken directly from the Q-TIP assets, not from the surviving spouse's other assets.
By prudently combining the unified credit with the marital deduction, the estate of the first spouse will pay no estate tax. The surviving spouse also has a unified credit that can be applied to any estate tax owing at his or her death. Therefore, for estates under $1,200,000 (2 x $600,000), assuming no increase in value during the time between the death of the first spouse and second spouse and assuming no reduction of the unified credit for either spouse, a properly structured estate plan eliminates taxation on both spouses' estates through the maximum use of the unified credit.
III. Using the Unified Credit in Estate Planning
Assume that:
1. a married couple has all their assets as community property;
2. the value of that community property is $1,000,000;
3. the husband is the first to die and the wife lives another 8 years;
4. the couple has two children; and
5. no gifts were ever made that exceeded the annual gift tax exclusion.
Upon the death of the husband, the husband's estate (50% ofthe community property) is worth $500,000 and his wife retains her 50% share of the community property ($500,000). The husband's estate will pay no estate tax since his unified credit is worth $600,000.
Example 1 : If the husband leaves all his property outright to this wife, then his wife will have an estate totaling $1,000,000. On the death of his wife, assuming no growth in her estate, she will now have a $1,000,000 estate subject to estate tax, but a unified credit worth only $600,000. This means her estate will be subject to estate tax on the balance of $400,000. The tax will be $153,000 according to the current tax rate schedule.
Example 2 : Same facts as Example 1 except husband left his property to an exemption trust, which permitted his wife the right to receive all the income from the trust during her life and certain other powers (such as the power to invade the principal under an ascertainable standard and the 5&5 power discussed previously). Upon her death the trust assets could then be divided between the couple's two children and the exemption trust would not be part of the wife's estate for estate tax purposes. Upon her death, her estate would be worth $500,000 and her unified credit worth $600,000 would eliminate any estate taxes.
If we assume a 4% growth rate during the 8 years she outlives her husband, then under Example 1, her estate will appreciate from $1,000,000 to $1,368,600 and the estate tax will be $255,000.
Under Example 2, her estate consists of her share of community property valued at $500,000 which will appreciate to $684,285 and the estate tax will be $19,400, a reduction of $236,150.
IV. Non-tax Aspects of Estate Planning
Couples with minor children need to carefully plan their estates, although the focus is usually on taking care of the children rather than saving estate taxes. The major assets are usually life insurance and the family home. In case of the deaths of both parents, provisions for the guardian(s) for the children and trustee(s) for the property must be carefully considered. While the funding of these trusts might follow the exemption trust and marital deduction trust pattern, the exemption trust is geared for the care and support of the children.
Also, decisions must be made such as: Should the trustee(s) save and conserve the trust estate for the college education of the children? At what ages should the children receive the trust principal and what amounts and when? All at 21? Half at 25 and the remaining principal at 35? What happens if the children die without having any children? Who then receives the property? The decedent's family, a specified charity or charities?
A carefully planned estate will cover a variety of remote contingencies, provide for the continuing personal and financial care and support of the decedent's spouse and family, and reduce or eliminate estate taxes.
Friday, April 17, 2009
ESTATE PLANNING: MORE THAN A WILL
By Parag P. Patel, Esq.
During our lifetime, most of us strive to create and build upon our net worth. We generate savings, purchase a home, and eventually invest in stocks, bonds, mutual funds, IRAs and retirement plans. Unfortunately, most of us risk losing an unnecessarily large amount of these assets by failing to plan to protect them.
Recent surveys have revealed that over 40% of our population does not have a will. For those individuals, their death often creates a scenario whereby their family must needlessly waste money to petition the court for an individual to administer the estate. In many instances, this insult is compounded by the assets being subject to taxes, which could easily have been avoided. Thus, an integral part of anyone's financial planning must be an estate plan.
Traditionally, an estate plan was simply a will. However, with the growing medical needs of an aging population, as well as the ever-present threat of the Internal Revenue Service, prudent estate planning requires additional protections for all of us. Even the best written will has little value if one's assets are depleted in later years by health care costs which can be mitigated or borne by someone else.
Any prudent estate plan should address four questions:
(1) Where do I want my money to go after I am dead?
(2) How can I minimize any taxes as a result of my death?
(3) How can I protect my estate and myself if I become disabled?
(4) Do I want my life to be extended by life support even though a medical event has left me in critical condition without any hope of recovery?
The basic documents, which are necessary to answer these questions, are a will, living will and power of attorney. A will declares who shall inherit an individual's assets (the beneficiaries) and who shall be responsible for distributing them to such beneficiaries (the executor). For young parents, a will can also be used to appoint a guardian for their children and a trustee to manage a child's money until they are old enough to handle it themselves.
Often, individuals wish to care for their spouse first, then their children. Often, this intention is reflected in a will. If you die without a will, though, your spouse is only entitled to the first $50,000.00 outright. In New Jersey, he or she must split the rest of your assets with your children, no matter how young or old they are. If you have no children, your parents step into their place.
Even if you have a will, your assets are not completely protected. It is necessary to execute a Power of Attorney to provide to appoint someone to care for you and your assets if you are disabled. Individuals, who become disabled mentally and do not have a power of attorney, can only be protected by an expensive and humiliating procedure known as a guardianship, whereby they are judged to be "incompetent" in the public forum of a court.
Finally, a living will should be executed to announce your intentions in the event an accident, stroke or other serious medical event leaves you brain dead or physically depleted of any possible quality of life. A living will protects your assets from being used for unnecessary and costly life support. Without a living will, there is no authority, outside of a court proceeding, to allow a doctor to discontinue this treatment.
During our lifetime, most of us strive to create and build upon our net worth. We generate savings, purchase a home, and eventually invest in stocks, bonds, mutual funds, IRAs and retirement plans. Unfortunately, most of us risk losing an unnecessarily large amount of these assets by failing to plan to protect them.
Recent surveys have revealed that over 40% of our population does not have a will. For those individuals, their death often creates a scenario whereby their family must needlessly waste money to petition the court for an individual to administer the estate. In many instances, this insult is compounded by the assets being subject to taxes, which could easily have been avoided. Thus, an integral part of anyone's financial planning must be an estate plan.
Traditionally, an estate plan was simply a will. However, with the growing medical needs of an aging population, as well as the ever-present threat of the Internal Revenue Service, prudent estate planning requires additional protections for all of us. Even the best written will has little value if one's assets are depleted in later years by health care costs which can be mitigated or borne by someone else.
Any prudent estate plan should address four questions:
(1) Where do I want my money to go after I am dead?
(2) How can I minimize any taxes as a result of my death?
(3) How can I protect my estate and myself if I become disabled?
(4) Do I want my life to be extended by life support even though a medical event has left me in critical condition without any hope of recovery?
The basic documents, which are necessary to answer these questions, are a will, living will and power of attorney. A will declares who shall inherit an individual's assets (the beneficiaries) and who shall be responsible for distributing them to such beneficiaries (the executor). For young parents, a will can also be used to appoint a guardian for their children and a trustee to manage a child's money until they are old enough to handle it themselves.
Often, individuals wish to care for their spouse first, then their children. Often, this intention is reflected in a will. If you die without a will, though, your spouse is only entitled to the first $50,000.00 outright. In New Jersey, he or she must split the rest of your assets with your children, no matter how young or old they are. If you have no children, your parents step into their place.
Even if you have a will, your assets are not completely protected. It is necessary to execute a Power of Attorney to provide to appoint someone to care for you and your assets if you are disabled. Individuals, who become disabled mentally and do not have a power of attorney, can only be protected by an expensive and humiliating procedure known as a guardianship, whereby they are judged to be "incompetent" in the public forum of a court.
Finally, a living will should be executed to announce your intentions in the event an accident, stroke or other serious medical event leaves you brain dead or physically depleted of any possible quality of life. A living will protects your assets from being used for unnecessary and costly life support. Without a living will, there is no authority, outside of a court proceeding, to allow a doctor to discontinue this treatment.
Friday, April 3, 2009
What does divorce do to your estate plan?
According to census bureau statistics, nearly half of married couples will at some time go through a divorce. If you are going through the divorce process, you’ve got a lot of company.
So, do you need a new will? What does the process of divorce do to your estate plan?
You need to remember that in New Jersey you are considered legally married until the judge signs the final divorce decree. There is no such thing in New Jersey as a legal separation.
This means that if you die before the divorce if final, your soon-to-be ex is still considered to be your husband or wife and is entitled, under New Jersey law, to claim his or her spousal share, approximately one-third, of your estate.
If you have a will giving everything to your spouse, and you die before the divorce is over, then the spouse gets everything! The will is still valid! It doesn’t matter if the divorce was been going on for 3 years. It doesn’t matter if you have been separated for 10 years. It doesn’t matter if the divorce will be final next week. It doesn’t matter if you’re living with a new boyfriend or girlfriend. The spouse gets everything unless you have changed that will. And if you have changed that will, your spouse may still elect to take his or her spousal share.
If you are in the midst of a divorce and die without a will, your spouse will be entitled to a share of your estate, as decided by intestacy laws, and he or she will also be in charge of the administration of your estate.
Once the divorce is final, if you don’t have a will, the state intestacy statute governs and your children would be your heirs, or if you have none, your parents, or brothers and sisters, etc.
If you made a will while you were married, and are then divorced, the will is still valid, but any provisions naming the former spouse are interpreted as if the former spouse had predeceased you. After the divorce is final, your will may be satisfactory, interpreted as if the ex-spouse had predeceased you.
This doesn’t apply to trusts, however. If your estate plan includes a trust, mentions of the ex-spouse must be affirmatively amended to be deleted.
The terms of living wills and medical directives survive the divorce. No legislation or case law has yet tested this issue. You may be well advised to rewrite your living will and medical directives if you don’t want your ex to "pull the plug."
What about your 401(k) plan? If you are domiciled in New Jersey when you die, the state legislature has done your thinking for you. If there is a divorce, any beneficiary designation for a life insurance policy, annuity contract, pension, profit-sharing plan or other contractual arrangement, providing for payment to a spouse, will be construed as if the former spouse had predeceased. Comparable to the wills situation, the divorce must be final for this rule to apply. In many other states it is up to you to change the beneficiary designation.
However, if your insurance is in an irrevocable life insurance trust, which is a common vehicle, the protective statute won’t change the terms of the trust, and benefits may be given to or used for your ex-spouse. And irrevocable trusts being, well, irrevocable, there is no fix. Most life insurance trusts are drafted to take care of this by addressing what happens if the current spouse becomes the ex-spouse.
If you remarry, the federal law enacted as part of the Retirement Equity Act automatically makes the new spouse a beneficiary of qualified plans. Qualified plans include 401(k) plans, profit-sharing plans and pensions plans, but not IRA’s. If you are married, your spouse is automatically the beneficiary of your qualified plan unless he or she has consented in writing to another beneficiary designation.
Even after the divorce is final, it is important to have your estate planning attorney review your divorce decree or agreement. Your obligations under the agreement may effect your retirement plan. Your ex-spouse may retain rights in a retirement account, or the divorce decree may require maintenance of life insurance payable to the ex-spouse or children.
So, do you need a new will? What does the process of divorce do to your estate plan?
You need to remember that in New Jersey you are considered legally married until the judge signs the final divorce decree. There is no such thing in New Jersey as a legal separation.
This means that if you die before the divorce if final, your soon-to-be ex is still considered to be your husband or wife and is entitled, under New Jersey law, to claim his or her spousal share, approximately one-third, of your estate.
If you have a will giving everything to your spouse, and you die before the divorce is over, then the spouse gets everything! The will is still valid! It doesn’t matter if the divorce was been going on for 3 years. It doesn’t matter if you have been separated for 10 years. It doesn’t matter if the divorce will be final next week. It doesn’t matter if you’re living with a new boyfriend or girlfriend. The spouse gets everything unless you have changed that will. And if you have changed that will, your spouse may still elect to take his or her spousal share.
If you are in the midst of a divorce and die without a will, your spouse will be entitled to a share of your estate, as decided by intestacy laws, and he or she will also be in charge of the administration of your estate.
Once the divorce is final, if you don’t have a will, the state intestacy statute governs and your children would be your heirs, or if you have none, your parents, or brothers and sisters, etc.
If you made a will while you were married, and are then divorced, the will is still valid, but any provisions naming the former spouse are interpreted as if the former spouse had predeceased you. After the divorce is final, your will may be satisfactory, interpreted as if the ex-spouse had predeceased you.
This doesn’t apply to trusts, however. If your estate plan includes a trust, mentions of the ex-spouse must be affirmatively amended to be deleted.
The terms of living wills and medical directives survive the divorce. No legislation or case law has yet tested this issue. You may be well advised to rewrite your living will and medical directives if you don’t want your ex to "pull the plug."
What about your 401(k) plan? If you are domiciled in New Jersey when you die, the state legislature has done your thinking for you. If there is a divorce, any beneficiary designation for a life insurance policy, annuity contract, pension, profit-sharing plan or other contractual arrangement, providing for payment to a spouse, will be construed as if the former spouse had predeceased. Comparable to the wills situation, the divorce must be final for this rule to apply. In many other states it is up to you to change the beneficiary designation.
However, if your insurance is in an irrevocable life insurance trust, which is a common vehicle, the protective statute won’t change the terms of the trust, and benefits may be given to or used for your ex-spouse. And irrevocable trusts being, well, irrevocable, there is no fix. Most life insurance trusts are drafted to take care of this by addressing what happens if the current spouse becomes the ex-spouse.
If you remarry, the federal law enacted as part of the Retirement Equity Act automatically makes the new spouse a beneficiary of qualified plans. Qualified plans include 401(k) plans, profit-sharing plans and pensions plans, but not IRA’s. If you are married, your spouse is automatically the beneficiary of your qualified plan unless he or she has consented in writing to another beneficiary designation.
Even after the divorce is final, it is important to have your estate planning attorney review your divorce decree or agreement. Your obligations under the agreement may effect your retirement plan. Your ex-spouse may retain rights in a retirement account, or the divorce decree may require maintenance of life insurance payable to the ex-spouse or children.
Tuesday, March 17, 2009
Buy-Sell Agreements
By Parag Patel, Esq.
What if your business partner retires, sells her portion of the business, or gets a divorce? To make sure there is a smooth transition following the departure of a business partner, it is important that business owners in limited liability companies, corporations and partnerships write a buy-sell agreement at the start of their relationship. A buy sell agreement provides for an orderly disposition of business interests and is beneficial in setting the value for estate tax purposes.
In General
An Estate plan which is appropriate for the owner of a small business can involve complex tax and non-tax issues when developing a buy-sell agreement among shareholders.
From the standpoint of the corporation and the remaining shareholders, a properly planned buy-sell agreement normally will restrict the transfer of stock and provide for the orderly continuation of the ownership and control of the corporation upon the happening of certain events, such as the death, disability or retirement of a shareholder. The buy-sell agreement can prevent unwanted outsiders from becoming shareholders and eliminate the need for negotiations with surviving spouses and/or children. A buy-sell agreement may perform the role of a succession plan, providing for continuity or orderly succession of corporate management. Provisions may be made to anticipate the cash liquidity needs of the purchasing shareholders by putting in place life insurance to partly or wholly fund the future purchase.
From the standpoint of the estate of a deceased shareholder, the existence of a buy-sell agreement can assure the estate a liquid asset rather than an unmarketable interest in a small business. The planning process can provide the decedent, while alive, with the opportunity to negotiate and obtain the fairest or best price for his or her stock. In a retirement or disability situation, the buy-sell agreement provides a market for the stock and provides an additional source of retirement or disability funds.
Finally, if properly drawn, the buy-sell agreement may establish a valuation of the stock for estate tax purposes.
Types of Restrictions in Buy-sell Agreements
The buy-sell agreement may contain a variety of restrictions on the transferability of stock.
The most usual restriction is a limitation on transfers to certain classes of persons, such as members of a family who are working in the business. This is usually combined in the case of a lifetime buy-out with a first option or right of first refusal to the corporation, the other shareholders or some combination of both. In the case of the death of a shareholder, usually there is a mandatory purchase requirement by the corporation or the other shareholders.
Frequently, the same agreement will provide for an option or right of first refusal in a lifetime situation and a mandatory buy and sell on death.
The same agreement may also differentiate among various lifetime situations. For example, disability or retirement may require a mandatory buy and sell. Any other lifetime situation may create an option or right of first refusal. This differentiation usually is a function of the ability to pay. Disability and death buyouts may be funded by insurance, and retirement can be anticipated. Other situations may depend on the corporation's or shareholders' ability to pay, and must be left to discretion based on the facts at the time.
Events That Activate Buy-sell Provisions
The agreement may provide that any one of the following events will give rise to the option, right of first refusal or obligation to buy and sell:
1. Death.
2. Disability.
3. Termination of employment.
4. A shareholder's desire to sell his or her stock to a non-shareholder.
5. Divorce (to keep the ex-spouse from owning stock).
6. Bankruptcy.
Establishing the Purchase Price
Establishing the purchase price is one of the most critical provisions of the agreement. Too often, a valuation is selected that yields an inappropriate price when finally used. If the agreement provides for a purchase price that is revalued by the Internal Revenue Service for estate tax purposes, the estate could be liable for taxes based on the IRS revaluation, where it has only received the value based on the formula in the agreement. This could result in an unanticipated shift in the beneficial enjoyment of the estate.
Some of the more traditional methods of valuation are book value, appraised value, capitalization of earnings, an agreed fixed dollar amount and various formula provisions thought to reflect the idiosyncrasies of a particular corporation.
Methods of Funding and Payment
Methods of funding the buy-sell agreement should be selected so there will be some certainty about the source and extent of liquid funding. When there is a reliable source of funding, payment in full at the closing may be possible.
If funding is not available, the entire payment, or any part, may be paid in installments, with interest, and usually evidenced by a promissory note.
Life insurance funding is usually recommended unless age or health concerns do not allow it. If the parties want to fund the buy-sell agreement for retirement, it may be advisable to acquire a form of whole life or universal life expected to build large accumulations of cash value that could be withdrawn at the appropriate time.
Disability buy-out insurance also should be considered as a funding source for any agreement upon the disability of a shareholder. Care should be taken to have the agreement require payment only at the time funds are available under the insurance policy.
If the payment is not a lump sum cash payment at closing, the parties should consider some type of security arrangement to help insure deferred payments. Types of security arrangements might include personal guarantees from other shareholders or the corporation; mortgages or security interests in certain real estate or other corporate assets; pledge of the purchased stock; a bank standby letter of credit; life insurance on obligor individuals or key persons, collaterally assigned to the holder of the note; or a related corporation guarantee.
Corporate Redemptions
In an Entity Purchase Agreement, the corporation is a party to the agreement and is also the purchaser. The corporation pays the purchase price with after-tax dollars but can deduct interest payments as an ordinary business expense.
An Entity Purchase Agreement often can be conveniently funded with life insurance owned and paid for by the corporation insuring the lives of each of the shareholders subject to the agreement. The premiums are not deductible.
Alternatively, in the Cross Purchase Agreement, the other shareholder or shareholders are the purchasers of the stock of a selling shareholder. If there is more than one potential purchaser, the proportions each has the option to purchase, or is required to purchase, should be set out.
Purchasing shareholders acquire an income tax basis in the stock they purchase equal to the amount paid. If insurance is used, the purchasing shareholders should own the policies and should be the beneficiaries, so it is their money used to acquire the stock.
A Cross Purchase Agreement avoids concern over whether the corporation will have sufficient surplus to redeem stock. If there are more than two or three shareholders, however, the Cross Purchase Agreement can become unwieldy and may require a large number of life insurance policies. Each shareholder must own a life insurance policy on each other shareholder, and the shareholders pay the premiums individually. Premium payments may be inequitable if there is a large disparity in the percentage ownership of the stock, or in the ages of the parties. Awkwardness also arises from the fact that the estate of a deceased shareholder (or a departed shareholder in the case of a lifetime sale) will own life insurance policies on all of the surviving or remaining shareholders. A method should be included to require (or permit) the surviving or remaining shareholders to purchase the insurance then held by the estate or ex-shareholder.
Conclusion
A successful buy-sell agreement must resolve many difficult tax and planning issues, while simultaneously addressing business management and succession concerns.
What if your business partner retires, sells her portion of the business, or gets a divorce? To make sure there is a smooth transition following the departure of a business partner, it is important that business owners in limited liability companies, corporations and partnerships write a buy-sell agreement at the start of their relationship. A buy sell agreement provides for an orderly disposition of business interests and is beneficial in setting the value for estate tax purposes.
In General
An Estate plan which is appropriate for the owner of a small business can involve complex tax and non-tax issues when developing a buy-sell agreement among shareholders.
From the standpoint of the corporation and the remaining shareholders, a properly planned buy-sell agreement normally will restrict the transfer of stock and provide for the orderly continuation of the ownership and control of the corporation upon the happening of certain events, such as the death, disability or retirement of a shareholder. The buy-sell agreement can prevent unwanted outsiders from becoming shareholders and eliminate the need for negotiations with surviving spouses and/or children. A buy-sell agreement may perform the role of a succession plan, providing for continuity or orderly succession of corporate management. Provisions may be made to anticipate the cash liquidity needs of the purchasing shareholders by putting in place life insurance to partly or wholly fund the future purchase.
From the standpoint of the estate of a deceased shareholder, the existence of a buy-sell agreement can assure the estate a liquid asset rather than an unmarketable interest in a small business. The planning process can provide the decedent, while alive, with the opportunity to negotiate and obtain the fairest or best price for his or her stock. In a retirement or disability situation, the buy-sell agreement provides a market for the stock and provides an additional source of retirement or disability funds.
Finally, if properly drawn, the buy-sell agreement may establish a valuation of the stock for estate tax purposes.
Types of Restrictions in Buy-sell Agreements
The buy-sell agreement may contain a variety of restrictions on the transferability of stock.
The most usual restriction is a limitation on transfers to certain classes of persons, such as members of a family who are working in the business. This is usually combined in the case of a lifetime buy-out with a first option or right of first refusal to the corporation, the other shareholders or some combination of both. In the case of the death of a shareholder, usually there is a mandatory purchase requirement by the corporation or the other shareholders.
Frequently, the same agreement will provide for an option or right of first refusal in a lifetime situation and a mandatory buy and sell on death.
The same agreement may also differentiate among various lifetime situations. For example, disability or retirement may require a mandatory buy and sell. Any other lifetime situation may create an option or right of first refusal. This differentiation usually is a function of the ability to pay. Disability and death buyouts may be funded by insurance, and retirement can be anticipated. Other situations may depend on the corporation's or shareholders' ability to pay, and must be left to discretion based on the facts at the time.
Events That Activate Buy-sell Provisions
The agreement may provide that any one of the following events will give rise to the option, right of first refusal or obligation to buy and sell:
1. Death.
2. Disability.
3. Termination of employment.
4. A shareholder's desire to sell his or her stock to a non-shareholder.
5. Divorce (to keep the ex-spouse from owning stock).
6. Bankruptcy.
Establishing the Purchase Price
Establishing the purchase price is one of the most critical provisions of the agreement. Too often, a valuation is selected that yields an inappropriate price when finally used. If the agreement provides for a purchase price that is revalued by the Internal Revenue Service for estate tax purposes, the estate could be liable for taxes based on the IRS revaluation, where it has only received the value based on the formula in the agreement. This could result in an unanticipated shift in the beneficial enjoyment of the estate.
Some of the more traditional methods of valuation are book value, appraised value, capitalization of earnings, an agreed fixed dollar amount and various formula provisions thought to reflect the idiosyncrasies of a particular corporation.
Methods of Funding and Payment
Methods of funding the buy-sell agreement should be selected so there will be some certainty about the source and extent of liquid funding. When there is a reliable source of funding, payment in full at the closing may be possible.
If funding is not available, the entire payment, or any part, may be paid in installments, with interest, and usually evidenced by a promissory note.
Life insurance funding is usually recommended unless age or health concerns do not allow it. If the parties want to fund the buy-sell agreement for retirement, it may be advisable to acquire a form of whole life or universal life expected to build large accumulations of cash value that could be withdrawn at the appropriate time.
Disability buy-out insurance also should be considered as a funding source for any agreement upon the disability of a shareholder. Care should be taken to have the agreement require payment only at the time funds are available under the insurance policy.
If the payment is not a lump sum cash payment at closing, the parties should consider some type of security arrangement to help insure deferred payments. Types of security arrangements might include personal guarantees from other shareholders or the corporation; mortgages or security interests in certain real estate or other corporate assets; pledge of the purchased stock; a bank standby letter of credit; life insurance on obligor individuals or key persons, collaterally assigned to the holder of the note; or a related corporation guarantee.
Corporate Redemptions
In an Entity Purchase Agreement, the corporation is a party to the agreement and is also the purchaser. The corporation pays the purchase price with after-tax dollars but can deduct interest payments as an ordinary business expense.
An Entity Purchase Agreement often can be conveniently funded with life insurance owned and paid for by the corporation insuring the lives of each of the shareholders subject to the agreement. The premiums are not deductible.
Alternatively, in the Cross Purchase Agreement, the other shareholder or shareholders are the purchasers of the stock of a selling shareholder. If there is more than one potential purchaser, the proportions each has the option to purchase, or is required to purchase, should be set out.
Purchasing shareholders acquire an income tax basis in the stock they purchase equal to the amount paid. If insurance is used, the purchasing shareholders should own the policies and should be the beneficiaries, so it is their money used to acquire the stock.
A Cross Purchase Agreement avoids concern over whether the corporation will have sufficient surplus to redeem stock. If there are more than two or three shareholders, however, the Cross Purchase Agreement can become unwieldy and may require a large number of life insurance policies. Each shareholder must own a life insurance policy on each other shareholder, and the shareholders pay the premiums individually. Premium payments may be inequitable if there is a large disparity in the percentage ownership of the stock, or in the ages of the parties. Awkwardness also arises from the fact that the estate of a deceased shareholder (or a departed shareholder in the case of a lifetime sale) will own life insurance policies on all of the surviving or remaining shareholders. A method should be included to require (or permit) the surviving or remaining shareholders to purchase the insurance then held by the estate or ex-shareholder.
Conclusion
A successful buy-sell agreement must resolve many difficult tax and planning issues, while simultaneously addressing business management and succession concerns.
Sunday, March 1, 2009
Stretch IRA - How Your IRA Can Survive Several Generations
The stretch IRA concept is a wealth-transfer strategy that can help you extend the period of tax-deferred earnings on your retirement assets. After the owner of the IRA dies, the beneficiaries will also have the longest allowable period of tax-deferral on the required distributions of the IRA assets. This strategy can allow distributions from your retirement assets to be extended over several generations. Because of this, your family could save significant dollars in income taxes over their lifetimes.
A stretch IRA strategy can be established at any time, as long as you have named an individual person as the beneficiary. It's also important to name an individual person as a contingent beneficiary in case your primary beneficiary predeceases you. If set up correctly, your beneficiaries should be able to take their required IRA distributions over their individual life expectancies.
However, there are a number of steps that need to be followed to put this strategy in place. These steps include the following:
1. Selection of individual beneficiaries.
As previously mentioned, you will need to designate an individual beneficiary. Although there might be certain reasons for naming a trust as a beneficiary (e.g., asset protection for the beneficiaries), you should keep in mind that you will jeopardize the ability to use this strategy if you do it. Even with a qualified trust, distributions must be paid out over the life expectancy of the oldest beneficiary. With this in mind, you could jeopardize you ability to stretch out distributions to your grandchildren if you name a trust as the beneficiary.
2. Discuss your plans with an experienced advisor.
The benefits of this strategy could also be jeopardized if the IRA is not set up properly. Therefore, you need to speak with an experienced tax advisor who has worked with this strategy before.
3. Establish and maintain separate accounts for your beneficiaries.
If you have two or more beneficiaries, you need to set up a separate account for each one of them. You should also designate a certain percentage of you IRA assets to each of your beneficiaries. By doing this, each beneficiary can then choose to have their share distributed over their individual life expectancy.
4. Inform your beneficiaries of your plans.
You should also let your beneficiaries know about their future interest in your account when you pass away.
There are a couple of other things to keep in mind. The names of the account holder and the individual beneficiary must appear on the IRA account, and the beneficiary distributions must begin no later than Dec. 31 of the year after the death of the account holder. If these rules are not followed, the funds from the IRA could be exposed to a significant income tax penalty for missing the required mandatory distribution (50% of the distribution that should have been taken).
On a final note, it should be remembered that this strategy may not be suitable for everyone. For example, if you think that you will need access to your IRA money to meet your daily living needs during retirement, then this strategy might not help you. Please note I always advise people to consult with their own qualified legal advisor prior to making any decisions.
Do you want to know more about the benefits and restrictions of the stretch IRA strategy? Email or Call me.
Tuesday, February 24, 2009
Asset Protection
For the client who needs to protect assets, estate planning may include the use of asset protection trusts (such as foreign-situs trusts) that will put assets safely out of reach. Although there are potentially many reasons to use such vehicles, their use is not for everyone; many factors must first be considered. This article explores the world of the "Integrated Estate Planning Trust," discusses why and when it is used and offers a model planning structure.
INTRODUCTION
Today, asset protection planning is generally a concept familiar to wealth-planning professionals worldwide. However, while it has become more familiar and accepted, too often, such planning is done in a vacuum and without regard for its effect on the client's overall estate plan.
The same can be said for conventional estate planning; the emphasis tends to be on tax mitigation at death, the smooth transition of property, probate avoidance and ensuring that intended beneficiaries receive the intended property in the intended fashion. Unfortunately, the lifetime side of the estate plan has typically been ignored particularly, planning to preserve the client's estate during his life.
The collective thinking of the planning community has evolved tremendously over the past 10 years. The time has come for asset protection planning and estate planning to be joined into a new concept-integrated estate plan(ning) (IEP).
ASSET PROTECTION PLANNING
Asset protection planning recognizes the fact that preservation and protection of a client's estate during his life is at least as important (and in the view of many, more important) than preserving and protecting it after death.
The financial uncertainties stemming from (1)engaging in business or a profession or (2) being an entrepreneur or property owner and (3) economic and social factors have caused many successful people to adopt strategies to safeguard their accumulated wealth. A number of factors have contributed to the growing interest in and recognition of the asset protection component of the overall IEP. These factors include: (1) expanding theories of legal liability, (2) threat of litigation, (3) result-oriented judges and juries, (4) the unavailability of affordable, adequate or appropriate insurance coverage, and (5) the continuing national increase in the volume of litigation. Of course, other reasons may serve as motivating factors to persons of means who reside in (or who have assets) in other jurisdictions, as discussed below.
DEFINITION
Asset Protection Planning may be defined as the process of organizing assets and affairs in advance so as to safeguard them from loss or dissipation.
Stated another way, wealth may be more or less vulnerable to risk, depending on the nature of the property and the manner in which the property is held. Thus, at least in part, the asset protection component of the IEP will involve reorganizing the manner in which property is held so that it is less vulnerable to threats than it otherwise would be (e.g., converting joint tenancy property to a tenancy by the entirety or placing property in trust for the benefit of third parties or the settlor).
Asset protection planning is broader than simply planning for the possibility of future litigation. Clients will be motivated to plan for different reasons, not necessarily tied to the possibility of litigation. Thus, a client in a civil-law jurisdiction may desire to achieve "testamentary freedom" and avoid the forced heirship provisions applicable in his home country; a client residing (or with assets) in a politically or socially volatile part of the world may seek to protect his accumulated wealth from the various threats posed by such instability. However, the asset protection component of an IEP is not to be used to:
Hide Assets
Planning to or "hiding" assets can be dangerous; the dangers arise from the likelihood that a client will have to choose between protecting assets and committing perjury if he becomes involved in litigation. Whether or not litigation ever arises, a client may face difficult decisions each year when the client's Form 1040; full disclosure on a return is inconsistent with planning based on concealing assets. Further, hiding assets may result in criminal prosecution. Finally, the tangled web that often results from such planning is inconsistent with the goal of creating a user-friendly IEP.
While many clients appreciate the confidentiality that can be obtained through an IEP, a proper plan will not rely on secrecy for its efficacy.
Defraud creditors
There is some uncertainty as to when asset protection planning can be implemented (and the extent to which it can be implemented, if at all) when a client has a pending or expected legal threat. This uncertainly is much less prevalent today that in the past.
The easy clients are those with neither pending nor threatened claims who seek to protect against the unexpected. The difficult clients are those on the brink of bankruptcy (although pre-bankruptcy planning may help). There is a vast gray area in between.
Fraudulent conveyance law varies by state; there is also some Federal fraudulent conveyance law. A statutory body of fraudulent conveyance law applicable to certain situations exists at the federal level as well. For the good of the client and the planner as well, any asset protection planning must be implemented within the bounds of propriety as defined by reference to applicable fraudulent conveyance law.
Our common-law system favors the free alienability of property; an individual without creditor concerns is free to dispose of his property as he sees fit, whether in the form of charitable gifts or gifts to children, to a spouse or in trust. Fraudulent conveyance laws tend to focus not on who is the transferee, but on the transferor's intent at the time of the transfer.
Fraudulent conveyance law generally protects present creditors and subsequent creditors from transfers made by a person who is (or foreseeably will become) their debtor. However, "subsequent creditors" does not include every person who becomes a creditor in the future; there is also a "future potential" class of creditors. The distinction is clarified by a Florida decision, 1 which stated that asset transfers are permissible as to one's possible creditors, but not as to one's probable creditors. The operative inquiry is whether the client has any outstanding judgments, and whether he has any litigation or investigations pending, threatened or expected 2.
Evade Taxes
Some U.S. clients and their advisors are attracted to foreign-based planning by hoped-for tax advantages. As relatively few tax maneuvers involving foreign entities exist today for the global investor, a well designed IEP will have no particular income, gift or estate tax advantage other than those that can be accomplished through "conventional" inter vivos or testamentary planning. Importantly, a well-designed IEP will have no particular income, gift, excise, or estate tax disadvantages either, whether from the domestic or foreign standpoint. Both the planner and the client should be aware on an ongoing basis that certain tax issues will exist in the IEP setting. These tend to be not much different from (nor much more involved than) those associated with other types of entities than clients and planners are familiar with. Although there may be additional government reporting obligations (depending on the nature and design of the overall planning structure), neutrality in terms of tax liability will therefore generally prevail under an IEP.
INTRODUCTION
Today, asset protection planning is generally a concept familiar to wealth-planning professionals worldwide. However, while it has become more familiar and accepted, too often, such planning is done in a vacuum and without regard for its effect on the client's overall estate plan.
The same can be said for conventional estate planning; the emphasis tends to be on tax mitigation at death, the smooth transition of property, probate avoidance and ensuring that intended beneficiaries receive the intended property in the intended fashion. Unfortunately, the lifetime side of the estate plan has typically been ignored particularly, planning to preserve the client's estate during his life.
The collective thinking of the planning community has evolved tremendously over the past 10 years. The time has come for asset protection planning and estate planning to be joined into a new concept-integrated estate plan(ning) (IEP).
ASSET PROTECTION PLANNING
Asset protection planning recognizes the fact that preservation and protection of a client's estate during his life is at least as important (and in the view of many, more important) than preserving and protecting it after death.
The financial uncertainties stemming from (1)engaging in business or a profession or (2) being an entrepreneur or property owner and (3) economic and social factors have caused many successful people to adopt strategies to safeguard their accumulated wealth. A number of factors have contributed to the growing interest in and recognition of the asset protection component of the overall IEP. These factors include: (1) expanding theories of legal liability, (2) threat of litigation, (3) result-oriented judges and juries, (4) the unavailability of affordable, adequate or appropriate insurance coverage, and (5) the continuing national increase in the volume of litigation. Of course, other reasons may serve as motivating factors to persons of means who reside in (or who have assets) in other jurisdictions, as discussed below.
DEFINITION
Asset Protection Planning may be defined as the process of organizing assets and affairs in advance so as to safeguard them from loss or dissipation.
Stated another way, wealth may be more or less vulnerable to risk, depending on the nature of the property and the manner in which the property is held. Thus, at least in part, the asset protection component of the IEP will involve reorganizing the manner in which property is held so that it is less vulnerable to threats than it otherwise would be (e.g., converting joint tenancy property to a tenancy by the entirety or placing property in trust for the benefit of third parties or the settlor).
Asset protection planning is broader than simply planning for the possibility of future litigation. Clients will be motivated to plan for different reasons, not necessarily tied to the possibility of litigation. Thus, a client in a civil-law jurisdiction may desire to achieve "testamentary freedom" and avoid the forced heirship provisions applicable in his home country; a client residing (or with assets) in a politically or socially volatile part of the world may seek to protect his accumulated wealth from the various threats posed by such instability. However, the asset protection component of an IEP is not to be used to:
Hide Assets
Planning to or "hiding" assets can be dangerous; the dangers arise from the likelihood that a client will have to choose between protecting assets and committing perjury if he becomes involved in litigation. Whether or not litigation ever arises, a client may face difficult decisions each year when the client's Form 1040; full disclosure on a return is inconsistent with planning based on concealing assets. Further, hiding assets may result in criminal prosecution. Finally, the tangled web that often results from such planning is inconsistent with the goal of creating a user-friendly IEP.
While many clients appreciate the confidentiality that can be obtained through an IEP, a proper plan will not rely on secrecy for its efficacy.
Defraud creditors
There is some uncertainty as to when asset protection planning can be implemented (and the extent to which it can be implemented, if at all) when a client has a pending or expected legal threat. This uncertainly is much less prevalent today that in the past.
The easy clients are those with neither pending nor threatened claims who seek to protect against the unexpected. The difficult clients are those on the brink of bankruptcy (although pre-bankruptcy planning may help). There is a vast gray area in between.
Fraudulent conveyance law varies by state; there is also some Federal fraudulent conveyance law. A statutory body of fraudulent conveyance law applicable to certain situations exists at the federal level as well. For the good of the client and the planner as well, any asset protection planning must be implemented within the bounds of propriety as defined by reference to applicable fraudulent conveyance law.
Our common-law system favors the free alienability of property; an individual without creditor concerns is free to dispose of his property as he sees fit, whether in the form of charitable gifts or gifts to children, to a spouse or in trust. Fraudulent conveyance laws tend to focus not on who is the transferee, but on the transferor's intent at the time of the transfer.
Fraudulent conveyance law generally protects present creditors and subsequent creditors from transfers made by a person who is (or foreseeably will become) their debtor. However, "subsequent creditors" does not include every person who becomes a creditor in the future; there is also a "future potential" class of creditors. The distinction is clarified by a Florida decision, 1 which stated that asset transfers are permissible as to one's possible creditors, but not as to one's probable creditors. The operative inquiry is whether the client has any outstanding judgments, and whether he has any litigation or investigations pending, threatened or expected 2.
Evade Taxes
Some U.S. clients and their advisors are attracted to foreign-based planning by hoped-for tax advantages. As relatively few tax maneuvers involving foreign entities exist today for the global investor, a well designed IEP will have no particular income, gift or estate tax advantage other than those that can be accomplished through "conventional" inter vivos or testamentary planning. Importantly, a well-designed IEP will have no particular income, gift, excise, or estate tax disadvantages either, whether from the domestic or foreign standpoint. Both the planner and the client should be aware on an ongoing basis that certain tax issues will exist in the IEP setting. These tend to be not much different from (nor much more involved than) those associated with other types of entities than clients and planners are familiar with. Although there may be additional government reporting obligations (depending on the nature and design of the overall planning structure), neutrality in terms of tax liability will therefore generally prevail under an IEP.
Sunday, February 15, 2009
Why should I go to the trouble of planning my estate and writing a will?
Estate planning pays real dividends—in results achieved, in dollars saved, and, most important, in security and peace of mind. And it doesn't have to be expensive, traumatic, or even especially time consuming.
An estate plan is your blueprint for where you want your property to go after you die. Estate planning lets you do the following:
• Determine what happens to your property—who, what, when, and how. It enables you to coordinate gifts in your lifetime with bequests in your will or trust. You can apportion property among your family members, your friends, and charities that are important to you. If you don't have a will or a trust, state law will step in and determine how to dispose of your property, in ways that you might not intend.
• Determine who will be in charge of carrying out your wishes—your executor if you have a will, and your trustee if you have a trust.
• Save money on probate, taxes, and other expenses of settling an estate.
• Be in control of your own life. A living trust can provide a way to manage your property should you become disabled. A living will or a health-care advance directive can set up a plan for your medical care, should you no longer be able to make decisions for yourself.
• Coordinate estate planning with other kinds of financial planning. For example, the new tax law has made significant changes in incentives to save for education, making this an ideal time to look into planning for the education of children and grandchildren, as well as other financial issues.
• Decide whether your business will be sold or stay in the family—and if it stays in the family, who will run it.
An estate plan is your blueprint for where you want your property to go after you die. Estate planning lets you do the following:
• Determine what happens to your property—who, what, when, and how. It enables you to coordinate gifts in your lifetime with bequests in your will or trust. You can apportion property among your family members, your friends, and charities that are important to you. If you don't have a will or a trust, state law will step in and determine how to dispose of your property, in ways that you might not intend.
• Determine who will be in charge of carrying out your wishes—your executor if you have a will, and your trustee if you have a trust.
• Save money on probate, taxes, and other expenses of settling an estate.
• Be in control of your own life. A living trust can provide a way to manage your property should you become disabled. A living will or a health-care advance directive can set up a plan for your medical care, should you no longer be able to make decisions for yourself.
• Coordinate estate planning with other kinds of financial planning. For example, the new tax law has made significant changes in incentives to save for education, making this an ideal time to look into planning for the education of children and grandchildren, as well as other financial issues.
• Decide whether your business will be sold or stay in the family—and if it stays in the family, who will run it.
Sunday, February 1, 2009
Letter to Your Spouse
By Parag Patel, Esq.
In addition to your estate planning, it's a good idea to have a non-binding letter to your spouse, children and other heirs outlining where the important documents are kept and who to contact for help in administering your estate.
The following example is meant to be given to your spouse. Edit it to suit your needs. Your loved ones will feel more secure knowing the complete financial picture and having all the information in one place. Place copies in a safe location and be sure everyone knows where to find the letter.
Letter to My Spouse
Dear Spouse,
As we have discussed, you should use this letter (which is not to be misconstrued as my will) after my death or serious disability to serve as a reminder about a number of matters. The purpose is to make your task of handling legal and financial matters easier.
Our attorney and our accountant have significant personal information. Their names and direct phone numbers are ______________________________________________.
Safety deposit box. Our safety deposit box is in both our names and contains papers that you will find useful at the time of my death. You will also find my Will, copies of my birth certificate, and other valuable items. The box is located at __________________. The number of the box is _____________________. You will find my key to the box in ___________________________.
Will. The original of my Will is in our safe deposit box at the bank. You have received a copy of my will and an additional copy is in ________________.
Executors. I have appointed _______________________ and ___________________ to serve as co-executors of my estate. They will handle most of the legal and financial matters but will need your assistance.
Funeral arrangements. As we have discussed, here are my instructions for a funeral _______________________________________________________.
Credit cards. Please destroy all the credit cards in my name except those that are issued jointly to both of us. You do not want to be burdened with the problems of improper use of my cards.
Brokerage house. Please call my securities broker ________________ at _____________ and instruct him to nullify my standing or special instructions. Follow this with a written confirmation. After the accounts are transferred to your control, you can act as you wish.
Life insurance. My life insurance policies are in my __________________. Our life insurance agent is __________________ and his telephone number is ___________________. He will assist you in obtaining and completing claims forms so that you can promptly begin collecting these benefits.
Personal financial statement. Attached to this letter is an updated personal financial statement that is a bit more detailed in describing the stocks, real estate, partnerships, bank accounts and other investments we have made. When you read this, you will have a good handle on all our investment decisions. I suggest that you consider employing ____________, who I have consulted with from time to time as an investment adviser.
Casualty insurance. The policies that we have on our home, automobiles and other property have been purchased through _________________, whose telephone number is __________________. Be sure that none of the policies are permitted to lapse.
Home. Our home will continue to be owned by you and full title will pass to you outside of the probate court. Our deed and policy of title insurance are held in ________________.
Automobiles. All of our vehicles are registered in both of our names. Registration papers are in _____________________.
Loans. In addition to the loans we have on our real estate, which are represented by notes and deeds of trust, the policies of title insurance and deeds are in _________________. Please give your attention to that account with the advice of our estate-planning adviser. The circumstances will change because everything I own will take on a new tax basis at the time of my death. Accordingly, you have a new set of circumstances to deal with regarding income taxes on any asset sales after my death.
Tax Returns. Copies of our tax returns for the past 10 years are located in _______________. You can also contact our accountant for copies of returns filed in recent years.
Pension Plan. We have a substantial amount in a pension plan. The name and address of the plan administrator is _____________. I have been dealing primarily with __________________ whose telephone number is _______________. If the administrator is not clear about what our benefits are, consult with our estate-planning adviser.
Miscellaneous. Until my estate is settled, you should keep careful records of all checks you receive, as well as what you spend. Turn over all checks made out to me, or in our joint names, to our executor. (Checks made out to you alone may be deposited or cashed by you as always.) You can continue to use our joint bank account if you wish. Keep a record of all bills paid. As questions come up, my executor or estate-planning adviser is available to consult with our family.
Love,
Your Spouse
In addition to your estate planning, it's a good idea to have a non-binding letter to your spouse, children and other heirs outlining where the important documents are kept and who to contact for help in administering your estate.
The following example is meant to be given to your spouse. Edit it to suit your needs. Your loved ones will feel more secure knowing the complete financial picture and having all the information in one place. Place copies in a safe location and be sure everyone knows where to find the letter.
Letter to My Spouse
Dear Spouse,
As we have discussed, you should use this letter (which is not to be misconstrued as my will) after my death or serious disability to serve as a reminder about a number of matters. The purpose is to make your task of handling legal and financial matters easier.
Our attorney and our accountant have significant personal information. Their names and direct phone numbers are ______________________________________________.
Safety deposit box. Our safety deposit box is in both our names and contains papers that you will find useful at the time of my death. You will also find my Will, copies of my birth certificate, and other valuable items. The box is located at __________________. The number of the box is _____________________. You will find my key to the box in ___________________________.
Will. The original of my Will is in our safe deposit box at the bank. You have received a copy of my will and an additional copy is in ________________.
Executors. I have appointed _______________________ and ___________________ to serve as co-executors of my estate. They will handle most of the legal and financial matters but will need your assistance.
Funeral arrangements. As we have discussed, here are my instructions for a funeral _______________________________________________________.
Credit cards. Please destroy all the credit cards in my name except those that are issued jointly to both of us. You do not want to be burdened with the problems of improper use of my cards.
Brokerage house. Please call my securities broker ________________ at _____________ and instruct him to nullify my standing or special instructions. Follow this with a written confirmation. After the accounts are transferred to your control, you can act as you wish.
Life insurance. My life insurance policies are in my __________________. Our life insurance agent is __________________ and his telephone number is ___________________. He will assist you in obtaining and completing claims forms so that you can promptly begin collecting these benefits.
Personal financial statement. Attached to this letter is an updated personal financial statement that is a bit more detailed in describing the stocks, real estate, partnerships, bank accounts and other investments we have made. When you read this, you will have a good handle on all our investment decisions. I suggest that you consider employing ____________, who I have consulted with from time to time as an investment adviser.
Casualty insurance. The policies that we have on our home, automobiles and other property have been purchased through _________________, whose telephone number is __________________. Be sure that none of the policies are permitted to lapse.
Home. Our home will continue to be owned by you and full title will pass to you outside of the probate court. Our deed and policy of title insurance are held in ________________.
Automobiles. All of our vehicles are registered in both of our names. Registration papers are in _____________________.
Loans. In addition to the loans we have on our real estate, which are represented by notes and deeds of trust, the policies of title insurance and deeds are in _________________. Please give your attention to that account with the advice of our estate-planning adviser. The circumstances will change because everything I own will take on a new tax basis at the time of my death. Accordingly, you have a new set of circumstances to deal with regarding income taxes on any asset sales after my death.
Tax Returns. Copies of our tax returns for the past 10 years are located in _______________. You can also contact our accountant for copies of returns filed in recent years.
Pension Plan. We have a substantial amount in a pension plan. The name and address of the plan administrator is _____________. I have been dealing primarily with __________________ whose telephone number is _______________. If the administrator is not clear about what our benefits are, consult with our estate-planning adviser.
Miscellaneous. Until my estate is settled, you should keep careful records of all checks you receive, as well as what you spend. Turn over all checks made out to me, or in our joint names, to our executor. (Checks made out to you alone may be deposited or cashed by you as always.) You can continue to use our joint bank account if you wish. Keep a record of all bills paid. As questions come up, my executor or estate-planning adviser is available to consult with our family.
Love,
Your Spouse
Wednesday, January 21, 2009
Ten Things to Do to Prepare a Will for Probate
If you are the executor of a will there are many things you must do to get that will ready for probate. Probate means the process by which the deceased’s assets are gathered; outstanding debts, taxes, and expenses of the funeral and the probate process are paid; and the assets are distributed to the beneficiaries in the will. Following here are the top ten things needed to prepare for probate.
Get names and addresses of all person named in the will;
Determine if the deceased has any pending financial or legal matters requiring immediate attention;
Arrange for a meeting with everyone named in the will;
Gather, do not destroy, any of the deceased’s records, tax returns, checks, or other documents;
Get death certificates (from funeral home);
Keep careful records of all funeral-related expenses;
Don’t pay debts unless truly necessary;
Change locks on the door if deceased lived alone;
Secure valuable items;
Notify insurance carriers of the recent death.
Get names and addresses of all person named in the will;
Determine if the deceased has any pending financial or legal matters requiring immediate attention;
Arrange for a meeting with everyone named in the will;
Gather, do not destroy, any of the deceased’s records, tax returns, checks, or other documents;
Get death certificates (from funeral home);
Keep careful records of all funeral-related expenses;
Don’t pay debts unless truly necessary;
Change locks on the door if deceased lived alone;
Secure valuable items;
Notify insurance carriers of the recent death.
Friday, January 16, 2009
Estate Planning When a Spouse is Confronting Health Issues (Estate Planning for the Healthy Spouse)
When one spouse is a resident of a nursing facility or medical institution (the "institutionalized spouse"), but the other spouse continues to live in the community (the "community spouse"), the community spouse may take a number of steps to retain a maximum level of resources without jeopardizing the institutionalized spouse's Medicaid eligibility.1
Medicaid is a joint federal and state program created under Title XIX of the Social Security Act of 1965. It provides a source of funding for long-term care to those aged, blind and disabled individuals who qualify financially. 42 U.S.C. §1396 et seq.; N.J.A.C. 10:71-1 et seq. Eligibility for Medicaid is based upon financial need. For example, under the "Medicaid Only" program, an applicant's countable resources cannot exceed $2,000.00. N.J.A.C. 10:71-4.4.
Following the enactment of the Medicaid program, based upon concern over the widespread practice of purposeful asset divestiture, mostly by the wealthy, to obtain Medicaid eligibility, Congress enacted legislation to impose periods of ineligibility, or "penalty periods," in cases in which a Medicaid applicant divested himself of assets for less than fair market value in an attempt to render himself "needy." See Rainey v. Guardianship of Mackey, 773 So. 2d 118, 119 (Fla. Dist. Ct. App. 2000); In re John XX, 652 N.Y.S. 2d 329 (Sup. Ct. 1996), appeal denied, 659 N.Y.S. 2d 854 (1997). This legislation imposes a 36-month "look-back period," in which Medicaid officials will "look back" from the application date to analyze asset transfers by the applicant. Id. If a Medicaid applicant disposes of assets for less than fair market value within the 36-month look-back period, the applicant may be subject to a period of Medicaid ineligibility (a "penalty period"), based upon the value of the uncompensated transfer. 42 U.S.C. §1396(p).
By understanding the Medicaid rules and designing strategies consistent with those rules, the attorney can assist the community spouse in planning his or her estate when the spouse is confronting health issues.
A. Asset Titling — Deeds, Bank Accounts, And Life Insurance
Transfer Of The Institutionalized Spouse's Interest In The Principal Residence to the Community Spouse
The Medicaid transfer penalties do not apply to all uncompensated asset transfers. For example, under current Medicaid law, certain transfers of the Medicaid applicant's principal residence are "exempt" for purposes of determining Medicaid eligibility. One such exempt transfer of the applicant's principal residence for less than fair market value is a transfer to the Medicaid applicant's community spouse. Retitling a couple's jointly held home to the community spouse is a significant estate planning measure for the community spouse.
Among the benefits of transferring the applicant's interest in the home to the community spouse is that the home will escape the imposition of a "Medicaid lien" as mandated by the Medicaid estate recovery program. N.J.S.A. 30:4D-7.2 et seq.; 42 U.S.C. §1396p(b)(1)(B). Under the estate recovery program, the State of New Jersey is entitled to recover payments made on behalf of a Medicaid recipient through the imposition of liens on any real or personal property owned by the Medicaid recipient or in which the Medicaid recipient held legal title at the time of death. Id. New Jersey seeks recovery only from estates of deceased Medicaid recipients.
Thus, by engaging in Medicaid planning and transferring the institutionalized spouse's interest in the home to the community spouse, Medicaid will not penalize the transfer; moreover, Medicaid will be unable to impose a lien on the home because the institutionalized spouse will have no legal title to or legal interest in the home at the time of his or her death.
Other techniques involving the principal residence may assist in maximizing the resources of the community spouse. The community spouse-occupied principal residence is an exempt asset. N.J.A.C. 10:71-4.4. Consequently, prepayment of real estate taxes constitutes a valid spend-down. Begley, T. and Jeffreys, J., Representing the Elderly Client: Law and Practice, §8.02[C] at 8-7 (Aspen 2003). In addition, because personal effects and household goods are excluded up to a total value of $2,000,2 N.J.A.C. 10:71-4.4, such goods may be purchased as part of a spend-down plan.
In fact, because the community spouse-occupied principal residence is an exempt asset, N.J.A.C. 10:71-4.4, resources may be converted from countable to excludable by selling the residence and purchasing a more expensive home. Begley, T. and Jeffreys, J., Representing the Elderly Client: Law and Practice, §8.03[C] at 8-9 (Aspen 2003).
Retitling Of Bank Accounts And Life Insurance
If the community spouse has a life insurance policy, a retirement account (e.g., an IRA), or an annuity naming the institutionalized spouse as beneficiary, the beneficiary designation should be changed to a third party (for example, the couple's children). Otherwise, if the beneficiary is designated as the institutionalized spouse, the proceeds would be paid to the institutionalized spouse, who would become ineligible for Medicaid until those funds were expended for his or her nursing care.
Similarly, bank accounts should be retitled so that they are not in the name of the institutionalized spouse.
B. Changing The Will To Exclude The Disabled Spouse
If the community spouse has a Last Will and Testament naming the institutionalized spouse as beneficiary, and the will is not changed to name the children or other third parties as beneficiaries, the estate would be distributed to the institutionalized spouse, who would become ineligible for Medicaid util those funds were expended for his nursing care. For this reason, a revision to the community spouse's will is a necessary element of a Medicaid plan.
Of course, when changing the Last Will and Testament of the community spouse, the attorney must consider the impact that such a change would have on the elective share.
A successful strategy for addressing these two concepts is the execution of a new will in which the community spouse leaves the institutionalized spouse's elective share in a testamentary Special Needs Trust that will not affect his/her eligibility for Medicaid or other needs-based governmental programs.
Under the state elective share statute, N.J.S.A. 3B:8-1, et seq., the surviving spouse has a right to take one-third of the augmented estate of a deceased spouse. Because the statute also provides that half of anything placed in a trust for the surviving spouse counts against the elective share, if the community spouse puts two-thirds of his or her estate in a Special Needs Trust for the surviving spouse, the elective share is satisfied.
The testamentary elective share trust may be designed as a Special Needs Trust so that all distributions of principal are left to the sole discretion of the trustee and may be made only for products and services which supplement governmental benefits received by the disabled spouse.
The amount of the estate above the elective share may be left outright to the children or other heirs.
C. Durable Power Of Attorney With Gift-Giving Power
A financial power of attorney is a legal instrument by which an individual (the "principal") authorizes another person(s) (the "attorney(s)-in-fact" or "agent(s)") to perform specific acts enumerated in the instrument on behalf of the principal See N.J.S.A. 46:2B-8.2; 2A C.J.S. Agency § 44; Regan, J., Morgan, R. and English, D., Tax, Estate & Financial Planning For The Elderly, §13.03[1] at 13-5 (Matthew Bender 1999). An agent under a power of attorney is specifically authorized by New Jersey statute to conduct banking transactions on behalf of a principal. N.J.S.A. 46:2B-11.
Care must be taken by the attorney in the structuring and execution of a power of attorney instrument. In order to execute a power of attorney, the principal must possess the capacity to contract, or to understand the nature and the effect of the act of appointing an agent. See Mazart, G., New Jersey Elder Law Practice, §2 at 2-3 (New Jersey Institute for Continuing Legal Education 1999).
Because an ordinary power of attorney is only effective during the time that the principal is competent, it is void when the principal becomes incapacitated, rendering it ineffective as a tool for addressing disability. Consequently, New Jersey statutory law authorizes the use of a "durable" power of attorney, in which the instrument is not affected by the disability of the principal. N.J.S.A. 46:2B-8.2. A power of attorney is "durable" if it states: "This power of attorney shall not be affected by subsequent disability or incapacity of the principal;" or "This power of attorney shall become effective upon the disability or incapacity of the principal;" or similar words. Id.
When a power of attorney is durable, all action taken by the agent pursuant to that power during the principal's disability or incompetence has the same effect, and binds the principal as if the principal were competent. N.J.S.A. 46:2B-8.3. Thus, the durable power of attorney provides the principal with the opportunity to select his or her own agent to act in the event of incapacity, which is a favorable alternative to, and may avoid, resorting to the courts for such appointment in a guardianship or conservatorship proceeding. See J. Regan, R. Morgan and English, D., Tax, Estate & Financial Planning For The Elderly, §13.03[2] at 13-6 (Matthew Bender 1999).
Critical for purposes of Medicaid planning is the fact that a power of attorney cannot be construed as authorizing the attorney-in-fact to "gratuitously transfer property of the principal to the attorney-in-fact or to others except to the extent that the power of attorney expressly and specifically so authorizes." N.J.S.A. 46:2B-8.13a. Consequently, if the power of attorney is to be used to conduct Medicaid planning including gifting strategies on behalf of the institutionalized spouse, it must specifically include gifting powers.
While blanket gifting provisions, giving authorization generally to make gifts of the principal's property, allow the agent authority to conduct Medicaid planning, blanket gifting powers may also create problems. For example, such a provision could be used by an agent/child to make gifts favoring himself over the principal's other children. While such conduct could be considered contrary to the agent's fiduciary duty to avoid self-dealing, the blanket gifting provision could also be deemed to be a waiver of the agent's fiduciary duty to avoid self-dealing.
For these reasons, as well as the fact that blanket gifting provisions may trigger tax traps, it may be prudent to tailor gifting provisions (for example, to permit gifting, including to the agent, as long as the agent and siblings are treated equally; or to permit gifting to the agent only when prior approval for the transfer is given by the alternate agent).
D. Other Techniques
Divorce
Divorce from an institutionalized spouse may be troublesome concept, from a personal standpoint. In fact, a divorce consummated in the context of Medicaid planning is considered to be one of the more "extreme Medicaid planning strategies." H. Fliegelman and D. Fliegelman, Giving Guardians The Power To Do Medicaid Planning, 32 Wake Forest L. Rev. 341, 364 (Summer 1997). Nevertheless, it may be a prudent financial strategy for a community spouse.
If the court grants an equitable distribution to a community spouse, or recognizes a Qualified Domestic Relations Order ("QDRO") incident to a divorce, the resulting distribution to the community spouse may greatly exceed the Community Spouse Resource Allowance available to the community spouse absent a divorce.
The New Jersey Supreme Court was presented with a property settlement agreement entered into between the guardian/child of an incapacitated nursing home resident and the community spouse seeking to divorce him in In re L.M., 140 N.J. 480 (1995). There, the settlement agreement provided for the transfer of the ward's pension interest to the spouse. The Supreme Court recognized the agreement as, in whole or in part, an attempt at Medicaid planning. Id. at 489. Nevertheless, it held that the transfer, which was incorporated into a Qualified Domestic Relations Order ("QDRO"), successfully shielded the pension from Medicaid consideration. Id.
The Community Spouse Resource Allowance ("CSRA")
The Community Spouse Resource Allowance ("CSRA") is the amount of non-exempt resources (owned jointly or separately by either spouse) that the law permits the community spouse to retain without jeopardizing the Medicaid eligibility of the institutionalized spouse. Regan, J., Morgan, R. and English, D., Tax, Estate & Financial Planning For The Elderly, §10.11[3] at 10-63 (Matthew Bender 1999).
In 2004, the community spouse is permitted to retain a maximum of $92,760 and a minimum of $18,552. The CSRA is computed as of the first day that the institutionalized spouse begins a 30-day or more period of institutionalization. Id. As of the date of computation, the community spouse is permitted to retain $18,552 (as of January 1, 2004) or half of the couple's resources, up to a maximum of $92,760 (as of January 1, 2004). If that amount is more than the actual resources in the community spouse's sole name, the difference will be recouped by a transfer from the institutionalized spouse.
In order to maximize the community spouse's resource allowance, a sound Medicaid plan will aim to transfer the couple's countable assets, with the exception of an amount equal to twice the CSRA ($185,520 in 2004). Then, after the spouse is institutionalized and the CSRA is calculated (ideally at $92,760), the remaining $92,760 will be spent down on nursing home care and other medical costs and preserved using various planning techniques.
Because the CSRA is calculated based upon assets but not liabilities, if the couple's resources are less than twice the CSRA maximum, one technique aimed at maximizing the community spouse's CSRA involves the spouse obtaining a loan from his or her children in the amount of the couple's resources. After the CSRA is calculated, the loan can be immediately repaid from the institutionalized spouse's resources, i.e., the spend-down requirement. See id.
The Minimum Monthly Maintenance Needs Allowance ("MMMNA")
When a spouse is institutionalized, the Medicaid rules permit the community spouse to keep her own separate income titled in her sole name, plus one-half of the income in the couple's joint names. Begley, T. and Jeffreys, J., Representing the Elderly Client: Law and Practice, §8.06[A][1] at 8-50 to 8-51 (Aspen 2003); Regan, J., Morgan, R. and English, D., Tax, Estate & Financial Planning For The Elderly, §10.11[2] at 10-58 (Matthew Bender 1999). If that amount does not equal the minimum monthly maintenance needs allowance ("MMNA"), calculated at $1,515 until July 1, 2004, the community spouse may seek the shortfall from the income of the institutionalized spouse, pursuant to the "income first rule". Id.
If the income of the institutionalized spouse is insufficient to meet the shortfall, then the community spouse may seek to receive that amount of resources above the CSRA calculated to generate income necessary to meet the shortfall.
The Excess Shelter Allowance
The community spouse also has the right to an excess shelter allowance. Shelter expenses are defined as "rent or mortgage (including principal and interest), taxes and insurance, a utility standard for the individual's utility expenses, and in the case of a condominium or cooperative, the monthly required maintenance charge." N.J.A.C. 10:71-5.7(c)(1). If the cost of the community spouse's monthly shelter exceeds a specified amount ($454.50 through July 1, 2004), he or she is entitled to payment of that difference from the income of the institutionalized spouse.
The community spouse's total excess shelter allowance and MMNA cannot exceed a certain amount ($2,266.50 in 2003), except by resort to a fair hearing. Begley, T. and Jeffreys, J., Representing the Elderly Client: Law and Practice, §8.06[A][1] at 8-50 to 8-51 (Aspen 2003). By Donald D. Vanarelli, Esq.
Medicaid is a joint federal and state program created under Title XIX of the Social Security Act of 1965. It provides a source of funding for long-term care to those aged, blind and disabled individuals who qualify financially. 42 U.S.C. §1396 et seq.; N.J.A.C. 10:71-1 et seq. Eligibility for Medicaid is based upon financial need. For example, under the "Medicaid Only" program, an applicant's countable resources cannot exceed $2,000.00. N.J.A.C. 10:71-4.4.
Following the enactment of the Medicaid program, based upon concern over the widespread practice of purposeful asset divestiture, mostly by the wealthy, to obtain Medicaid eligibility, Congress enacted legislation to impose periods of ineligibility, or "penalty periods," in cases in which a Medicaid applicant divested himself of assets for less than fair market value in an attempt to render himself "needy." See Rainey v. Guardianship of Mackey, 773 So. 2d 118, 119 (Fla. Dist. Ct. App. 2000); In re John XX, 652 N.Y.S. 2d 329 (Sup. Ct. 1996), appeal denied, 659 N.Y.S. 2d 854 (1997). This legislation imposes a 36-month "look-back period," in which Medicaid officials will "look back" from the application date to analyze asset transfers by the applicant. Id. If a Medicaid applicant disposes of assets for less than fair market value within the 36-month look-back period, the applicant may be subject to a period of Medicaid ineligibility (a "penalty period"), based upon the value of the uncompensated transfer. 42 U.S.C. §1396(p).
By understanding the Medicaid rules and designing strategies consistent with those rules, the attorney can assist the community spouse in planning his or her estate when the spouse is confronting health issues.
A. Asset Titling — Deeds, Bank Accounts, And Life Insurance
Transfer Of The Institutionalized Spouse's Interest In The Principal Residence to the Community Spouse
The Medicaid transfer penalties do not apply to all uncompensated asset transfers. For example, under current Medicaid law, certain transfers of the Medicaid applicant's principal residence are "exempt" for purposes of determining Medicaid eligibility. One such exempt transfer of the applicant's principal residence for less than fair market value is a transfer to the Medicaid applicant's community spouse. Retitling a couple's jointly held home to the community spouse is a significant estate planning measure for the community spouse.
Among the benefits of transferring the applicant's interest in the home to the community spouse is that the home will escape the imposition of a "Medicaid lien" as mandated by the Medicaid estate recovery program. N.J.S.A. 30:4D-7.2 et seq.; 42 U.S.C. §1396p(b)(1)(B). Under the estate recovery program, the State of New Jersey is entitled to recover payments made on behalf of a Medicaid recipient through the imposition of liens on any real or personal property owned by the Medicaid recipient or in which the Medicaid recipient held legal title at the time of death. Id. New Jersey seeks recovery only from estates of deceased Medicaid recipients.
Thus, by engaging in Medicaid planning and transferring the institutionalized spouse's interest in the home to the community spouse, Medicaid will not penalize the transfer; moreover, Medicaid will be unable to impose a lien on the home because the institutionalized spouse will have no legal title to or legal interest in the home at the time of his or her death.
Other techniques involving the principal residence may assist in maximizing the resources of the community spouse. The community spouse-occupied principal residence is an exempt asset. N.J.A.C. 10:71-4.4. Consequently, prepayment of real estate taxes constitutes a valid spend-down. Begley, T. and Jeffreys, J., Representing the Elderly Client: Law and Practice, §8.02[C] at 8-7 (Aspen 2003). In addition, because personal effects and household goods are excluded up to a total value of $2,000,2 N.J.A.C. 10:71-4.4, such goods may be purchased as part of a spend-down plan.
In fact, because the community spouse-occupied principal residence is an exempt asset, N.J.A.C. 10:71-4.4, resources may be converted from countable to excludable by selling the residence and purchasing a more expensive home. Begley, T. and Jeffreys, J., Representing the Elderly Client: Law and Practice, §8.03[C] at 8-9 (Aspen 2003).
Retitling Of Bank Accounts And Life Insurance
If the community spouse has a life insurance policy, a retirement account (e.g., an IRA), or an annuity naming the institutionalized spouse as beneficiary, the beneficiary designation should be changed to a third party (for example, the couple's children). Otherwise, if the beneficiary is designated as the institutionalized spouse, the proceeds would be paid to the institutionalized spouse, who would become ineligible for Medicaid until those funds were expended for his or her nursing care.
Similarly, bank accounts should be retitled so that they are not in the name of the institutionalized spouse.
B. Changing The Will To Exclude The Disabled Spouse
If the community spouse has a Last Will and Testament naming the institutionalized spouse as beneficiary, and the will is not changed to name the children or other third parties as beneficiaries, the estate would be distributed to the institutionalized spouse, who would become ineligible for Medicaid util those funds were expended for his nursing care. For this reason, a revision to the community spouse's will is a necessary element of a Medicaid plan.
Of course, when changing the Last Will and Testament of the community spouse, the attorney must consider the impact that such a change would have on the elective share.
A successful strategy for addressing these two concepts is the execution of a new will in which the community spouse leaves the institutionalized spouse's elective share in a testamentary Special Needs Trust that will not affect his/her eligibility for Medicaid or other needs-based governmental programs.
Under the state elective share statute, N.J.S.A. 3B:8-1, et seq., the surviving spouse has a right to take one-third of the augmented estate of a deceased spouse. Because the statute also provides that half of anything placed in a trust for the surviving spouse counts against the elective share, if the community spouse puts two-thirds of his or her estate in a Special Needs Trust for the surviving spouse, the elective share is satisfied.
The testamentary elective share trust may be designed as a Special Needs Trust so that all distributions of principal are left to the sole discretion of the trustee and may be made only for products and services which supplement governmental benefits received by the disabled spouse.
The amount of the estate above the elective share may be left outright to the children or other heirs.
C. Durable Power Of Attorney With Gift-Giving Power
A financial power of attorney is a legal instrument by which an individual (the "principal") authorizes another person(s) (the "attorney(s)-in-fact" or "agent(s)") to perform specific acts enumerated in the instrument on behalf of the principal See N.J.S.A. 46:2B-8.2; 2A C.J.S. Agency § 44; Regan, J., Morgan, R. and English, D., Tax, Estate & Financial Planning For The Elderly, §13.03[1] at 13-5 (Matthew Bender 1999). An agent under a power of attorney is specifically authorized by New Jersey statute to conduct banking transactions on behalf of a principal. N.J.S.A. 46:2B-11.
Care must be taken by the attorney in the structuring and execution of a power of attorney instrument. In order to execute a power of attorney, the principal must possess the capacity to contract, or to understand the nature and the effect of the act of appointing an agent. See Mazart, G., New Jersey Elder Law Practice, §2 at 2-3 (New Jersey Institute for Continuing Legal Education 1999).
Because an ordinary power of attorney is only effective during the time that the principal is competent, it is void when the principal becomes incapacitated, rendering it ineffective as a tool for addressing disability. Consequently, New Jersey statutory law authorizes the use of a "durable" power of attorney, in which the instrument is not affected by the disability of the principal. N.J.S.A. 46:2B-8.2. A power of attorney is "durable" if it states: "This power of attorney shall not be affected by subsequent disability or incapacity of the principal;" or "This power of attorney shall become effective upon the disability or incapacity of the principal;" or similar words. Id.
When a power of attorney is durable, all action taken by the agent pursuant to that power during the principal's disability or incompetence has the same effect, and binds the principal as if the principal were competent. N.J.S.A. 46:2B-8.3. Thus, the durable power of attorney provides the principal with the opportunity to select his or her own agent to act in the event of incapacity, which is a favorable alternative to, and may avoid, resorting to the courts for such appointment in a guardianship or conservatorship proceeding. See J. Regan, R. Morgan and English, D., Tax, Estate & Financial Planning For The Elderly, §13.03[2] at 13-6 (Matthew Bender 1999).
Critical for purposes of Medicaid planning is the fact that a power of attorney cannot be construed as authorizing the attorney-in-fact to "gratuitously transfer property of the principal to the attorney-in-fact or to others except to the extent that the power of attorney expressly and specifically so authorizes." N.J.S.A. 46:2B-8.13a. Consequently, if the power of attorney is to be used to conduct Medicaid planning including gifting strategies on behalf of the institutionalized spouse, it must specifically include gifting powers.
While blanket gifting provisions, giving authorization generally to make gifts of the principal's property, allow the agent authority to conduct Medicaid planning, blanket gifting powers may also create problems. For example, such a provision could be used by an agent/child to make gifts favoring himself over the principal's other children. While such conduct could be considered contrary to the agent's fiduciary duty to avoid self-dealing, the blanket gifting provision could also be deemed to be a waiver of the agent's fiduciary duty to avoid self-dealing.
For these reasons, as well as the fact that blanket gifting provisions may trigger tax traps, it may be prudent to tailor gifting provisions (for example, to permit gifting, including to the agent, as long as the agent and siblings are treated equally; or to permit gifting to the agent only when prior approval for the transfer is given by the alternate agent).
D. Other Techniques
Divorce
Divorce from an institutionalized spouse may be troublesome concept, from a personal standpoint. In fact, a divorce consummated in the context of Medicaid planning is considered to be one of the more "extreme Medicaid planning strategies." H. Fliegelman and D. Fliegelman, Giving Guardians The Power To Do Medicaid Planning, 32 Wake Forest L. Rev. 341, 364 (Summer 1997). Nevertheless, it may be a prudent financial strategy for a community spouse.
If the court grants an equitable distribution to a community spouse, or recognizes a Qualified Domestic Relations Order ("QDRO") incident to a divorce, the resulting distribution to the community spouse may greatly exceed the Community Spouse Resource Allowance available to the community spouse absent a divorce.
The New Jersey Supreme Court was presented with a property settlement agreement entered into between the guardian/child of an incapacitated nursing home resident and the community spouse seeking to divorce him in In re L.M., 140 N.J. 480 (1995). There, the settlement agreement provided for the transfer of the ward's pension interest to the spouse. The Supreme Court recognized the agreement as, in whole or in part, an attempt at Medicaid planning. Id. at 489. Nevertheless, it held that the transfer, which was incorporated into a Qualified Domestic Relations Order ("QDRO"), successfully shielded the pension from Medicaid consideration. Id.
The Community Spouse Resource Allowance ("CSRA")
The Community Spouse Resource Allowance ("CSRA") is the amount of non-exempt resources (owned jointly or separately by either spouse) that the law permits the community spouse to retain without jeopardizing the Medicaid eligibility of the institutionalized spouse. Regan, J., Morgan, R. and English, D., Tax, Estate & Financial Planning For The Elderly, §10.11[3] at 10-63 (Matthew Bender 1999).
In 2004, the community spouse is permitted to retain a maximum of $92,760 and a minimum of $18,552. The CSRA is computed as of the first day that the institutionalized spouse begins a 30-day or more period of institutionalization. Id. As of the date of computation, the community spouse is permitted to retain $18,552 (as of January 1, 2004) or half of the couple's resources, up to a maximum of $92,760 (as of January 1, 2004). If that amount is more than the actual resources in the community spouse's sole name, the difference will be recouped by a transfer from the institutionalized spouse.
In order to maximize the community spouse's resource allowance, a sound Medicaid plan will aim to transfer the couple's countable assets, with the exception of an amount equal to twice the CSRA ($185,520 in 2004). Then, after the spouse is institutionalized and the CSRA is calculated (ideally at $92,760), the remaining $92,760 will be spent down on nursing home care and other medical costs and preserved using various planning techniques.
Because the CSRA is calculated based upon assets but not liabilities, if the couple's resources are less than twice the CSRA maximum, one technique aimed at maximizing the community spouse's CSRA involves the spouse obtaining a loan from his or her children in the amount of the couple's resources. After the CSRA is calculated, the loan can be immediately repaid from the institutionalized spouse's resources, i.e., the spend-down requirement. See id.
The Minimum Monthly Maintenance Needs Allowance ("MMMNA")
When a spouse is institutionalized, the Medicaid rules permit the community spouse to keep her own separate income titled in her sole name, plus one-half of the income in the couple's joint names. Begley, T. and Jeffreys, J., Representing the Elderly Client: Law and Practice, §8.06[A][1] at 8-50 to 8-51 (Aspen 2003); Regan, J., Morgan, R. and English, D., Tax, Estate & Financial Planning For The Elderly, §10.11[2] at 10-58 (Matthew Bender 1999). If that amount does not equal the minimum monthly maintenance needs allowance ("MMNA"), calculated at $1,515 until July 1, 2004, the community spouse may seek the shortfall from the income of the institutionalized spouse, pursuant to the "income first rule". Id.
If the income of the institutionalized spouse is insufficient to meet the shortfall, then the community spouse may seek to receive that amount of resources above the CSRA calculated to generate income necessary to meet the shortfall.
The Excess Shelter Allowance
The community spouse also has the right to an excess shelter allowance. Shelter expenses are defined as "rent or mortgage (including principal and interest), taxes and insurance, a utility standard for the individual's utility expenses, and in the case of a condominium or cooperative, the monthly required maintenance charge." N.J.A.C. 10:71-5.7(c)(1). If the cost of the community spouse's monthly shelter exceeds a specified amount ($454.50 through July 1, 2004), he or she is entitled to payment of that difference from the income of the institutionalized spouse.
The community spouse's total excess shelter allowance and MMNA cannot exceed a certain amount ($2,266.50 in 2003), except by resort to a fair hearing. Begley, T. and Jeffreys, J., Representing the Elderly Client: Law and Practice, §8.06[A][1] at 8-50 to 8-51 (Aspen 2003). By Donald D. Vanarelli, Esq.
Thursday, January 1, 2009
HOW IS MY NJ ESTATE DISTRIBUTED WITHOUT A WILL IN NJ?
New Jersey law provides how your Estate will be distributed if you do die without a Will. The property referred to in this section deals with assets in the decedent's name alone.
A)If you die leaving a spouse or domestic partner and children of the same marriage, the spouse or domestic partner will inherit the entire estate. (i.e., no stepchildren or children of a prior union)
B)If you die leaving a spouse or domestic partner and children of a prior union, the spouse or domestic partner will inherit the first 25% of the estate, but not less than $50,000.00 nor more than $200,000.00, plus one-half of any balance of the estate. Your children take the balance equally. Grandchildren will take a portion of their deceased parent's share
C)If you die leaving a spouse or domestic partner, child or children a stepchild or stepchildren, the spouse or domestic partner will inherit the first 25% of the estate, but not less than $50,000.00 nor more than $200,000.00, plus one-half of any balance of the estate. Your children take the balance of the estate equally. Grandchildren will take a portion of their deceased parent's share.
D)If you die leaving a spouse or domestic partner and no children, but are survived by parents, the spouse or domestic partner will inherit the first 25% of the estate, but not less than $50,000.00 nor more than $200,000.00 plus three-fourths of any balance of the estate. Your parents take the balance equally.
E)If you die leaving a child or children but no spouse or domestic partner, children will inherit equally. Grandchildren will take a portion of their deceased parent's share.
F) If you die leaving no spouse or domestic partner, children or grandchildren, your parents take all. If no parent survives, your brothers and sisters will take equally.
G)Where there is no immediate family, your property may go to more distant relatives (grandparents, aunts, uncles, cousins, etc.), then to stepchildren, or even revert to the State.
A)If you die leaving a spouse or domestic partner and children of the same marriage, the spouse or domestic partner will inherit the entire estate. (i.e., no stepchildren or children of a prior union)
B)If you die leaving a spouse or domestic partner and children of a prior union, the spouse or domestic partner will inherit the first 25% of the estate, but not less than $50,000.00 nor more than $200,000.00, plus one-half of any balance of the estate. Your children take the balance equally. Grandchildren will take a portion of their deceased parent's share
C)If you die leaving a spouse or domestic partner, child or children a stepchild or stepchildren, the spouse or domestic partner will inherit the first 25% of the estate, but not less than $50,000.00 nor more than $200,000.00, plus one-half of any balance of the estate. Your children take the balance of the estate equally. Grandchildren will take a portion of their deceased parent's share.
D)If you die leaving a spouse or domestic partner and no children, but are survived by parents, the spouse or domestic partner will inherit the first 25% of the estate, but not less than $50,000.00 nor more than $200,000.00 plus three-fourths of any balance of the estate. Your parents take the balance equally.
E)If you die leaving a child or children but no spouse or domestic partner, children will inherit equally. Grandchildren will take a portion of their deceased parent's share.
F) If you die leaving no spouse or domestic partner, children or grandchildren, your parents take all. If no parent survives, your brothers and sisters will take equally.
G)Where there is no immediate family, your property may go to more distant relatives (grandparents, aunts, uncles, cousins, etc.), then to stepchildren, or even revert to the State.
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