- Will Planning
Where There's a Will, There's a (Better) Way
Many of our clients innocently create accounts, and even hold real property, in ways that circumvent their Will plan. In the best case, this might mean more taxes or sacrifice non-tax trust protections. In the worst case (and the examples are legion), this results in an ugly family fight, even litigation. Why so much emphasis on the style of ownership? Simply put, it matters. It defines to whom your asset passes upon your death. If you create a joint-tenancy-with-rights-of-survivorship account (“JTWROS”) or pay-on-death bank account (“POD”) or transfer-on-death brokerage account (“TOD”), you are undertaking to direct that account’s disposition when you die. And this may well be inconsistent with your Will plan. Even beyond those designations that are governed by specific statutes in the Texas Estates Code, some of the mega-financial institutions (Fidelity and Schwab to name a couple) have created their own version of accounts to “avoid probate.” These are often referred to by them as “beneficiary-designated” accounts, and they are touted by the institution as a way to avoid probate and have your heir(s) obtain easy access at your passing. To be sure, avoiding probate has a superficial allure to it. But recall that Texas probate is one of the most (if not the most) streamlined probate processes in the country. In approximately the same time it takes to secure a death certificate (which is the legal documentation required to access all of the above type accounts), one can secure “letters testamentary” as executor under Texas law (at least in most counties), allowing that executor to access all probate accounts. Why then do these institutions tout these types of “non-probate” accounts? Some people suggest they are focused on the retail customer, who does not have trust planning and tax planning objectives. Others, more jaded perhaps, sense that the institution is looking out as much for their own protection, not interested in getting ensnared in a potential Will contest that could conceivably affect probate accounts. Whatever their motivation, we emphatically urge our clients to default to avoiding these non-probate type accounts, unless we specifically approve them in the overall estate plan. Take John and Mary who are married and have Wills that create trusts for the surviving spouse upon the first death (in part for tax planning, and in part to protect from a second marriage). If John has a beneficiary-designated account that passes outright to Mary upon his death, he has sacrificed the trust protections as to that account. On the other hand, if his Will passes his estate in full to Mary, such an account would not be detrimental. Consider the children of a widowed client of ours who are to share the estate equally under her Will. One of the children, let’s call him Don, is Mom’s agent under her power of attorney and is the point person for helping with her financial affairs in her declining years. Mom set up a joint account with Don years ago, so he could sign checks and handle funds. The account was styled “JTWROS.” Don now sells Mom’s home and places the sale proceeds in the JTWROS account. Mom later dies, and the proceeds of the home appear to pass to Don on the face of the account, but has he perhaps breached his fiduciary duty by redirecting those from her Will to himself? Possibilities here: Don shares these funds equally with his siblings (has he made a taxable gift by doing so?). Or, perhaps a family feud ensues. Worst case of all, the parties polarize and a lawsuit absorbs a good portion of these funds. What about the new Texas law that allows a “transfer-on-death-deed”? Similar concerns arise, in that the superficial allure is to streamline matters upon death of the property owner, when indeed this could well complicate matters instead. As its name suggests, the transfer-on-death deed is a deed under which “Mom” retains her ownership in the real estate in question for life, but [revocably] directs its disposition in the deed as of her death. If Mom names two or more beneficiaries on such deed and one predeceases her, that share passes through Mom’s Will. Say she names Peter and James, both of whom have children, but Peter predeceases her. Peter’s share passes through her Will, which probably provides 50% to James and 50% to Peter’s children. Now, this means James is getting his half from the deed and another 50% of the remaining half via Mom’s Will; Peter’s children suffer by 25%, unintentionally. Moreover, these “TODD” deeds, while conceived to simplify matters at death, might stall a sale (and even require a court proceeding) if a title company is concerned about potential creditor issues until the “claims” period expires; this is not an issue when the real estate passes through the probate process. All in all, strategies that appear to be a “magic pill” need to be vetted with your estate planning attorney, given the particularities of your estate plan, and we at Farner & Perrin are here to do just that. Let us know when questions arise around these types of issues and we will help you navigate them.
Has the Estate Tax Law Been 'Simplified' by 'Portability'?
“Portability” is an estate tax relief provision for married individuals which was made a permanent part of the Federal estate tax statutes in 2013. The portability law provides that if a married individual dies and does not utilize all of his Federal estate tax exemption, then his surviving spouse may add her deceased spouse’s unused exemption amount to her own. (For ease of presentation, let’s assume that the husband is the first spouse to die, although be assured the same concepts apply if the wife dies first.) An individual’s estate tax exemption may be unused because his estate is not large enough to fully utilize the recently-expanded exemption amount, or because he left everything to his wife (a gift which qualifies for the marital deduction, so does not use exemption). In the latter case, portability can apply even in very large estates. In order to “port” unused exemption to the surviving wife, the husband’s executor must file a Federal Estate Tax Return (Form 706) for his estate, due nine months after the husband’s death, unless extended. This is a complex return to assemble and prepare, and essentially discloses all assets owned by the husband at the time of his death, as well as all outstanding liabilities. If this return is not timely filed, portability is lost. Think of it as claiming a “carry-forward” type tax benefit. Prior to portability, the primary method of preserving the husband’s estate tax exemption was to incorporate a bypass trust in the husband’s Last Will. The bypass trust was then funded following the husband’s death, with assets in his estate equal in value to his remaining exemption amount. While the bypass trust would benefit the wife for her lifetime, it would not be taxed as a part of her estate when she later died. If the husband’s estate was not large enough to fully fund his bypass trust, then his unused exemption would be lost, whereas with portability the unused portion can be added to the surviving wife’s exemption. These days, many married taxpayers have opted to simplify their Wills for good reason. There are certain advantages to relying on portability to preserve the husband’s unused estate tax exemption, primary among them being simplicity. Under the portability regime, all of the husband’s estate can be left outright to the surviving wife, foregoing the need for a bypass trust and its attendant administrative requirements. Additionally, with assets passing from husband to wife, these assets are eligible for a basis adjustment at the husband’s death and again at the wife’s death. This is especially important with appreciating assets. By contrast, assets held in a bypass trust are not included as a part of the wife’s estate, and therefore are only eligible for a basis adjustment at the husband’s death. Thus, relying on portability could save capital gains tax on assets sold after the wife’s death. Farner & Perrin, L.L.P., encourages our married clients to actively review whether they still wish to incorporate a bypass trust at the first death, a decision that could save ongoing costs associated with trust administration, and could have potential income tax benefits as well. On the other hand, there are definite disadvantages to relying on portability and foregoing the use of a bypass trust, and these must be weighed against the advantages. First, there is always the risk that the surviving wife could change her Will following the husband’s death, and that his children may not receive what the husband had intended to leave to them. This might be more of a risk in a blended family, but also could occur if the surviving wife remarries and leaves the assets to her new husband. A bypass trust better assures that the husband’s children receive his remaining assets following the wife’s later death, because his Last Will controls the disposition of the bypass trust assets when the wife dies. Also, one limitation of the new portability law is that it allows a surviving wife to port only her most recent husband’s unused exemption. So, if a widow remarries and then her second husband predeceases her also, she will lose the exemption that she “ported” from her first husband’s estate. There are also two subtle tax nuances that may favor the use of the bypass trust over portability. If a bypass trust is used, the estate tax exemption amount is measured at the husband’s death and may appreciate by the time of the wife’s death, to the extent the trust assets grow. In other words, the bypass trust is initially funded with the amount of exempt property, which can then appreciate during the wife’s lifetime and still be fully excluded from her estate at her death. Whereas, any unused exemption “ported” from a deceased husband does not grow during the surviving wife’s lifetime. Instead, it remains fixed as of the husband’s death; to wit, the amount ported when the husband dies will be the amount that the wife adds to her exemption when she dies, say 15 years later (assuming no remarriage). This can be an especially important advantage to using a bypass trust in estates where significant appreciation in assets is expected over time. Secondly, while the surviving wife can port her husband’s unused estate tax exemption, she cannot port his unused generation-skipping tax (GST) exemption. This can be significant where the estate plan includes lifetime trusts for children, with grandchildren as the ultimate beneficiaries. In such a case, if a couple relies on portability and foregoes the bypass trust option, their family will be limited in how much can be funded into these “GST exempt” trusts, based on the GST exemption available only at the wife’s death (in other words, the husband’s GST exemption will be wasted). By contrast, amounts funded into a bypass trust at the husband’s death can be made “GST exempt” by application of the husband’s GST exemption. The effect of this is generally to double the amount that can later avoid estate tax, at the children’s deaths. Many observers of the national debate over Federal finances ponder whether Congress may reduce the estate tax exemption in the future. If that were to happen, the bypass trust and its potential to “grow” the exemption may be important to consider. As with most tax issues, each case is unique and must be analyzed given its particulars, with an appreciation that the “tax tail” should not wag the dog.
Whose Will Controls at the End of a Trust Created in my Will?
The answer, as with most legal questions is, “it depends.” First, let’s recall that the very nature of a trust is a division of rights in more than one beneficiary, phased over time. Typically, person A is the named primary beneficiary for A’s lifetime (or shorter period expressed in your Will), and then your Will must address where the remaining trust property goes at A’s death. So, the short answer is that your Will governs the trust and defines the parties to benefit from the trust. Let’s assume your Will creates a trust for A for life, and says the remaining trust property will pass to B upon A’s death. Where the complication arises is that your Will may (optionally) allow A’s Will to override your ultimate disposition to B. Technically speaking, your Will may grant a “power of appointment” over the trust to A. Some practitioners humorously refer to a “power to appoint” as a “power to disappoint,” since it is the means by which B might be cut out/disappointed. And the devil is in the details. We must read your Will to discern the extent of the power you grant to A. For example, your Will may grant A an unlimited power of appointment, meaning you allow A to cut out B in favor of anyone of A’s choosing – which A may do in A’s Will. While it certainly appears that A’s Will controls in that situation, keep in mind that is only by reference to reading the power granted to A in your Will. Bottom line is your Will is the driver if your Will created the trust. So, you have an opportunity to custom-design how and to what extent A’s Will may “override” your Will insofar as the disposition of the trust upon A’s death. As the term “custom-design” implies, the ways people do so are as unique as the people involved. But allow us to cite a few examples, as food for thought. For purposes of these examples, let’s assume you have two children, A and B. Your Will says if A has children at A’s death, the trust passes to A’s children, but if none then living, then to B or B’s children, but if all deceased, then to X and Y.
- Unlimited: You give A the power to cut out A’s children and all others, in A’s Will.
- Classic: You give A the power to appoint to any of your descendants only. This way, A could favor one of A’s children over another for any reason, or even exclude them in favor of B. This could also be useful to change the terms on which A’s children will receive the trust (e.g., the age at which they may become trustee or withdraw the funds themselves).
- Classic restricted: You give A the power to appoint only to A’s children, and only equally among them, though A can differ their respective trusts for special reasons. Or you give A the classic power to appoint, but you restrict A to use the trustees your Will dictates (e.g., A cannot appoint A’s spouse as trustee for A’s children if your Will does not so authorize).
- Classic or spouse or charity: You give A the classic power to appoint, but you also allow a certain percentage (or all) to go to a spouse or charity, as A’s Will may determine. You could limit the spouse to a named spouse, or restrict A to placing the trust property in further trust for spouse until spouse’s death or earlier remarriage.
- Classic but more flexible after the last of your descendants dies: In addition to the classic power, if A survives all of A’s children, and B and all of B’s children, then you give A an unlimited power to appoint (see #1). Or, if you do not want A to divert the trust from X and Y, you could give A the power to divide among X and Y as A’s Will determines.
- Trust Planning
Brief Primer on Trusts
To Whom is a Trustee Answerable? The question of a Trustee’s duties and to whom the Trustee is answerable depends largely on the specific wording of the Trust in question. However, it is instructive to understand trust relationships in general before launching into an analysis of the Trust’s specific terms. The Trustee has “legal title” to the trust assets, meaning the unilateral power to conduct transactions with the same. Transactions include buying and selling assets and distributing income and principal from the Trust to its beneficiaries. The beneficiaries are divided into two categories, separated in time. The first beneficiary (or beneficiaries) are the ones entitled to get distributions currently. We will assume the Trust provides for distributions to one beneficiary for that person’s lifetime. We will call that person the “life beneficiary.” The second set of beneficiaries are the ones (or one) to whom the Trust passes when the life beneficiary dies. We call them the “remaindermen.” Now we have enough vocabulary to answer the initial question. The Trustee has duties to and is answerable to both the life beneficiary and the remaindermen. The specific Trust’s terms determine which of those sets of beneficiaries have greater rights. If the Trust states that the Trustee is to distribute any amounts in his discretion to the life beneficiary, then the remaindermen have very limited rights; they should expect they may not receive anything necessarily. Whereas, if the Trust provides that the life beneficiary is entitled to distributions for “health, support and maintenance,” then the Trustee is answerable to the remaindermen if the Trustee over-distributes to the life beneficiary. Another (optional) element in a Trust may limit the recourse of the remaindermen to hold the Trustee accountable: That is, if the Trust specifies that life beneficiary has a “power to appoint” the Trust, this is essentially the power to redirect the Trust away from a given remainderman. In such a case, any remainderman who challenges the Trustee in “over-distributing” to the life beneficiary may be left out of the Trust as a practical matter. Why is this so? When the life beneficiary realizes the remainderman is poised to challenge distributions the life beneficiary has received, that life beneficiary may well redirect the Trust away from the challenging remainderman. Bottom line: The parties to a Trust are the Trustee, the life beneficiary and the remaindermen. Their relative powers and rights depend on the terms of the Trust in question. In addition, if the Trust grants a power to appoint, the remaindermen may be well-advised to be circumspect before challenging the Trustee’s distributions to the life beneficiary.
The Role and Responsibilities of a Trustee
Before one can understand the role and responsibilities of a trustee, one must first understand some basics about a trust. At its core, a trust is divided ownership in the assets held by the trust: divided between a trustee, who holds legal title to the trust assets, and the beneficiary, who enjoys the beneficial ownership of the trust assets. In other words, the trustee manages and invests the trust assets, for the benefit of the trust beneficiary, who receives funds from the trust as directed in the governing trust document. Since the trustee has legal ownership of the assets held in a trust, but is managing the trust for the beneficiary, the trustee is a fiduciary and owes fiduciary duties to the beneficiary. In order to fulfill these duties, the trustee needs to understand the intention of the grantor (who established the trust), the power granted to the trustee, how and when distributions are to be made to the beneficiary, and what administrative functions need to be performed. It is important to note that there may be limitations on the trustee’s powers and additional duties imposed by state law, even though they were not listed in the trust documents. There are three main aspects to the responsibilities of a trustee:
- Act in the beneficiary’s best interests.
- Be familiar with the beneficiary’s needs and circumstances. To act in the beneficiary’s best interests, the trustee needs to know what those interests are.
- Avoid conflicts of interests. The Trustee owes the beneficiary a duty of loyalty and to avoid conflicts of interests. For example, the trustee should not take compensation for acting as a trustee unless the trust document or the state law allows it and the compensation is reasonable. Similarly, self-dealing such as purchasing trust assets or transacting trust business with family members can create an appearance of a conflict of interests.
- Exercise due care in the management of trust assets
- Collect the trust assets. The trustee needs to inventory what the trust owns and owes, and ensure all the trust assets are properly titled into the name of the trust.
- Protect the trust assets. The trustee needs to maintain adequate fire and other hazard insurance on the trust property. The trustee is also responsible for defending the trust against any legal claims against the trust assets. Valuables may need to be in a safe deposit box while real property has to be maintained in good condition.
- Invest the trust assets. The trustee has a duty to make the trust assets productive. The Prudent Investor Rule requires that the trustee must deal with the trust property as he would deal with his own assets in acting on his own behalf. The trust document and applicable law may limit what investments the trust can hold. Within these limits, the trustee shall invest the trust assets prudently and with the beneficiary’s best interests in mind.
- Distribute the trust assets. The trustee has a duty to distribute the trust assets in accordance with the governing trust document and applicable state law, and with the best interests of the beneficiary in mind. For example, the trust document may require that all the trust income be distributed annually, while the trust principal may be distributed only for health, education, maintenance, and support needs of the beneficiary. If the trust document specifically forbids certain distributions, e.g., an expensive car, the trustee is required to decline a request for such distribution.
- Perform administrative responsibilities.
- Maintain accurate and complete records of all income, expenses, purchases, sales and other transactions of the trust.
- File periodic and final accountings as required by applicable laws. Generally, a trustee is required to furnish the beneficiary with an annual report of the trust assets. The trustee is also responsible for filing an annual trust income tax return (Form 1041) with the IRS, should the trust’s income exceeds certain thresholds. If the trust holds business interests, there might be additional reporting requirements or tax returns required for these businesses as well.
- Coordinate with other fiduciaries. If there are multiple trustees, each co-trustee will have to coordinate and share information about decisions with others, and follow whatever voting procedures are in place for decision-making.
- Hire and manage third-party professionals. The trustee does not have to go it alone. The trustee can hire third-party professionals to assist with the management of the trust. However, the trustee has a duty to manage and review the performance of these professionals. Ultimately, the trustee is still responsible for any decisions made and action taken.
- Resign as a trustee. Depending on the trust document, the trust may only last for a specific timeframe, and/or allow for the trustee’s resignation and succession. Resignation is always an option for a trustee who can no longer serve.
Trust Planning, Who Do You Trust?
Non-Tax Considerations Depending on the size and nature of your estate, you may want to consider a more simplified Will while the estate tax exemption remains high, and you may be wondering whether you can dispense with the use of trusts in your plan. Aside from tax considerations (discussed below), the use of trusts is a highly individual matter. Estate planning is not only about taxes, but is also about inability, disability, creditors and predators, in-laws and outlaws. It is sometimes about protecting your heir from himself or herself, and sometimes more about protecting him or her from other people. It is about your legacy, about what you worked for and whom you wish to benefit from that hard work, and to what extent. A trust can provide added protection in all these circumstances: shielding assets from creditor and divorce claimants, providing asset management, and securing how assets are used in perpetuating your legacy. For all these reasons, even if we lived in a tax free world, most of our clients would still opt to include a trust in their Will for at least one of their heirs. A classic example is the “blended family,” where the wife wants to leave her estate to her husband, but have the remaining balance at his death secured for her own children. This requires a trust. Another popular approach is to leave an adult child his or her inheritance in a lifetime trust (of which the child is named as trustee), thereby protecting the inheritance from the child’s possible divorce or creditor problems and securing the amount remaining at the child’s death for grandchildren. Although these are vitally important considerations, we should remind ourselves of the responsibilities a trust imposes. Once activated (in this case, by death), a separate set of accounts and an annual trust income tax return are required. In addition, the trustee could be subject to challenge (even litigation) by the “remaindermen” (the parties who are entitled to the trust after the primary beneficiary is gone), either for improper investment choices or distribution decisions. Consider this scenario: wife is trustee of the family trust created in her deceased husband’s Will. She would like to “shut down” the trust, since she believes it serves no further tax purpose, given the estate tax law and the size of her estate at the time. It would behoove wife to get the children’s written agreement to such a course of action before proceeding. For the very reason that trusts provide various levels of protection, they cannot be disregarded unilaterally or arbitrarily. Testamentary Trusts That Save Taxes In addition, for our clients who are planning to mitigate the ultimate estate tax burden that falls on their family, the use of trusts in their estate planning is integral. Trusts can be structured so that the assets held in trust are not taxed as a part of the beneficiary’s estate when the beneficiary dies. These trusts can take a variety of forms and are called by a myriad of names (uniform nomenclature being long overdue in the estate planning community), but some of the most common types of tax-motivated trusts are discussed below. When one spouse dies, oftentimes his or her estate (up to the estate tax exemption amount) will pass into trust for the surviving spouse, and many times the children will also be included as beneficiaries of this trust. While the surviving spouse can be (and usually is) both the trustee and primary beneficiary of this trust, this trust is considered a separate entity for both income tax and estate tax reporting. As such, when the surviving spouse later dies, this trust will bypass estate taxes at the survivor’s death, having been shielded from estate tax by application of the first spouse’s exemption when he or she died. For this reason, this trust is most commonly called the “bypass trust,” but is also known by the name “family trust” and “credit shelter trust,” among others. However, now that “portability” has become a permanent aspect of our estate tax laws, a surviving spouse can potentially ‘share’ his or her deceased spouse’s unused estate tax exemption, limiting the necessity of a bypass trust from a tax point of view. When property is left to children after both spouses have died, the children’s assets can also pass into trust rather than to the children outright. Typically, each child will have a separate trust, so that investments and distributions can accommodate that child’s investment objectives and distribution needs, independent of the other children’s needs. Once a child reaches a specified age, the child usually becomes his or her own trustee, and is then able to manage the trust assets. Oftentimes called a “descendant’s trust” or “generation-skipping trust,” this type of trust allows for a child to be both a beneficiary and trustee of his or her trust, and yet maintain the trust as a separate entity for tax purposes. As such, this trust will not be estate taxed when the child dies, allowing the trust assets to pass to the next generation with no estate taxes at the child’s death. The availability of this tax advantage is limited to the amount of the parent=s generation-skipping tax exemption as of the parent’s death. Lifetime Trust Planning The trusts mentioned above are most commonly used by our clients as a part of their Will plan and do not become effective until one or both spouses die. Whereas, sometimes our clients decide to utilize their tax exemptions during their lifetimes and create gift trusts into which they transfer assets while they are living. Gift trusts can hold all manner of assets, though assets that are most likely to appreciate during a client’s lifetime are the most attractive targets for lifetime gifting. This allows the assets to grow outside the client’s estate, so that the appreciation will not be estate taxed. Since gift trusts are irrevocable once created, it is important that the client have a very high comfort level with the terms of the trust, and the permanent nature of the gift of the transferred asset. Life insurance trusts (into which clients transfer their life insurance policies) are popular gifting vehicles, because few people expect to utilize their life insurance policies themselves, and therefore are comfortable giving them away. Life insurance trusts (as all gift trusts) can be structured to be generation-skipping, and thereby afford a very effective leverage of a client’s generation-skipping tax exemption. The value of each gift to the trust is the annual premium payment on the life insurance policies, and this is the amount of generation-skipping tax exemption that is applied to shelter the entire trust from the second generation’s estate tax. This is so even though the ultimate face amount of the proceeds payable to the trust may be in excess of the generation-skipping tax exemption. Another popular lifetime estate planning trust is the Grantor Retained Annuity Trust (or “GRAT”). A GRAT is a trust where the creator of the trust (the grantor) retains an annuity payment back from the trust for a term of years (thus, the name). The value of the gift to the ultimate trust beneficiaries (typically the client’s children) is reduced by the value of the grantor’s retained annuity payments. To minimize the taxable gift, the annuity payments are typically structured to equal the initial value of the gifted property. This structure is referred to as a “zeroed-out GRAT” (i.e., the value of the taxable gift is virtually zero). While this may not sound attractive, this technique can transfer significant wealth to a client’s children if the assets transferred to the GRAT out-perform the IRS-dictated interest rate to be paid to the grantor with each annuity payment. The optimum assets to use for this trust are ones that are expected to increase rapidly in value, during the GRAT term. This is because a GRAT essentially transfers the ‘upside’ potential to the children. Assume for example that Mom transfers $1 million in assets to a 2-year GRAT when the applicable Federal interest rate is 3%. In order to “zero out” this GRAT, Mom must receive annual annuity payments totaling $1,045,000. Once Mom is paid back the $1,045,000, if excess value is left in the GRAT at the end of the 2 years, then all such excess value (the ‘upside’ potential) goes to the children completely gift tax free. Worst case, if the assets do not increase in value as expected, the assets are all paid back to Mom as part of the annuity, but there is virtually no downside risk. Importantly however, the grantor needs to survive the term of the GRAT in order for the transaction to be effective. Thus, mortality risk is an issue with these types of trusts, though they are usually designed as only 2 or 3 year trusts. One of the most powerful lifetime trusts to employ is the intentionally defective grantor trust (often called an “IDGT”). This type of gift trust causes the grantor to be the income taxpayer for the trust. The result is the grantor reports all income and loss earned in the trust on his or her individual income tax return, and any transactions between the trust and the grantor are invisible for income tax purposes. Not appealing at first glance, upon closer look this trust has distinct advantages. First and foremost, it allows the gift trust to grow in value for children and grandchildren, without being depleted by the usual income tax burdens. In effect, this type of trust allows the grantor to make future additional indirect gifts to the trust (the payment of its income tax), without these payments counting as gifts for gift tax purposes. Indeed, the Internal Revenue Service has explicitly approved this result in a 2007 Revenue Ruling. The point is that substantial wealth transfer can be achieved by this feature, given enough time. Secondly, as noted above, the income tax status of the trust allows the grantor to enter into transactions with the trust on an income-tax neutral basis. As a result, sales and leases between the grantor and the trust (which would otherwise be income taxable) are not tax recognition events. This feature allows the tax-free installment sale of an asset by the grantor to the trust at its current value, which if it appreciates significantly in future years has the effect of shifting all the growth to the gift trust/IDGT, with no diminution for income or capital gains taxes. The above summary is by necessity a generic overview of some of the most popular estate planning opportunities available with trusts. It is by no means an exhaustive treatment of trust planning, and is necessarily oversimplified to some degree. Also, many of these strategies are often applied in tandem to layer their advantages. Please visit with us further so that we may review your individual situation and discuss which options work best for your family.
- Funding Education
Get Educated on Getting Family Educated
As most of us are aware, tuition and fees at American colleges have increased exponentially in recent years, dramatically above the pace of inflation. Given this trend, financing college clearly requires advance planning. Families of means should give particular consideration to the most tax efficient ways of paying for higher education. Probably the most popular avenue for this planning is the Section 529 Savings Plan (the “529 Plan”). (Section 529 prepaid tuition plans are more limited in nature and are beyond the scope of this article.) Other alternatives include annual gifts to a Texas Uniform Transfers to Minors Account (“TUTMA”), a minor’s trust (in particular, a Section “2503(c) Trust”), and the direct payment of tuition to institutions of higher learning, which is not treated as a gift under Section 2503(e) of the Internal Revenue Code. Perhaps the simplest approach is the direct payment of tuition. However, its greatest disadvantage is that the donor (parent or grandparent paying for the education) must be alive at the time of the college experience in order to remove the education funds from his or her estate in this way. By contrast, a donor can make advance annual gifts qualifying for the gift tax annual exclusion through a TUTMA or 2503(c) Trust. (This exclusion amount started at $10,000 per donor/per year and is adjusted annually for inflation.) TUTMA gifts can easily be made by the donor into an account in the donor’s name as “custodian” for the minor, but it is important to recognize that the child owns the TUTMA account unrestricted at age 21. (Note that Texas law allows the custodian the right to transfer a TUTMA account into a 2503(c) Trust for the benefit of the minor. Let us know if you wish to explore this option.) The 2503(c) Trust differs from the TUTMA in that the child may be granted a mere thirty days upon reaching age 21 to demand the trust property, in lieu of which the trust may continue for a specified period, such as when the child reaches age 30. Income in a TUTMA is taxed to the child, whereas the income of a 2503(c) Trust is taxed to the Trust itself unless distributed to or for the child, or unless the child has reached age 21. Also note that children under age 18 (and full-time students under age 24) are now generally subject to the “kiddie tax,” under which their unearned income is taxed at their parents’ tax rates. The 529 Plan stands out above these alternatives as a superior means of securing funds for college in a tax efficient manner. This is largely because all income earned within a 529 Plan is tax-free, as long as it is used toward qualified higher educational expenses. These include tuition, room and board, fees, books and equipment required for enrollment in post-secondary schools (also, limited expenses on pre-collegiate tuition). Contributions to a 529 Plan qualify for the gift tax annual exclusion. In fact, 529 Plans enjoy the singular ability to “front-end load” annual gifts, using the donor’s coming 5 years’ of annual exclusion gifts for the named beneficiary of the 529 account, simply by electing on a gift tax return in the first year. It is imperative that the donors elect the five-year forward spread of the gifts on gift tax returns in year 1. The election avoids use of any of their gift tax exemptions, but they must also keep in mind that they have thereby used their annual gift tax exclusions for that child or grandchild for years 2 through 5. In addition, these gifts are no longer a part of the donor’s estate for Federal estate tax purposes, assuming the donor lives the full five years. Remarkably, even though these are completed gifts for transfer tax purposes, the tax law allows the donor to control the 529 account. The donor may change not only the investments (within the limits allowed by the Plan, generally once a year among a choice of portfolios), but may even change the ultimate beneficiary of the 529 account, with no adverse gift tax consequences as long as the new beneficiary is in the same family and generation as the initial beneficiary. The donor can go so far as to withdraw funds from the account for a purpose other than the beneficiary’s education, though such withdrawals are indeed income taxable and, to the extent representing income, are also subject to a 10% penalty. Also note that state income tax issues may arise in states other than Texas, depending on the residency of the beneficiary. Though qualification for financial aid is not usually a focus of affluent families, it is worth noting that 529 Plans enjoy more favorable treatment in this area than the TUTMA (which is fully countable) and the 2503(c) Trust, which is more subjectively counted as a resource for determining financial aid eligibility. A 529 Plan of which the student is the owner is generally excluded for this purpose, as is one owned by a grandparent. If a parent is the owner of the 529 Plan, it is countable as a family resource as opposed to a resource of the student. Keep in mind that all states have a 529 Plan (some have more than one) and your residency and choice of colleges are not relevant for investment in a given state’s 529 Savings Plan. In choosing a Plan, a donor should consider its investment return/choices, annual fees and exit fee to move to another state’s Plan if that becomes advisable. We invite you to consult resources that compare various attributes of the multitude of 529 Plans, including: www.morningstar.com, www.savingforcollege.com and www.529consulting.com. Farner & Perrin, L.L.P., values its part in assisting you in leaving a lasting legacy. Let us assist you in developing strategies to provide for the education of your family so as to enhance their lives and contributions to society.
- Creditor Protection
When Predators Lurk Below the Surface: Protecting Your Assets in Litigious Times
Much of our efforts focus on protecting wealth from our clients’ most significant known creditor, the IRS. Often, however, our clients are concerned about the possibility that unforeseen creditors may arise during their lifetimes and threaten the asset base that they have worked so long to build and secure. These unanticipated creditors could arise as the result of a lawsuit stemming from a driving accident, a business deal gone bad, or a professional liability claim. Even when these claims are frivolous or of a dubious merit, plaintiffs’ attorneys have been known to succeed in winning court judgments. While umbrella insurance coverage provides significant protection against certain risks, there are also legal strategies that can help protect you and your family from catastrophic loss in the event of an unanticipated judgment against you. While there are many possible asset protection vehicles, including some that require your assets be moved out-of-state or even outside the U.S., this discussion is centered on strategies applied in the State of Texas to its domiciliaries. Bear in mind that any asset protection vehicle is subject to the Texas Fraudulent Conveyance Act, and therefore a proper solvency analysis must be undertaken before moving forward with this type of planning. Once solvency becomes questionable or a potential creditor is known, it is too late to undertake asset protection planning. Certain asset classes enjoy favored status in terms of creditor protection. Among these are qualified retirement plans, IRAs, commercial annuities and life insurance policies (though “inherited” IRAs may not be protected, given a bankruptcy court case to that effect). Also, the State of Texas has always had a generous homestead protection statute, protecting a home with up to 10 urban acres or 200 rural acres from creditor exposure. Historically, the homestead protection has been unlimited in value. However, a Federal bankruptcy statute has made some inroads on this historic protection. Among other limitations for individuals in bankruptcy, there is now a limitation on the value of the homestead protection if the home was acquired within the roughly 40-month period preceding the bankruptcy. There is also a similar cap on a bankrupt individual who owes a debt arising from a violation of Federal security laws, which may be particularly significant to persons who are officers or directors of publicly-traded companies. Another time-honored means of protecting wealth from predators is the “spendthrift” trust. Indeed, leaving assets to a beneficiary in a spendthrift trust has been the traditional method of shielding assets from the beneficiary’s creditors, or even protecting the beneficiary from him/herself. Spendthrift provisions prevent the beneficiary from using his or her trust as collateral and limit the reach of creditors. These provisions are generally respected by the courts as being within the power of a donor to place conditions on any gift he or she makes. For this reason, many parents choose to leave assets in trust for their descendants for as long as state law allows, protecting the bequeathed property from the potential of creditor seizure for several generations. Note that this principle does not extend to the settlor (or creator) of the trust B that is, the vast majority of American jurisdictions, including Texas, adhere to the traditional notion that a person cannot shield such person’s own assets from the claims of his or her own creditors by placing assets in a trust for his or her own benefit. Notably, several U.S. states have joined the ranks of many foreign jurisdictions and now extend creditor protection to such “self-settled” trusts. This result requires one to place the trust assets with a trustee in such jurisdiction, oftentimes with uncertain results. A vehicle of more recent vintage is the family limited partnership, which also offers some asset protection features. Under most state statutes, including those of Texas, a judgment creditor may petition a court for a “charging order” with respect to a limited partnership interest in a partnership, but generally may not reach the underlying partnership assets in satisfaction of any claims against the limited partner. If a court issues a charging order, the creditor becomes an assignee of the partnership, and as such is entitled to receive any partnership distributions that the debtor-partner would have otherwise received. As a practical matter, these distributions could be limited (or even non-existent), depending on the terms of the partnership agreement. Thus, the creditor runs a risk in pursuing a charging order, since in so doing the creditor may also be required to assume the income tax liability with respect to the debtor’s share of the partnership income; note, however, that due to some uncertainty in interpretation, the tax liability result is not altogether clear. Suffice it to say that because of the potential problems associated with possessing a charging order against a limited partnership interest in a partnership, judgment creditors may be wary of seeking them, making the partnership vehicle at least an obstacle for creditors to overcome, encouraging favorable settlement. In deciding whether now is the time to consider asset protection planning for you and your family, remember that it is seldom too soon, but often too late, to begin this process. Once a creditor is known or likely to appear, asset protection transfers will be void and of no effect as to such creditor. Even worse, the Texas Fraudulent Transfers Act may apply, with potential punitive damages available to the creditor. If you would like to explore these issues further as to your specific situation, our Firm can be of assistance.
- Recent Newsletters
March 2018 Newsletter
Giveth the Tax Man
On December 22, 2017, President Trump signed the highly anticipated “Tax Cuts and Jobs Act” of 2017. Significant gift/estate tax relief is provided by the new law. Notably however, proposals to repeal the estate tax did not prevail. This appears to signal that the estate tax is here to stay.
Key provisions of the new estate/gift tax law are as follows:
- Specifically, the estate and gift tax exemption for 2018 is $11,180,000. More generally, the estate tax exemption is doubled from (a base before inflation of) $5,000,000 to $10,000,000, for an eight year period. On December 31, 2025, the new law “sunsets,” and the exemption will revert to $5,000,000 (adjusted for inflation, the exemption is estimated to be in the range of $6.5M by then). Going forward, the index for inflation is adjusted using a slightly diminished CPI measure.
- Most taxpayers will not itemize their deductions under the new law, and therefore will lose the benefit of their charitable contributions. For those taxpayers who continue to itemize, charitable contributions remain deductible, with an increased cap on cash contributions to public charities (now 60% of adjusted gross income). The former “Pease limitation,” which phased out charitable deductions above certain income thresholds, has been eliminated. The net result is that significant charitable gifts will be rewarded, while the more modest charitable giver will effectively be penalized from an income tax perspective.
- 529 Plans can now disburse up to $10,000 tax free per year for tuition at elementary and secondary schools. Previously, only college or graduate school expenses qualified for tax-free disbursements from 529 Plans.
- Traditional IRAs that have been converted to Roth IRAs can no longer be recharacterized as traditional IRAs. Under prior law, this recharacterization option provided a benefit if the IRA declined in value before the due date of the income tax return reporting the conversion.
These are some action items to consider:
- Since the higher gift/estate tax exemption will expire at the end of 2025 under current law, this may present a “use it or lose it” opportunity. High net worth clients may wish to consider using these higher exemption amounts (and the corresponding generation-skipping exemption) with gifts to trusts for children or spouses. Many creative and leveraged gifting options can be developed to fit your family’s situation. Of particular interest in a secure marriage is one spouse’s creation of a trust for the other spouse that escapes inclusion in both estates. Death before 2026 is another option for using the higher exemption (but not one we generally recommend).
- If your Will makes a “formula” gift of your estate (or generation-skipping) exempt amount, we highly recommend you consult with a Farner & Perrin attorney regarding the effects of the new tax law. In all likelihood that formula gift has just doubled, and a revision to your Will may be in order.
- Taxpayers with estates below the estate tax exemptions may need to re-evaluate the use of a bypass trust (see following article).
Finally, the substantial income tax changes to the tax law are beyond the scope of this article. We would be pleased to consult with you on the effects the new law might have on your business income, and whether a business re-structuring might be beneficial.
Back to Basics or Back to Basis?
Given the generous exemptions against the Federal estate tax, many of our clients are moving away from traditional “bypass” trust planning. We are seeing this arise not only as married couples update their planning, but we also see the issue arise after one of them has died with a bypass trust in their Will. This article discusses each of these situations and options they present. Let’s consider the case of Adam and Eve, and assume Eve survives Adam.
Traditionally, a bypass trust was seen as the best of both worlds, a veritable utopia. Upon Adam’s death, Eve managed and had access to the trust assets, but these assets were outside her taxable estate at her later death. A “cap” was placed on the bypass trust at funding, being Adam’s estate tax exempt amount as of his death. Yet, the trust assets could grow beyond that cap and pass to their progeny (Cain and Abel) upon Eve’s later death, with no estate tax. The accepted trade-off for estate tax exclusion was greater exposure to capital gains tax following the survivor’s death. If the trust were not deemed a part of the survivor’s estate, the tax relief provision granting a step up in basis at death would not be available for the trust assets upon the survivor’s death.
Fast forward to 2013 when “portability” was added as a permanent tax law feature. In very general terms, portability can be thought of as a “carry forward” of the exemption of the first to die, which is then added to the exemption of the second to die at the second death. If Adam died in 2018 with an $11M+ exemption and Eve died in 2026 with a $6M+ exemption, a full $17M+ might be able to be sheltered from estate tax in 2026, without use of a trust. As a result, the bypass trust might not be as compelling to Adam and Eve, depending on the size of their estates.
At this point in the drama, Adam and Eve are tempted…to remove any trust for their spouse in their Wills. They are lured by the idea of going back to basics: a simple outright bequest of all their estate to their spouse, mostly so that all assets can enjoy a step up in basis at the second death. They figure that if estate tax is not looming large over them, they will focus on saving their heirs exposure to capital gains tax.
However, like many couples, Adam and Eve desire an estate plan to protect Cain and Abel from the wiles of the surviving parent (who we will posit has a history of bad judgment and) who might remarry or otherwise disinherit them. In short, trust planning is still compelling for this couple, but the bypass trust turns out not to be utopia for capital gains tax reasons.
This couple may be well advised to incorporate a trust for their spouse that can achieve all their wishes. They want a trust to control the assets to better assure their own children ultimately inherit their estate. They also want to elect that the trust be treated as if in the survivor’s estate, in order to get the basis adjustment when the second spouse dies. This election is made on the Federal estate tax return of the first to die, and is referred to as a “qualified terminable interest property trust election,” or “QTIP” election. In the past, many of our clients have had both a bypass trust and a QTIP trust in their [old] estate plan, and some of them may benefit from revisiting whether this should be distilled down to one trust at the first death.
Bear in mind that this is a very fact-driven decision, depending not only on the ages of the of the couple and their net worth, but also the nature of their assets (e.g., IRAs and retirement plans are outliers for some of the above purposes). Of course, one of the biggest variables is the vicissitudes of Congress, which is all but impossible to predict. Recent tax changes have shown us that an estate plan made in 2008 for the same couple may look quite different than that recommended in 2018. Feel free to contact one of the Farner & Perrin attorneys to assess your particular situation.
The second context where we are seeing an increased emphasis on basis planning is after the first spouse’s death, when the bypass trust is dictated in the first spouse’s Will. Eve comes in to probate Adam’s Will and indicates she would prefer not to fund his bypass trust, so Cain and Abel can enjoy a further step up in basis on the trust assets when she later dies. In Eve’s case, let’s assume she is under a nefarious (and slimy, shall we say) influence, and may well cut the boys out of her Will eventually. The law protects Adam’s wishes by requiring her to fund the trust as intended (even if in actuality he intended it only due to tax reasons).
However, in harmonious family situations, we have counseled clients who wish to enter into a family settlement agreement to forego funding the bypass trust, or to dissolve one that has been funded previously. But this must be analyzed against possible gift tax consequences and even the risk of a future lawsuit. For example, Eve must consider a grandchild who, as a minor, is not able to sign the settlement agreement and may otherwise stand to share in Adam’s estate as per the bypass trust in his Will.
In sum, Adam/Eve should not be too impulsive in biting at the chance to move away from trust planning, without proper legal advice. We at Farner & Perrin encourage each client to embrace making their own decisions and understand the ramifications of their choices.
The Crude Oil Blues
The ever-talented George Strait may have crooned about Amarillo and All his Ex’s in Texas, but The Crude Oil Blues is a ballad instead made famous by rank-and-file Texans. Individuals owning oil and gas interests, as is so common in Texas, often fail to consider the requirements of transferring such mineral interests to their family members or other beneficiaries at death. Executors or beneficiaries too often encounter a daunting process to have those interests and their cash flow transferred into their names. In fact, some opt to leave these interests unresolved, due to lease inactivity or depressed market conditions. These loose ends in the administration of a decedent’s estate will ultimately cause greater entanglements for future generations, especially as the interests get fractionalized.
To ease the transfer of mineral interests at death, mineral owners may be well advised to consider placing their mineral interests in a limited liability company (LLC) during lifetime. The consolidation of Texas mineral interests into an LLC has compelling merits, with compounded benefits for individuals owning interests in multiple states. Whereas most of these interests within families constitute royalty interests, the mineral LLC offers an additional benefit for owners of working interests. That is, critical liability protection is achieved for the high-risk activities of oil and gas production. In fact, our Firm recommends that working interests and royalty interests be segregated into distinct LLCs so as not to expose the royalty interests to the risk of working interest liability within the same LLC entity.
As an example, meet George and Norma, both Texas residents. George owns, as his separate property, mineral interests in Texas, Louisiana and Oklahoma. Norma does not own any mineral interests herself, and has no experience with oil and gas interests or their management. George retires from his illustrious music career and at long last, passes away leaving his entire estate outright to Norma. Norma, as executor of George’s estate, probates his Texas Will in Atascosa County, Texas. Let’s review the steps Norma must take to transfer George’s mineral interests. Then, let’s compare the alternate results if George had formed Crude Oil Blues, LLC, during his lifetime.
Default strategy: Outright ownership of mineral interests at George’s death
- Not only must a Texas probate be undertaken for George’s estate, but in addition his out-of-state mineral interests require that Norma initiate ancillary probate proceedings in both Louisiana and Oklahoma. Once these probate processes are concluded, Norma must file a deed in each county (or parish) where George owned mineral interests in order to transfer the interests into her name. Norma must then contact each oil and gas operator with an active lease regarding the minerals and provide the necessary paperwork to have them reissue division orders in her name. The requirements for achieving revised division orders are as varied as the companies involved, and the royalty payments may be held in suspense for months while this is pending, first being a transfer from George to his Estate, then from the Estate to Norma.
- At Norma’s death, she leaves everything to their surviving children, equally and outright. The children must now go through the same onerous processes of multiple probate proceedings, filing deeds of conveyance and obtaining revised division orders, first out of Norma’s name to her Estate, then from her Estate in shares to her children. The mineral interests are fractionalized between the new owners (and further so, as each generation passes the interests down to future generations). This provides enterprising landmen with a chance to secure one party’s agreement on a lease and use such as leverage in negotiating with the others. A consolidated LLC could avoid that issue and more, as follows:
Alternate strategy: minerals owned in Crude Oil Blues, LLC, at George’s death
- Prior to George’s death, he conveys all of his mineral interests into Crude Oil Blues, LLC, and has division orders reissued to remit payments to the LLC. George is sole Member and sole Manager of the LLC. Since Norma is not versed on managing mineral interests, George includes provisions for the succession of management in the LLC Company Agreement, naming Hank, Jr., as successor Manager if George cannot serve.
- As a result, rather than owning mineral interests at his death, George instead owns 100% of the LLC membership interest. Accordingly, instead of bequeathing mineral interests to Norma, George bequeaths her all of his LLC membership interest. The membership interest passes under George’s Will via his Texas probate process, given it is personal property (rather than real property, as is a royalty interest). As a result, none of the underlying minerals require ancillary probate proceedings in Louisiana or Oklahoma. Furthermore, since the LLC already owns the minerals, there is no change in ownership of the minerals themselves (and therefore, no requirement to transfer by deed or reissue division orders). Norma now has the benefit of the royalty cash flow (through LLC distributions), but looks to Hank, Jr., to manage the interests on behalf of the LLC.
- At Norma’s death, her Will passes the LLC membership interest to the surviving children. They now each own a 50% interest in the LLC. As at George’s death, no deeds, out-of-state probate, nor revised division orders are necessary. Moreover, the mineral interests themselves (still wholly-owned by the LLC) are not further fractionalized down the family lines.
If George has the foresight to undertake the LLC plan, then once he is deceased, it’s pretty much Love without End, Amen.
F&P Folly and Prudence
- Fair is not always equal, and equal is not always fair.
- The worst thing about being a lawyer is we have to point out the worst things that can happen, and many times the worst thing does happen.
- Fly first class; your son-in-law will.
- At 40th anniversary party, husband announces, “My wife makes all the small decisions in this marriage, and I make all the big decisions….So far, there have only been small ones.”
- Graduation advice: Never trust anyone from Dallas.
Previous Newsletter (September 2017)
As Houston works to recover and rebuild after Hurricane Harvey, the law offices of Farner & Perrin, LLP, are fully operational and ready to address your ongoing legal needs. This is truly a catastrophic time for our city, and yet there is much resiliency and determination all around. We extend our very best wishes for eventual full recovery to those affected by the storm.
Be aware that individuals and businesses in any of the following counties may be eligible for certain Federal tax relief: Aransas, Austin, Bastrop, Bee, Brazoria, Calhoun, Chambers, Colorado, DeWitt, Fayette, Fort Bend, Galveston, Goliad, Gonzales, Hardin, Harris, Jackson, Jasper, Jefferson, Karnes, Kleberg, Lavaca, Lee, Liberty, Matagorda, Montgomery, Newton, Nueces, Orange, Polk, Refugio, Sabine, San Jacinto, San Patricio, Tyler, Victoria, Walker, Waller and Wharton.
The Federal tax relief comes in the form of extensions for certain taxpayer deadlines. Taxpayers with valid extensions through October 16, 2017 for their 2016 returns now have until January 31, 2018 to file those returns. (Note, however, that taxes which were not paid timely in April will continue to accrue interest and penalties, if applicable.) Additionally, quarterly estimated income tax that would normally be due in September and early January, as well as payroll excise tax due in October, will now be extended to January 31, 2018. This relief has been extended to Federal estate, gift and generation-skipping transfer tax returns as well. IRS has also announced that employer-sponsored retirement plans can make certain loans and hardship distributions to victims of Hurricane Harvey and members of their families. But, IRS is not waiving the 10% penalty that applies to “early” withdrawals.
Finally, the Texas Supreme Court has issued statewide special orders to modify and suspend court proceedings, reset limitations in civil cases, and allow out-of-state lawyers to practice temporarily in Texas for six months.
Contact a Farner & Perrin attorney if you need more information on these issues.
Change is Inevitable (except from a vending machine)
The 85th regular session of the Texas Legislature ended on May 29, 2017. Knowing trusts and estates legislation seldom attracts the interest of the media, here are some highlights that might impact your estate planning:
- Financial Powers of Attorney: The legislature made a number of substantial changes relative to financial powers of attorney, including the following:
➢ Appointment of Agents: An agent’s fiduciary duties arise only upon their acceptance of the appointment as agent, such as when the agent exercises authority or performs duties as agent. Two or more co-agents may be named, each of whom may act independently unless the document states otherwise. An agent may be given authority by the principal to name successor agents. Our Firm is cautious in granting these powers.
➢ Authority and Duties of the Agent: An agent is now authorized to take the following actions if expressly granted by a power of attorney: (1) create, amend, or revoke a trust; (2) make a gift; (3) create or change rights of survivorship; (4) create or change beneficiary designations; or (5) delegate authority under the power of attorney. An agent has a duty to preserve the principal’s estate plan, to the extent known by the agent. Farner & Perrin favors only powers 1 and 2, and only in certain cases.
➢ Third Party Acceptance of Power of Attorney: Except in limited circumstances, a third party presented with a power of attorney must now accept the power or request either an agent’s certification or an opinion of counsel that will substantiate the effectiveness of the power. A [separate] attorney for the agent needs to prepare and present the certification or opinion of counsel. Going forward, third parties are likely to require such a certification. As a result, we recommend that our clients execute proprietary powers of attorney from their brokerage firms (in addition to the statutory durable powers of attorney prepared by our Firm) in order to mitigate the obstacles presented by the new law. Farner & Perrin’s attorneys are pleased to field your questions concerning viability of your current power of attorney and recommend updates if advisable.
- Divorced Trust Beneficiaries: The Texas Estates Code was amended to clarify that the divorce of a trust beneficiary does not revoke express trust provisions in favor of the beneficiary’s ex-spouse. In response to this and recent case law developments, our Firm has developed specific provisions excluding former in-laws. We are glad to review your estate planning documents to evaluate this and add state-of-the-art language if applicable.
- Decanting: Texas Trust Code provisions authorizing “decanting” to a new trust have been slightly expanded. Decanting is the process of “pouring” an existing irrevocable trust into a new trust and remains fairly restrictive, even under the expanded Texas law. Decanting might be helpful for an irrevocable trust that needs some of its terms adjusted, especially the provisions for trustee succession. If applicable, this procedure can be done without court involvement.
- Beneficiary Designation for Motor Vehicles: Texas owners of motor vehicles may now designate a beneficiary to receive the motor vehicle upon the owner’s death, without the necessity of probate. This is achieved by submitting an application for title with the beneficiary designation to the Texas Department of Motor Vehicles (“TxDMV”). Be on the look out for a new motor vehicle title application that includes a beneficiary designation on the TxDMV website at http://www.txdmv.gov/motorists/buying-or-selling-a-vehicle.
- Digital Assets: Leaping into the 21st century, the Texas Estates Code now addresses access to an individual’s digital assets by four common types of fiduciaries: (1) executors or administrators of decedents’ estates, (2) court-appointed guardians or conservators of estates, (3) agents under financial powers of attorney, and (4) trustees. In general, if the digital custodian (e.g., Facebook) provides an online tool that allows the user to designate another person to access the user’s digital account, the user’s online instructions are now legally enforceable. In default of that, the user is legally authorized to give instructions in a Will or power of attorney.
Do You Have Super Powers, (and do you use them for good or evil)?
When you meet with a Farner & Perrin attorney, you are asked to provide us with a financial profile so that we can assess how the structure of your plan affects your specific assets. Many of our clients are fortunate to be beneficiaries of trusts and oftentimes do not realize they have certain powers over those trusts exercisable in their own Wills and otherwise.
We always inquire about those trusts, asking you to provide us with a copy. We then review the trust instrument to determine if you have any power to do the following: (1) name successor trustees; or (2) refine/redirect how the trust passes upon your death.
Some clients are inclined to defer (default) to the successor trustees named in the original instrument, but this can be quite burdensome/costly in the wrong case. Here’s an example. Benny-the-Beneficiary is the beneficiary of a trust from his parents. Benny is also the trustee of the trust, but if he cannot serve, the back-up trustee is Big Bank. When Benny dies, the trust passes to his two children, Bill and Jeff (both of whom are independently wealthy; Bill runs a software giant called Microsoft; Jeff runs an online shopping retailer called Amazon).
Benny would be well advised to undertake two planning steps, if the trust from his parents grants him the above-mentioned powers:
1. Benny could replace Big Bank as successor trustee in the event Benny is incapacitated or dies. Without this affirmative action by Benny, Big Bank becomes trustee at Benny’s death, acting as the “conduit” to take control of the trust assets and summarily pass them to Bill and Jeff. Since Big Bank takes on a “fiduciary” role at that point, there is a “toll charge” involved before Bill and Jeff can receive the assets. The toll charge is not insignificant (given the responsibility Big Bank has undertaken, including clearing pending tax obligations etc.). If Benny has been granted the power to replace Big Bank with say, Jeff, then Jeff can serve as that conduit trustee and distribute the trust assets to Bill and himself. To exercise this power, Benny simply executes a straightforward document, separate and apart from his Will. The key is identifying the issue, and that is where our Firm focuses. 2. Depending on the wording of his parents’ Wills, Benny could direct or “appoint” the disposition of his trust upon his death. Let’s assume Benny has the power to redesign how Bill and Jeff receive this wealth upon his death. Perhaps he feels that Bill and Jeff would be better served if their respective 50% shares of the trust were to pass in further trust upon his death. Jeff’s half could be held in a trust created under Benny’s Will, wherein Jeff is the trustee. Jeff’s continuing trust is protected from creditors or divorce, and is outside the reach of the Federal estate tax at Jeff’s death (up to a limit). The same would be true for Bill’s share of the trust.
Farner & Perrin is dedicated to helping clients who have these “super powers,” so that they don’t simply default to outdated trustee and beneficiary succession. You could say we want to see these powers used for the good for which they were intended.
A Generous Move by the IRS (you read that right)
In a taxpayer-friendly development, the IRS has issued guidance permitting certain estates to make a late “portability” election. This election allows a deceased person’s unused estate tax exemption amount ($5,000,000, indexed for inflation since 2011) to be “ported” to their surviving spouse by the filing of an estate tax return (IRS Form 706), due nine months after the first spouse’s death. The ported exemption is then available to shelter the surviving spouse’s subsequent transfers during lifetime or at death from the Federal gift/estate tax. Unfortunately, many individuals have been unaware of the availability of this portability election, and have failed to file a timely estate tax return.
Previously, the IRS had provided a simplified method for obtaining an extension of time to make a portability election. However, this simplified method was available only before January 1, 2015. Since then, the only way to make a late portability election has been to submit a private ruling request, which is an expensive and time-consuming process. Even so, the IRS has issued a substantial number of favorable private rulings granting an extension of time to elect portability on a late-filed estate tax return.
To provide relief for taxpayers and reduce the burden on the IRS, Rev. Proc. 2017-34 now provides a simplified method to obtain an extension of time to elect portability. This is available to estates of decedents that are not otherwise required to file an estate tax return (i.e., a gross estate below the $5,000,000+ threshold). This opportunity is only available until the later of Jan. 2, 2018, or the second anniversary of the first spouse’s date of death, by the filing of a complete IRS Form 706. There is no user fee for submissions for relief under this procedure.
If you know of an estate where the portability election was not timely made and could be of benefit to the surviving spouse, we encourage you to contact one of the Farner & Perrin attorneys to determine if this IRS relief might apply. We are always looking for ways to remediate and save taxes.
“Ain’t No Stoppin’ Us Now ~ we’ve got the groove”
A 70s retro groove, that is…*1979 Disco song by McFadden and Whitehead