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 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.

“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.

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.

1. Unlimited: You give A the power to cut out A’s children and all others, in A’s Will.

2. 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).

3. 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).

4. 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.

5. 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.