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USING THE MARITAL DEDUCTION TO AVOID ESTATE TAX
DISTRIBUTIONS OF ESTATE TO HEIRS AFTER DEATH OF SURVIVING SPOUSE
PLANNING FOR THE ESTATE IN EXCESS OF $3.5 MILLION
TRUSTS FOR CHILDREN AND GRANDCHILDREN
GRANTOR RETAINED INTEREST TRUSTS
GRANTOR RETAINED ANNUITY TRUSTS
POWER OF ATTORNEY FOR FINANCIAL MATTERS
GENERAL ESTATE PLANNING CONCERNS
Estate planning, quite simply, is the process of organizing your affairs in a manner which allows for an orderly transition at death and which accomplishes the following objectives:
One of the first issues faced by an individual interested in estate planning is whether to utilize a Revocable Living Trust or a Will as his or her principal estate planning document. As an initial matter, since most people are familiar with Wills, a brief description of the Revocable Living Trust is appropriate. A Revocable Living Trust is a trust agreement that you can enter into with yourself, i.e., you and (if married) your spouse are (1) the grantors of the trust who establish and transfer assets to the trust; (2) the trustees who are responsible for investing the trust assets; and (3) the beneficiaries for whom the trust is being administered and who will receive income and principal distributions. During your life the Revocable Living Trust holds legal title to your assets, such that upon your death you have no assets in your individual name which must pass through probate. The Revocable Living Trust serves as your alter ego during your life since you have complete control over all of the trust’s assets, investments, income and distributions. Following your death the Revocable Living Trust will act as a substitute for a Will, and distribute your property to your beneficiaries.
Since the principal objective of a Revocable Living Trust is to avoid probate it is appropriate to briefly consider the probate process. Probate is a court supervised procedure in which your executor is required to marshal all of your assets and liabilities, pay or otherwise provide for the payment of all your liabilities, including all applicable taxes, and then distribute your remaining assets to your beneficiaries in the manner which you direct.
Since probate is a court-administered process, unless the executor is an experienced probate lawyer, the executor will be required to hire a probate lawyer to make sure that the estate complies will all Probate Court procedures, and properly prepares and files all appropriate court materials.
Legal fees in probate cases are set by statue and are based upon the gross value of the decedent’s assets that are administered by probate. In addition, probate attorneys are frequently granted “extraordinary” fees in excess of the fees established by statute, in the case of complex estates or estates which otherwise require an above-average level of administration.
The other principal differences between a Revocable Living Trust and a Will are as follows:
It is also important to note that probate proceedings will be required in every state in which a decedent owns real estate. A California resident who owns real estate in Nevada, for example, will be subject to probate in California in the county of his or her residence, and will have a second probate, called an “ancillary” probate in the county in Nevada where the real estate is located. A Revocable Living Trust established by a California resident can hold legal title to the Nevada property, thereby avoiding the ‘ancillary” probate.
There are also two popular misconceptions regarding the use of Revocable Living Trusts. First, a Revocable Living Trust will not protect your assets from the claims of creditors. Second, although a Revocable living Trust will allow you to avoid probate on death, an estate planning attorney will still be necessary to help administer the trust in order to address complicated tax issues and tax elections that can still arise. Therefore, while the cost of probate may be avoided, there may still be extensive “post-death” planning and administration necessary.
There are other methods of transferring assets upon death in addition to probate and the use of a Revocable Living Trust. Certain types of assets, such as pension plans and insurance policies are generally left to beneficiaries by means of a beneficiary designation form. This is essentially a contract which states the name of the person or persons who are to be paid the contractual benefits upon death of the pension plan participant the insured person. However, if the designated beneficiary is the Estate or the pension participant or the insured, then a probate of the contractual payment will most likely be necessary.
Another popular method for avoiding probate without the cost of a Revocable Living Trust is by holding property as joint tenants with right of survivorship. However, as discussed in greater detail below, a husband and wife who hold property as joint tenants instead of as community property may miss a substantial tax benefit that arises on the death of the first spouse (the “step-up” in basis, discussed below). In addition, creating joint tenancy property with a third party such as a child can constitute a taxable gift for gift tax purposes.
California has recently adopted another form of property ownership that can be utilized by married couples, called “community property with right of survivorship.” This new form of ownership is intended to qualify for the “step-up” in basis. However, as discussed below, relying on community property with right of survivorship and not a Revocable Living Trust, to pass property to a surviving spouse without probate, may result in additional estate tax upon the death of the second spouse. In addition, unless the surviving spouse later transfers such property to a Revocable Living Trust, then such property will be subject to probate upon the death of the surviving spouse.
It is also important to note that while these methods offer a simple way to transfer property to your heirs, this property will still generally be included in your estate for estate tax purposes, and subject to estate tax.
One of the goals of a properly structured estate plan is to minimize, to the extent possible, the estate tax due upon the death of an individual. As a general rule, there are two important dollar figures for estate tax purposes during 2009, namely $3,500,000 and $7,000,000, as discussed.
Under current law, each individual has an estate tax credit which during 2009 exempts from estate tax the first $3,500,000 of that individual’s taxable estate. For this purpose, the taxable estate is the net estate, determined after subtracting all liabilities, certain deductible payments and bequests and charitable gifts. Since this $3,500,000 exemption applies on a per person basis, a husband and wife together have a combined exemption of $7,000,000. The effect of the current $3,500,000 exemption is that for individuals dying in 2009, the first $3,500,000 of the individual’s estate can pass completely free of any federal estate tax. However, if an individual made any taxable gifts (more than a certain amount a year, which was $12,000 in 2008 and $13,000 in 2009) during his or her lifetime, the $3,500,000 exemption may be reduced.
The estate tax is scheduled to be repealed for 2010 only, and then enacted again in 2011 with the estate tax rate and the estate tax credit set at 2002 levels. You should expect the estate tax and the estate tax credit will be modified during 2009. Your estate planning should not assume that the estate tax will be permanently repealed.
In order for a husband and wife to take full advantage of their combined exclusion, they must be sure to properly structure their estate.
Example 2: The same facts as in Example 1 above, except that upon John’s death his estate is left to a “by-pass” or “credit shelter” trust of which Mary is the trustee and the beneficiary, and is entitled to all income for life. No estate tax is incurred upon John’s death because of his $3,500,000 exemption. Upon Mary’s subsequent death her estate consists only of her remaining $3,500,000 since the “by-pass” trust proceeds are not included in her estate. Therefore, no estate tax is incurred upon her death either, leaving an additional $1,575,000 for their heirs.
You should note that if a husband and wife hold all of their property as either joint tenants with right of survivorship, or as community property with right of survivorship in order to avoid probate, the by-pass or credit shelter trust will not be created, which, as described above, will ultimately result in higher estate tax.
USING THE MARITAL DEDUCTION TO AVOID ESTATE TAX
If the estate of the first spouse to die exceeds $3,500,000 can estate tax be avoided? There are two principal deductions allowed against the estate tax. The first is the charitable deduction. Second, and far more important following the death of the first spouse is the availability of the unlimited marital deduction.
Special planning is also required if one or both spouses are not U.S citizens. For this purposes it is important to keep in mind that an individual who holds a green card is not a U.S. citizen. If the surviving spouse is not a U.S. citizen the marital deduction will be available only if the bequest to the surviving spouse is left to a Qualified Domestic Trust or “QDOT.” A QDOT is similar to a QTIP Trust except that at least one trustee of the QDOT must be a United States citizen, and distributions of principal from the QDOT to the surviving spouse may be subject to an immediate estate tax during the life of the surviving spouse. In addition, if the principal amount of the QDOT Trust exceeds $2,000,000 (without reduction for indebtedness, such as a mortgage or deed of trust), a bank must serve as the U.S. trustee, or otherwise a bond or letter of credit must be posted as security for ultimate payment of federal estate tax. The $2,000,000 amount does not include up to $600,000 attributable to the QDOT Trust’s interest in the surviving spouse’s personal residence and related furnishings.
DISTRIBUTIONS OF ESTATE TO HEIRS AFTER DEATH OF SURVIVING SPOUSE
When preparing an estate plan you must decide how, following the death of the surviving spouse, the balance of your estate will be distributed to your children and any other beneficiaries. If your children are all financially astute, you may wish to immediately distribute their respective shares of the estate to them after the death of the surviving spouse. However, in many cases parents choose to have the balance of the estate remain in trust and distributed to their children over a period of time. In many cases, trusts for children will pay a child’s expenses for health, support, maintenance and education until that child attains age 21. Upon attaining age 21 it is not uncommon for each child to begin directly receiving his or her share of the income from his or her trust. However, for larger trusts, this may be too much income at an early age, and may need to be reconsidered. Trust principal can be distributed at such age or ages as you select in your Will or Revocable Living Trust. Many estate plans provide for principal distributions of one-half at age 25 with the balance at age 30, or one-third at ages 25, 30 and 35. The determination of how an estate is to be distributed to your children is yours personally, and depends upon factors such as the size of the estate and the ability of your children to manage their funds.
PLANNING FOR THE ESTATE IN EXCESS OF $3.5 MILLION
As we have seen from the examples above, in a properly structured estate plan, no estate tax is normally due until death of the surviving spouse, and then only if the total estate is in excess of $7,000,000 (if both spouses die in 2009). It is for estates that will be subject to estate tax after the death of the second spouse that the “planning” aspect of the estate planning is of greatest significance, since estate tax can only be minimized by taking advantage of certain planning techniques, preferably while both spouses are still living.
The simplest method of reducing a taxable estate is by taking advantage of lifetime giving opportunities to children and other family members. A husband and wife together can make gifts of up to $26,000 per year to any number of beneficiaries without gift tax. (the “annual exemption”). For example, a husband and wife with three children can make annual gifts of $78,000 per year to their children without incurring any gift tax. These annual gifts can consist of cash, property or a combination of both. As discussed in greater detail below, the annual exemption is frequently utilized in connection with certain other estate planning techniques.
A second gift tax exemption is the use of the “lifetime” credit. The lifetime gift tax credit is $1,000,000, meaning that no gift tax will apply on the first $1,000,000 of lifetime gifts made by an individual. Note that gifts made that qualify for the annual exemption, or the gift tax charitable deduction, do not reduce the lifetime gift tax credit. However, if the lifetime credit is used, the estate tax credit will be reduced dollar-for-dollar. The gift tax rates are the same as the estate tax rates, and are scheduled to be reduced at the same time as the estate tax reduction.
TRUSTS FOR CHILDREN AND GRANDCHILDREN
Very often an individual may be interested in making a gift to his or her children or grandchildren, but wants to retain control over the management and distribution of the gifted funds. In such a case a trust can be established to hold these annual gifts. Trusts for children and grandchildren are usually irrevocable and therefore care must be taken in setting forth their terms and conditions since they cannot be amended except under certain limited circumstances. If annual gifts are to be made in trust to grandchildren, the annual gift must also be structured in a manner which qualifies for the annual exclusion from the Generation. Skipping Tax, which is a second tax imposed on direct transfers to grandchildren, and discussed in greater detail below.
One of the more creative approaches to reducing estates taxes is by holding certain business or investments assets in a family partnership or a family limited liability company (referred to collectively in this discussion as a “family partnership”). In a family partnership the parents, children and even grandchildren (or trusts for the benefit of children and grandchildren) are all partners. Typically a family partnership will hold investment assets such as investment real estate or stock and bonds. By transferring assets to a family partnership the transferor effectively reduces the value of the transferred assets since the transferor no longer holds direct title to the investment assets, but only partnership interest in the partnership which owns those assets.
As discussed in greater detail below, it may be appropriate to transfer life insurance policies into a separate irrevocable trust which may allow the insurance proceeds to be excluded from the estate of the insured.
One of the most important uses of estate planning is to address the manner in which new investments and new business activities are to be undertaken. When starting a new business activity or acquiring new investment assets consider whether children and grandchildren, or trusts established for their benefit, should participate in this new business or investment such that from day one a portion of the value of that investment is not included in your estate. Typically, children and grandchildren (or their trusts) will receive their interests in these new investments by using the annual gift exemption.
GRANTOR RETAINED INTEREST TRUSTS
A Grantor Retained Interest Trust (or “GRIT”) is a special type of trust in which the grantor makes a current gift but retains the income or use of the property for a period of years. The value of this gift for gift tax purposes is typically the current value of the property reduced by the present value of the grantor’s retained interest.
GRITs can be utilized for investment assets or for personal assets such as your personal residence. GRITs are quite complex and are subject to a number of technical rules that need to be discussed in depth with your estate planning lawyer.
GRANTOR RETAINED ANNUITY TRUSTS
A Grantor Retained Annuity Trust (or "GRAT") is a special type of trust in which the grantor makes a current gift (usually using appreciating assets) but retains an income interest - in the form of annuity payments - for a period of years. At the end of the GRAT term (as long as the grantor lives beyond the term of the GRAT), the beneficiaries of the GRAT receive whatever is left in the GRAT. The value of this gift for gift tax purposes is typically the current value of the property reduced by the present value of the grantor's retained interest. The value of such interest depends on the grantor's life expectancy and the value at which money is expected to grow (the IRC Section 7520 rate). GRATs may be prepared in a manner that results in no gift tax consequences.
If the assets in the GRAT appreciate at a rate greater than the IRC Section 7520 rate, the beneficiaries of the GRAT will receive the appreciation amount free of gift or estate tax obligations. GRATs are quite complex and are subject to a number of technical rules that need to be discussed in depth with your estate planning lawyer.
As mentioned above, in computing the federal estate tax a deduction is allowed for gifts made to charity. Such gifts are typically made in cash, and made outright to charitable organizations. However, there are a number of variations applicable to charitable giving that can provide additional benefits, both during your life and after death.
Gifts of Property: Charitable gifts may consist of tangible or intangible property in addition to cash. This can be significant in the case of intangible property that may be difficult to value, and which may not be generating significant cash flow relative to its estate tax value. Patents, copyrights and trademarks are examples of intangible property which may have a high value for federal estate tax purposes relative to the cash flow generated by that property. Your estate may also include tangible property such as work of art, memorabilia, etc. that you may believe properly belong in a museum or similar collection.
Private Foundations: In the case of large gifts (generally in excess of $5000,000), your estate plan can include the creation of a “private foundation,” which is essentially a family –controlled organization that your children can operate as a “fund” for making charitable gifts in the future. In many cases, controlling a private foundation that can make charitable gifts will offer your children many social and professional advantages in the community. A private foundation can be established during your life, and contributions that you make to the foundation during your lifetime will be deductible for income tax purposes (although certain limitations may apply, which you should discuss with your tax advisor). Your estate plan would then include a bequest to your pre-existing private foundation, which would qualify for the federal estate tax charitable deduction. If you have not created a private foundation during your life, your estate plan can direct your trustee or executor to do so, with such gifts qualifying for the federal estate tax charitable deduction.
Charitable Trusts: Another form of charitable giving that provides both family benefits and estate tax savings while satisfying your charitable intentions are certain forms of charitable trusts known as charitable remainder trusts and charitable lead trusts.
A charitable remainder trust is a type of trust which distributes income to family members for a period of years, or for life, and then the expiration of that period distributes the remaining balance to charity. When a charitable remainder trust is established, an immediate charitable deduction is allowed, not withstanding that the charity will not receive the gift until after the expiration of the reserved income term. The charitable deduction will be equal to the present value of the remainder interest, which will be less than the full value of the property contributed to the trust. A charitable remainder trust can be established during your life, in which case the gift (the present value of the remainder interest) will be deductible for income tax purposes, or your estate plan can include instruction to establish the charitable remainder trust upon your death, in which case the present value of the remainder interest will be deductible for federal estate tax purposes.
A charitable lead trust is similar to a charitable remainder trust, except that the charitable interest and the family interest are reversed, i.e., the charitable organization will receive income distributions from the trust for a period of years, and the remainder will be paid to your family. The charitable deduction will equal the present value of the income stream payable to the charity. The difference between the value of the property transferred to the trust and the amount of the charitable deduction will be a gift to your family, and will be subject to gift tax if established during your life, and subject to estate tax if established upon your death. However, by careful structuring of the length of the term that income payments are made to the charity, and the amount of income paid to the charity, the present value of the taxable transfer to your family can be significantly reduced, potentially to zero.
Charitable trusts are extremely complex, and are subject to a number of technical tax rules that are beyond the scope of these materials. A charitable trust should only be established after careful consultation with your tax advisor.
Gifts From Pension Plans: As discussed in greater detail below, funds included in a pension plan or IRA at death are not only included in your estate for estate tax purposes, but are also subject to income tax when distributed to your beneficiaries. Therefore, to the extent your estate planning will include charitable gifts, there may be significant tax savings if the funds held in your pension plan or IRA are utilized as the source of the charitable gift. To do so, the beneficiary designation forms for you pension plan or IRA must be amended, with the charitable gift established using the beneficiary designation forms, in conjunction with your other estate planning documents. Again, your tax advisor must be consulted when establishing a charitable gift in this manner.
One of the most important aspects of estate planning, and one which goes far beyond the simple preparation of wills, trusts and related documents, is making sure that the financial needs of your estate, your family and your dependents are provided for.
Upon the death of the first spouse the principal goal is to make sure that the surviving spouse, and dependents, if any, have an adequate income stream to continue providing for all household and related expenses.
Liquidity can be provided for by using some or all of the following:
Investment Assets: Certainly the first place to begin in evaluating your estate’s liquidity and your overall financial planning is with your own investment and savings portfolio. Typically, this will be your single most important resource. As discussed above, you may wish to hold these assets in a family partnership in order to reduce estate taxes on the death of the surviving spouse.
Pension and Other Employment Benefits: If the deceased spouse is a participant in a qualified retirement plan then the surviving spouse may wish to begin taking distributions from the plan, if necessary. The surviving spouse can instead “roll-over” the retirement plan into an IRA, and continue to allow the account to grow tax-free. Distributions from the pension plan or IRA will generally be taxable as ordinary income. The deceased spouse may have other benefits such as stock options that need to be considered, or employer-owned life insurance. Stock options may require a cash payment in order to be exercised, so you need to make sure that your estate has sufficient cash available for this purpose.
Closely-Held Business Interests: In many families a significant portion of the family’s net worth is tied to a closely-held family business. The business may be an operating or manufacturing company or a service business, and may be co-owned with related or unrelated partners. Without adequate succession planning, these types of closely-held business interests can be highly illiquid, resulting in many cases in a forced sale at an enormous discount below what the family believes to be the actual value of the business. For closely-held business which are co-owned with other related or unrelated parties, appropriate arrangements should be in place to deal with the buy-out of a deceased co-owner’s interest in the business upon death. Buy-Sell Agreements which have been negotiated by all of the co-owners while living are commonly utilized for this purpose. More difficult are those family businesses in which the children do not participate, and which are wholly owned by the family, so that there are no other co-owners with whom to enter into a Buy-Sell Agreement. In those cases the value of the business can actually disappear (particularly in the case of a service business) if consideration is not given to the sale or other disposition of the business upon the death of the active family member.
Life Insurance: Having adequate life insurance can be an important component in a properly structured estate plan, and a source of liquidity upon death. Payment of the life insurance death benefit upon the of the insured is generally not subject to income tax, and thereafter can be invested in income producing assets to generate a continuous income stream. However, the remaining balance of any life insurance proceeds will be included in the estate of the surviving spouse absent any other planning, which can create a substantial estate tax liability in the estate of the surviving spouse. For that reason many people hold life insurance policies through Insurance Trusts. An Insurance Trust is simply a trust that holds a life insurance policy as its principal asset. A number of formalities need to be observed in order to make sure that Insurance Trust achieves all of its desired goals.
The operation of an Insurance Trust is relatively simple. During the insured’s life the Insurance Trust will simply own the insurance policy, and certain procedures for the payment of premiums must be followed, which are outlined below. After the death of the insured, the surviving spouse may receive distributions of income and/or principal as necessary for his or her health, support, maintenance and education. Other beneficiaries, such as your children may also have these same distribution rights if the trust is drafted accordingly. After the death of the surviving spouse the Insurance Trust can have essentially the same terms as your Will or Revocable Living Trust, and may hold and/or distribute income and principal to your children and other beneficiaries consistent with the other aspects of your estate plan.
The Insurance Trust provides liquidity to the estate of the second spouse by purchasing assets from the estate or making loans to the estate. Since the beneficiaries of the estate should generally be the same as the beneficiaries of the Insurance Trust, the overall economic interests of the surviving beneficiaries will be unchanged by these arrangements.
The trustee of an Insurance Trust during the life of the insured person should be someone other than the insured. It is often recommended that the trustee also be someone other than the insured’s spouse. Annual premiums are paid by having the insured make a gift each year to the Insurance Trust. These gifts should come from the insured’s separate property, and therefore it may be necessary to establish a separate property bank account and a separate property agreement as between the insured and the insured‘s spouse. Upon receiving a gift which can be used to pay premiums, the trustee should give the trust beneficiaries written notice that a gift has been received and provide them with certain limited withdrawal rights know as “Crummey” withdrawal rights. This annual gift utilized to make premium payments will be considered a gift to the beneficiaries, and care must be taken that the amount of this gift plus any other annual gift made by the insured to those same beneficiaries fall within the annual gift exemption described above. Assuming that the beneficiaries do not exercise their withdrawal rights, the trustee then utilizes the gift to pay the life insurance premium.
If properly structured according to the rule set forth above, the surviving spouse will be assured of having the financial resources of the Insurance Trust available following the death of the insured spouse, and the principal balance of the Insurance Trust will not be included in the surviving spouse’s estate upon his or her death. Therefore, the life insurance proceeds will ultimately pass to the insured’s heirs free of estate tax.
An Insurance Trust may be established with either an existing insurance policy or with a new insurance policy. In the case of a new insurance policy, the trustee of the Insurance Trust should be the applicant for the policy. In the case of an existing policy there are two rules that need to be considered. First, if the insured dies within three years after the policy has been transferred to the Insurance Trust the insurance proceeds will be brought back into the insured’s estate. Second, in the case of an existing insurance policy that has cash surrender value of the policy at the time of the transfer (generally called the “interpolated terminal reserve”) will be considered a current gift and needs to be evaluated under the $13,000 annual exemption rules discussed above.
An Insurance Trust may not be an appropriate planning tool for everyone. If you require the use of the cash value of your life insurance for other investment purposes, then an Insurance Trust should not be utilized since the cash value of the insurance policy will not be available to you. In addition, since there are a number of technical rules that need to be followed in establishing and maintaining an Insurance Trust, if abiding by all of these formalities will prove difficult then an Insurance Trust may not be an appropriate vehicle.
Sale of Appreciated Assets: Upon the death of a spouse, the income tax basis of that spouse’s assets will be equal to their fair market value at the date of death. For example, if a spouse owns stock with an original cost of $25,000 and a date of death value of $100,000, the surviving spouse could sell that stock for $100,000 and not have any capital gain because the income tax basis of the stock has been increased to the date of death fair market value. Because of the significance of this rule it is extremely important to note the manner in which legal title assets will be held. This is because the basis step-up rules differ between community property and joint tenancy property. Under current law, joint tenancy property is generally treated as owned one-half by each spouse, and only the deceased spouse’s share of joint tenancy property receives an income tax basis step-up. With community property the value of both spouses interest will be increased to the date fair market value.
Reverse Mortgage: In recent years a number of insurance companies have begun offering reverse mortgages on principal residences. Under a reverse mortgage, the insurance company provides a lifetime annuity in exchange for security interest in the annuitant’s principal residence. The effect of a reverse mortgage is to turn the principal residence into an income producing asset. Upon the death of the annuitant the insurance company will be entitled to a portion of the proceeds from the sale of the principal residence generally equal to the amount of the advances plus an interest rate on those advances.
Payment of Estate Taxes: Upon the death of the surviving spouse, another crucial liquidity issue is the payment of estate taxes. The estate tax is due nine months after the date of death. There are only three exceptions to this rule, the first which provides for an extension of time for payment in the case of “hardship” which will exist to the extent that the estate consists of illiquid assets that cannot be sold quickly without significant economic loss. A second exception applies if over 35% of the decedent’s estate consists of interests in one or more closely-held businesses, which allows a deferral of tax for 5 years, and then allows 10 years for the payment of the estate tax attributable to the closely held business interests. A third exception that allows for installment payments for 5 years applies to certain leasing and financing businesses that do not qualify for the longer deferral provision.
Since the estate tax is imposed at a rate of 45% on estates of over $3,500,000, it is important to properly factor in the estate tax payment as a liability of the surviving spouse’s estate. As discussed above, insurance proceeds, preferably through an Insurance Trust can be utilized for payment of estate tax.
Another type of life insurance which is utilized primarily for the payment of estate tax is second-to-die insurance, which is a single policy of life insurance on the joint lives of a husband and wife. The insurance proceeds are paid only after the death of the surviving spouse which means that this type of insurance can be significantly less expensive then life insurance on a single life. In order to maximize the benefits of second-to-die insurance, it is recommended that this insurance be held in an Insurance Trust so that the insurance proceeds are not included in the estate of the second spouse to die. Because this insurance does not pay until the death of the surviving spouse, there are far fewer formalities in establishing an Insurance Trust for second-to-die insurance than in the case of a single life policy. However, a second-to-die insurance policy should not be held in the same Insurance Trust which owns a traditional one-life insurance policy on one of the spouses.
As discussed briefly above, a second tax known as the generation-skipping tax is imposed upon certain gifts made directly to grandchildren and other beneficiaries who are considered to be at least two generations younger that the donor. The generation skipping tax (“GST”) is imposed at the maximum federal estate tax rate, and is imposed in addition to the federal gift or estate tax imposed on such transfer. Therefore, careful planning is needed for transfers that may be subject to the generation-skipping tax.
Each person has a $3,500,000 GST exemption. This means that in a properly structured estate plan, a husband and wife can leave $7,000,000 to their grandchildren and other beneficiaries two or more generations younger, without incurring GST. It is important to note that an individual who is more than thirty–seven and one-half years (37-1/2) younger than the donor will be considered to be two generations below the donor.
In order to make full use of the GST exclusion of husband and wife, complex Wills and/or Revocable Living Trusts are required, and if you wish to make bequests to grandchildren then you will need to discuss the effect of the GST with your estate planning lawyer.
There is also special GST annual exemption which differs slightly from the annual exemption for gift tax purposes, which also needs to be reviewed in the event that you wish to make annual gifts to your grandchildren, in trust or otherwise.
As an initial matter, from a financial planning standpoint, a family needs to consider replacing the income of a wage earner in the event of the disability of that wage earner. Therefore, care must be taken that appropriate disability insurance coverage is in place which satisfies the financial needs of the family. Keep in mind that the financial needs of the family are greater in the case of disability than in the case of the death of the wage earner because of the financial burden of caring for the disabled person, in addition to the family’s regular living expenses.
POWER OF ATTORNEY FOR FINANCIAL MATTERS
In the event that a spouse is disabled and unable to administer his or her financial affairs then a durable power of attorney (‘durable” meaning that it survives the disability of the grantor) will allow the holder of the power to function as the disabled person’s attorney-in-fact and thereby take control over the financial affairs of the disable party. It is important to note that if the disabled party has a fully funded Revocable Living Trust then typically upon disability the disabled person will no longer serve as a trustee and the then co-trustee (generally the spouse) or if there is no co-trustee the next successor trustee can take over all financial affairs without the need for a durable power of attorney. A durable power of attorney can be prepared such that it is effective upon signing or instead can be a “springing“ power in that it will take effect only upon the disability of the person granting the power. Please note that a person who is mentally disabled cannot execute a power of attorney after becoming disabled and in such case, absent a fully funded Revocable Living Trust, it will be necessary to have a third party appointed as the conservator of the disabled person in a public court hearing. In certain cases a much more limited durable power of attorney can be utilized, one which allows the holder of the power to transfer the assets of the disabled person into a Revocable Living Trust. This type of limited durable power of attorney is frequently utilized in standard estate planning practice in the event that a spouse becomes disabled after the estate plan has been prepared but before all assets have been transferred to the Revocable Living Trust.
A separate type of power of attorney is utilized to make health care decisions for a medically disabled person. By appointing an attorney-in-fact for health care decisions, the grantor of the power has effectively given another person the right to deal with health care professionals on the grantor’s behalf and give instructions that will be given effect as if given by the grantor personally. There are a number of different forms of durable power of attorney for health care available. Many estate planners prefer utilizing the form published by the California Medical Association since the form is readily available and is familiar to most California physicians. This durable power of attorney for health care will allow you to give a third party the right to make your health care decisions if you are unable to do so, including the right to terminate all extraordinary medical care, i.e., to ‘pull the plug.”
A living will or directive to physician is a written declaration in which an individual can instruct his or her physician to withhold or withdraw life sustaining treatment in the event of a terminal or a permanent unconscious condition in the event that the person is unable to make those decisions for him or herself. Unlike a durable power of attorney for health care, this document does not name a third party to act as agent. If a physician is unwilling to comply with the terms of the declaration, the physician must take all reasonable steps as soon as possible to transfer the care of the patient to another physician who is willing to comply with the terms of the patient’s wishes.
A husband and wife may have one or more children that require long-term medical or psychological care and who may rely on government provided benefits such as Medi-Cal for portion or all of their support. Any bequest left to such c child in the estate plan of the parents must generally be depleted in full before government benefit can again be paid. For that reason, for situations such as these a special needs trust is established for a child in this position. Under the terms of a special needs trust the bequest to that child is normally not distributed outright to the child, but remains in trust for so long as he or she requires continuing care. Another party, typically a sibling, is named as trustee and is entitled to utilize income or principal or both for the benefit of that child so long as to do so does jeopardize the child’s continuing qualification for benefits under the appropriate governmental programs.
GENERAL ESTATE PLANNING CONCERNS
Selection of Fiduciaries: As a general rule, the surviving spouse will act as the executor of the estate of the first spouse to die and will function as the sole trustee of any trusts that are established or which continue in force after the death of a spouse. The roles of an executor of a Will and a trustee of a Revocable Living Trust are generally intertwined, and it is preferable to name the same people to act in both capacities. One exception to naming the surviving spouse as the sole trustee after the death of the first spouse (other than in connection with a spouse who is not a U.S. citizen, as discussed above), is if there are children from prior marriages of the deceased spouse, and the deceased spouse wants to make sure that those children are protected during the life of the surviving spouse.
In general, except in the case of extremely large or complex estates that may require a professional fiduciary, or to protect children from earlier marriages, it is not necessary to look outside of the two spouses for fiduciaries until after the death of the second spouse. Successor fiduciaries can include children, other relatives, trusted friends, professionals such as an attorney or accountant, or in appropriate cases, professional trust companies and banks. In many cases two or even three people can act as co-fiduciaries together, particularly when one person is skilled at the administrative aspects of operating the trust and investments, and the other fiduciary is personally familiar with the needs of all the beneficiaries.
If you have minor children, you should also use your estate plan to select a guardian for those children. When selecting a guardian, consideration must be given to the financial capability of the guardian to provide a household for your minor children (although the resources of trusts established for your children will be available for their financial needs) and most importantly, whether the people that you have selected as guardians are willing to take on the responsibility of raising your children. In the event that a husband and wife are named as guardians you should also consider the effect on the guardianship if one spouse were to die or if they were to divorce.
As discussed above, there are significant advantages to holding legal title to your property as community property and not as joint tenancy. The IRS has acknowledged that property held in joint tenancy may in fact be community property for income tax purposes. Therefore, one of the documents that should be utilized in an estate plan is a community property agreement in which the spouses confirm that to the extent they hold any property as joint tenants, in fact that property is actually community property and should be subject to taxation as such. In the case of an estate plan which utilizes a Revocable Living Trust, another document that should be executed along with the Revocable Living Trust is a general assignment of assets whereby the parties assign all of their assets to the trust. This is not a substitute for formally transferring title to your assets to the Revocable Living Trust, but if necessary can serve as a back-up in the event of the death of one of the parties before formal funding can be completed.
As you have seen from these materials, estate planning consists of far more than the simple preparation of wills, and/or living trust. In order to prepare Wills and/or a Revocable Living Trust that meets all of your needs, it is first necessary to have a comprehensive review of your financial resources and your estate planning goals and desires. Only then you can begin to consider many of the different estate planning and tax planning devices described above that may be appropriate for your particular situation.
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