Estate Planning Problem and Corresponding Answer

Kirk Bertino

Estate Planning Problem

Assume summer 2014 and no change in law.

The Client:

                John Kay, 56, married to Susan Kay, 41. They are U.S. citizens and reside in San Antonio, Texas. They have two children, Steve, 11, and Mary, 8. John also has a married son Gary, 24, from a previous marriage. Gary is married to Debi, 32, and they have a child aged 2. Debi also has a 6 year old child from a previous relationship. Gary once had a coke and alcohol problem, but he is “much better” now. Gary and Debi live in Taos and make a modest living selling pottery.

                John is a vice-president of the technology company “Cloudshare” and earns a salary of $440,000 annually. Susan owns a gymnastics business where she teaches classes and has open practice time for workouts. She operates the business as a partnership with Teri Ray. Susan receives approximately $50,000 per year from the partnership. The current value of the partnership is $150,000.

                Both John and Susan are in good health.

The Financial Position:

Assets                                                                                   Value

Checking                                                                              $      5,000

Stock                                     (Basis)

                Intel                       ($20,000)                             $   110,000

                Cree                      ($15,000)                             $   405,000

                Zynga                    ($20,000)                             $     45,000

                Yahoo                   ($15,000)                             $   175,000

                Dell                        ($20,000)                             $   160,000

                HP                          ($45,000)                             $     25,000

                Cisco                      ($15,000)                             $   305,000

                Cloudspace         ($50,000)                             $6,200,000

·         John’s Group Term Life Insurance Face Value $50,000 with Susan as named beneficiary.

·         John’s 401(k) with Susan as beneficiary: $1,900,000

·         Residence – Basis $270,000,        FMV $980,000

·         Vacation Condominium – Basis $280,000,              FMV $240,000

·         Lake Cabin in Michigan (John’s property prior to Marriage) – Basis $60,000,          FMV $185,000

·         Ranch in New Mexico –                 Basis $500,000                   FMV $3,830,000

(Inherited by John from his father. The ranch breaks even most years.)

Personal Property                                                           $190,000

Honda (S2000)                                                                   $  32,000

Suburban                                                                            $  20,000

Susan’s Property (as previously mentioned)       $150,000

Liabilities:

Mortgage on personal residence                              $510,000

Mortgage on Florida Condo                                         $120,000

Credit Card Debt                                                              $  90,000

Auto Loan                                                                           $  32,000

The Problem:

1)      What further questions do you want to ask John and Susan before you give them estate-planning advice?

2)      Feel Free to make any reasonable assumptions. Be sure and tell what assumptions you are relying on.

3)      What estate tax and estate problems would occur if John were to die today? Susan? Both?

4)      John currently has a simple will leaving everything to Susan and Susan has no will. What estate/tax/financial/personal/other advice do you have for John and Susan?

Write a plan of action for them.

5)      Explain why you chose the plan of action you selected.

6)      What Group did John Kay perform with? “Steppenwolf”

Answers:

What further questions do you want to ask John and Susan before you give them estate-planning advice?

·         Personal information of client:

·         First, middle, and last names as well as alias (a/k/a)

·         Date of birth

·         Primary address (domicile)

·         Phone numbers (cell, work, and home)

·         Email

·         Employer (Husband, Wife, Occupation, title, employer, address, phone number)

·         Business Associates (Name, business, buy-sell agreements)

·         Military Service (Husband, wife, current status, disability)

·         Children and dependents (Name, date of birth, parents)

·         Parents (Husband’s Wife’s) (Name, age, address, phone number, email)

·         Additional Family members (Names, age, address, phone numbers, email)

·         Special needs of family members or beneficiaries

·         Sketch a family tree

·         Citizenship

·         Marital agreements (obtain copies)

·         Business agreements (obtain copies)

·         Existing documents (obtain copies)

·         Assets (husband, wife, joint with spouse, joint with other than spouse)

                [Residence(s), mortgage(s)]

·         Banks and accounts

·         Investment accounts

·         Business interests

·         Annuities (Owner/Beneficiary-Primary/Contingent)

·         Life Insurance (Owner/Beneficiary – Primary/Contingent)

·         Advisors (Guardian of the children and their property, individual/corporate fiduciary to serve as personal representative after death of testator, Alternatives for both guardians and executors, Attorneys, Accountants, banker/trust officer, insurance advisor, investment advisor/broker, other) (Names, Addresses, Phone numbers and Email)

·         Documents to bring to interview (Wills, 3 years of personal income tax returns – fed and state, 3 years of business tax returns – include profit and loss and balance sheets, insurance policies – life/health/disability/casualty, Employee benefit plan descriptions – pension/profit sharing/group insurance/etc., business buy-sell agreements and employment contracts, pre/post-nuptial agreements and divorce decrees/property settlements, trust documents – created by you for you or members of your family, gift tax returns, homeowner’s policy and personal property floaters, deed to real estate, other)

·         Financial Acumen (on a scale of 1-10 the emotional maturity and financial acumen of the children)

·         Funeral/burial arrangements (Husband/wife - religious services, disposition of body, limitation on costs, other instructions)

·         Social Security status (reviewed in recent history?)

·         Homestead filed on the home?

·         Safe Deposit boxes (Number, institution, name in which is held)

·         Annual Income (Husband, Wife, dependent children – source – real property, interest, securities, other investments, trusts, pensions, Salary, other)

Family Financial Goals - On a scale of 1-5 have the client list the importance of the following:

·         Take care of family upon the client’s death.

·         Take care of family upon the event of disability.

·         College education for children.

·         Enjoy a comfortable retirement.

Estate Planning Goals – indicate if the following goals are desired by the client or issues are present:

·         Specific bequests – Add or delete a specific bequest to an individual or charity. Change the amount of a bequest.

·         Changes in valuation – In the last two years the value of the estate has changed by more than 20%.

·         Change in health – The client’s, the client’s spouse’s health or their children’s health has changed substantially in the last year.

·         Birth – A child or grandchild has been born since the making/last update of the estate plan.

·         Disability – A child/grandchild/dependent has become disabled/injured/incompetent since the making/last update of the estate plan.

·         Divorce/remarriage – A divorce or remarriage since the making/last up of the estate plan.

·         Cancellation of obligations or equalization of inheritance – The client would like to discharge a loan owed to him/her in the will. The client would like to add a clause to the will estate plan to equalize any gifts made in the past to certain children/grandchildren.

·         Life insurance - $100,000 or more of life insurance has been assed/dropped since the estate plan was made/last updated. The client would like to change a beneficiary in a policy. The client desires more life insurance, but is unsure what kind to get and how much.

·         Gifts to minors – The client would like to make a substantial gift to minor children/grandchildren.

·         Business Interests – The client has entered in to a stock/business buy-sell agreement since the making/last update of the estate plan. The business situation of the client has change significantly since the making/last update of the estate plan.

·         Guardians/Executors/Trustees – The client would like to name a specific individual as advisor to the executor(s) and trustee(s). The client would like to change the names of the guardians/executors/trustees.

·         Review of estate plan – The client would like to review his/her estate plan. The client would like to know how a change in tax law affects his/her estate plan.

Information to be kept in a Safe Deposit Box:

·         Birth Certificates

·         Marriage Certificates (including artifacts or documentation from any prior marriages or divorces.)

·         The clients and the client’s spouse’s will and trust agreements.

·         Listing of insurance policies or certificates

·         The clients and the client’s spouse’s social security numbers.

·         Military discharge papers.

·         Bonds, Stocks, and other securities.

·         Real estate deeds.

·         Business (buy-sell) agreements.

·         Automobile title insurance policies.

·         Property insurance policies.

What estate tax and estate problems would occur if John were to die today? Susan? Both?

If Susan were to die today her estate would pass intestate:

Intestate Succession – If the decedent does not have a will, property will pass according to state law. Typically a spouse with children would receive either (1) some dollar amount plus a fraction of the estate, or (2) some fraction of the estate. The fraction received by the spouse is often one third or one half of the estate. The children would receive the balance of the estate.

TEXAS ESTATES CODE

TITLE 2.  ESTATES OF DECEDENTS; DURABLE POWERS OF ATTORNEY

SUBTITLE E.  INTESTATE SUCCESSION

CHAPTER 201.  DESCENT AND DISTRIBUTION

SUBCHAPTER A.  INTESTATE SUCCESSION

Sec. 201.002.  SEPARATE ESTATE OF AN INTESTATE.  (a)  If a person who dies intestate leaves a surviving spouse, the estate, other than a community estate, to which the person had title descends and passes as provided by this section.

(b)  If the person has one or more children or a descendant of a child:

(1)  the surviving spouse takes one-third of the personal estate;

(2)  two-thirds of the personal estate descends to the person's child or children, and the descendants of a child or children; and

(3)  the surviving spouse is entitled to a life estate in one-third of the person's land, with the remainder descending to the person's child or children and the descendants of a child or children.

(c)  Except as provided by Subsection (d), if the person has no child and no descendant of a child:

(1)  the surviving spouse is entitled to all of the personal estate;

(2)  the surviving spouse is entitled to one-half of the person's land without a remainder to any person; and

(3)  one-half of the person's land passes and is inherited according to the rules of descent and distribution.

(d)  If the person described by Subsection (c) does not leave a surviving parent or one or more surviving siblings, or their descendants, the surviving spouse is entitled to the entire estate.

Sec. 201.003.  COMMUNITY ESTATE OF AN INTESTATE.  (a)  If a person who dies intestate leaves a surviving spouse, the community estate of the deceased spouse passes as provided by this section.

(b)  The community estate of the deceased spouse passes to the surviving spouse if:

(1)  no child or other descendant of the deceased spouse survives the deceased spouse; or

(2)  all of the surviving children and descendants of the deceased spouse are also children or descendants of the surviving spouse.

(c)  If the deceased spouse is survived by a child or other descendant who is not also a child or descendant of the surviving spouse, one-half of the community estate is retained by the surviving spouse and the other one-half passes to the deceased spouse's children or descendants.  The descendants inherit only the portion of that estate to which they would be entitled under Section 201.101.  In every case, the community estate passes charged with the debts against the community estate.

Sec. 201.059.  PERSON WHO DIES BY CASUALTY.  Death by casualty does not result in forfeiture of estate.

SUBCHAPTER C.  DISTRIBUTION TO HEIRS

Sec. 201.101.  DETERMINATION OF PER CAPITA WITH REPRESENTATION DISTRIBUTION.  (a)  The children, descendants, brothers, sisters, uncles, aunts, or other relatives of an intestate who stand

in the first or same degree of relationship alone and come into the distribution of the intestate's estate take per capita, which means by persons.

(b)  If some of the persons described by Subsection (a) are dead and some are living, each descendant of those persons who have died is entitled to a distribution of the intestate's estate.  Each descendant inherits only that portion of the property to which the parent through whom the descendant inherits would be entitled if that parent were alive.

Sec. 201.103.  TREATMENT OF INTESTATE'S ESTATE.  All of the estate to which an intestate had title at the time of death descends and vests in the intestate's heirs in the same manner as if the intestate had been the original purchaser.

If John were to die today with a will leaving everything to Susan his estate would pass as follows:

TEXAS ESTATES CODE

TITLE 2.  ESTATES OF DECEDENTS; DURABLE POWERS OF ATTORNEY

SUBTITLE C.  PASSAGE OF TITLE AND DISTRIBUTION OF DECEDENTS' PROPERTY IN GENERAL

CHAPTER 101.  ESTATE ASSETS IN GENERAL

SUBCHAPTER A.  PASSAGE AND POSSESSION OF DECEDENT'S ESTATE ON DEATH

Sec. 101.001.  PASSAGE OF ESTATE ON DECEDENT'S DEATH.  (a)  Subject to Section 101.051, if a person dies leaving a lawful will:

(1)  all of the person's estate that is devised by the will vests immediately in the devisees;

(2)  all powers of appointment granted in the will vest immediately in the donees of those powers; and

(3)  all of the person's estate that is not devised by the will vests immediately in the person's heirs at law.

(b)  Subject to Section 101.051, the estate of a person who dies intestate vests immediately in the person's heirs at law.

Liabilities for the debts of John and Susan would continue have to be paid in accordance with the following terms:

SUBCHAPTER B.  LIABILITY OF ESTATE FOR DEBTS

Sec. 101.051.  LIABILITY OF ESTATE FOR DEBTS IN GENERAL.  (a)  A decedent's estate vests in accordance with Section 101.001(a) subject to the payment of:

(1)  the debts of the decedent, except as exempted by law; and

(2)  any court-ordered child support payments that are delinquent on the date of the decedent's death.

(b)  A decedent's estate vests in accordance with Section 101.001(b) subject to the payment of, and is still liable for:

(1)  the debts of the decedent, except as exempted by law; and

(2)  any court-ordered child support payments that are delinquent on the date of the decedent's death.

Sec. 101.052.  LIABILITY OF COMMUNITY PROPERTY FOR DEBTS OF DECEASED SPOUSE.  (a)  The community property subject to the sole or joint management, control, and disposition of a spouse during marriage continues to be subject to the liabilities of that spouse on death.

(b)  The interest that the deceased spouse owned in any other nonexempt community property passes to the deceased spouse's heirs or devisees charged with the debts that were enforceable against the deceased spouse before death.

(c)  This section does not prohibit the administration of community property under other provisions of this title relating to the administration of an estate.

In the event once spouse predeceases the other the Homestead would be treated as follows:

TEXAS ESTATES CODE

TITLE 2.  ESTATES OF DECEDENTS; DURABLE POWERS OF ATTORNEY

SUBTITLE C.  PASSAGE OF TITLE AND DISTRIBUTION OF DECEDENTS' PROPERTY IN GENERAL

CHAPTER 102.  PROBATE ASSETS:  DECEDENT'S HOMESTEAD

Sec. 102.001.  TREATMENT OF CERTAIN CHILDREN.  For purposes of determining homestead rights, a child is a child of his or her mother and a child of his or her father, as provided by Sections 201.051, 201.052, and 201.053.

Sec. 102.002.  HOMESTEAD RIGHTS NOT AFFECTED BY CHARACTER OF THE HOMESTEAD.  The homestead rights and the respective interests of the surviving spouse and children of a decedent are the same whether the homestead was the decedent's separate property or was community property between the surviving spouse and the decedent.

Sec. 102.003.  PASSAGE OF HOMESTEAD.  The homestead of a decedent who dies leaving a surviving spouse descends and vests on the decedent's death in the same manner as other real property of the decedent and is governed by the same laws of descent and distribution.

Sec. 102.004.  LIABILITY OF HOMESTEAD FOR DEBTS.  If the decedent was survived by a spouse or minor child, the homestead is not liable for the payment of any of the debts of the estate, other than:

(1)  purchase money for the homestead;

(2)  taxes due on the homestead;

(3)  work and material used in constructing improvements on the homestead if the requirements of Section 50(a)(5), Article XVI, Texas Constitution, are met;

(4)  an owelty of partition imposed against the entirety of the property by a court order or written agreement of the parties to the partition, including a debt of one spouse in favor of the other spouse resulting from a division or an award of a family homestead in a divorce proceeding;

(5)  the refinance of a lien against the homestead, including a federal tax lien resulting from the tax debt of both spouses, if the homestead is a family homestead, or from the tax debt of the decedent;

(6)  an extension of credit on the homestead if the requirements of Section 50(a)(6), Article XVI, Texas Constitution, are met; or

(7)  a reverse mortgage.

Sec. 102.005.  PROHIBITIONS ON PARTITION OF HOMESTEAD.  The homestead may not be partitioned among the decedent's heirs:

(1)  during the lifetime of the surviving spouse for as long as the surviving spouse elects to use or occupy the property as a homestead; or

(2)  during the period the guardian of the decedent's minor children is permitted to use and occupy the homestead under a court order.

Sec. 102.006.  CIRCUMSTANCES UNDER WHICH PARTITION OF HOMESTEAD IS AUTHORIZED.  The homestead may be partitioned among the respective owners of the property in the same manner as other property held in common if:

(1)  the surviving spouse dies, sells his or her interest in the homestead, or elects to no longer use or occupy the property as a homestead; or

(2)  the court no longer permits the guardian of the minor children to use and occupy the property as a homestead.

Community Property shall be controlled as follows in the event one spouse predeceases the other:

STATES CODE

TITLE 2.  ESTATES OF DECEDENTS; DURABLE POWERS OF ATTORNEY

SUBTITLE C.  PASSAGE OF TITLE AND DISTRIBUTION OF DECEDENTS' PROPERTY IN GENERAL

CHAPTER 112. COMMUNITY PROPERTY WITH RIGHT OF SURVIVORSHIP

SUBCHAPTER A. GENERAL PROVISIONS

Sec. 112.001.  DEFINITION OF COMMUNITY PROPERTY SURVIVORSHIP AGREEMENT.  In this chapter, "community property survivorship agreement" means an agreement between spouses creating a right of survivorship in community property.

SUBCHAPTER B. COMMUNITY PROPERTY SURVIVORSHIP AGREEMENTS

Sec. 112.051.  AGREEMENT FOR RIGHT OF SURVIVORSHIP IN COMMUNITY PROPERTY.  At any time, spouses may agree between themselves that all or part of their community property, then existing or to be acquired, becomes the property of the surviving spouse on the death of a spouse.

Sec. 112.052.  FORM OF AGREEMENT.  (a)  A community property survivorship agreement must be in writing and signed by both spouses.

(b)  A written agreement signed by both spouses is sufficient to create a right of survivorship in the community property described in the agreement if the agreement includes any of the following phrases:

(1)  "with right of survivorship";

(2)  "will become the property of the survivor";

(3)  "will vest in and belong to the surviving spouse";  or

(4)  "shall pass to the surviving spouse."

(c)  Notwithstanding Subsection (b), a community property survivorship agreement that otherwise meets the requirements of this chapter is effective without including any of the phrases listed in that subsection.

(d)  A survivorship agreement may not be inferred from the mere fact that an account is a joint account or that an account is designated as JT TEN, Joint Tenancy, or joint, or with other similar language.

Sec. 112.053.  ADJUDICATION NOT REQUIRED.  A community property survivorship agreement that satisfies the requirements of this chapter is effective and enforceable without an adjudication.

                   

Sec. 112.252.  LIABILITIES OF DECEASED SPOUSE NOT AFFECTED BY RIGHT OF SURVIVORSHIP.  (a)  Except as expressly provided by Section 112.251, the community property subject to the sole or joint management, control, and disposition of a spouse during marriage continues to be subject to the liabilities of that spouse on that spouse's death without regard to a right of survivorship in the surviving spouse under an agreement made in accordance with this chapter.

(b)  The surviving spouse is liable to account to the deceased spouse's personal representative for property received by the surviving spouse under a right of survivorship to the extent necessary to discharge the deceased spouse's liabilities.

(c)  A proceeding to assert a liability under Subsection (b):

(1)  may be commenced only if the deceased spouse's personal representative has received a written demand by a creditor; and

(2)  must be commenced on or before the second anniversary of the deceased spouse's death.

(d)  Property recovered by the deceased spouse's personal representative under this section shall be administered as part of the deceased spouse's estate.

In the event that both parties die simultaneously the following applies:

TEXAS ESTATES CODE

TITLE 2.  ESTATES OF DECEDENTS; DURABLE POWERS OF ATTORNEY

SUBTITLE C.  PASSAGE OF TITLE AND DISTRIBUTION OF DECEDENTS' PROPERTY IN GENERAL

CHAPTER 121.  SURVIVAL REQUIREMENTS

SUBCHAPTER A.  GENERAL PROVISIONS

Sec. 121.001.  APPLICABILITY OF CHAPTER.  This chapter does not apply if provision has been made by will, living trust, deed, or insurance contract, or in any other manner, for a disposition of property that is different from the disposition of the property that would be made if the provisions of this chapter applied.

SUBCHAPTER B.  SURVIVAL REQUIREMENT FOR INTESTATE SUCCESSION AND CERTAIN OTHER PURPOSES

Sec. 121.051.  APPLICABILITY OF SUBCHAPTER.  This subchapter does not apply if the application of this subchapter would result in the escheat of an intestate estate.

Sec. 121.052.  REQUIRED PERIOD OF SURVIVAL FOR INTESTATE SUCCESSION AND CERTAIN OTHER PURPOSES.  A person who does not survive a decedent by 120 hours is considered to have predeceased the decedent for purposes of the homestead allowance, exempt property, and intestate succession, and the decedent's heirs are determined accordingly, except as otherwise provided by this chapter.

Sec. 121.053.  INTESTATE SUCCESSION:  FAILURE TO SURVIVE PRESUMED UNDER CERTAIN CIRCUMSTANCES.  A person who, if the person survived a decedent by 120 hours, would be the decedent's heir is considered not to have survived the decedent for the required period if:

(1)  the time of death of the decedent or of the person, or the times of death of both, cannot be determined; and

(2)  the person's survival for the required period after the decedent's death cannot be established.

SUBCHAPTER C.  SURVIVAL REQUIREMENTS FOR CERTAIN BENEFICIARIES

Sec. 121.101.  REQUIRED PERIOD OF SURVIVAL FOR DEVISEE.  A devisee who does not survive the testator by 120 hours is treated as if the devisee predeceased the testator unless the testator's will contains some language that:

(1)  deals explicitly with simultaneous death or deaths in a common disaster; or

(2)  requires the devisee to survive the testator, or to survive the testator for a stated period, to take under the will.

Sec. 121.102.  REQUIRED PERIOD OF SURVIVAL FOR CONTINGENT BENEFICIARY.  (a)  If property is disposed of in a manner that conditions the right of a beneficiary to succeed to an interest in the property on the beneficiary surviving another person, the beneficiary is considered not to have survived the other person unless the beneficiary survives the person by 120 hours, except as provided by Subsection (b).

(b)  If an interest in property is given alternatively to one of two or more beneficiaries, with the right of each beneficiary to take being dependent on that beneficiary surviving the other beneficiary or beneficiaries, and all of the beneficiaries die within a period of less than 120 hours, the property shall be divided into as many equal portions as there are beneficiaries.  The portions shall be distributed respectively to those who would have taken if each beneficiary had survived.

SUBCHAPTER D.  DISTRIBUTION OF CERTAIN PROPERTY ON PERSON'S FAILURE TO SURVIVE FOR REQUIRED PERIOD

Sec. 121.151.  DISTRIBUTION OF COMMUNITY PROPERTY.  (a)  This section applies to community property, including the proceeds of life or accident insurance that are community property and become payable to the estate of either the husband or wife.

(b)  If a husband and wife die leaving community property but neither survives the other by 120 hours, one-half of all community property shall be distributed as if the husband had survived, and the other one-half shall be distributed as if the wife had survived.

 Sec. 121.153.  DISTRIBUTION OF CERTAIN INSURANCE PROCEEDS.  (a)  If the insured under a life or accident insurance policy and a beneficiary of the proceeds of that policy die within a period of

less than 120 hours, the insured is considered to have survived the beneficiary for the purpose of determining the rights under the policy of the beneficiary or beneficiaries as such.

(b)  This section does not prevent the applicability of Section 121.151 to proceeds of life or accident insurance that are community property.

With regards to the John’s separate property in New Mexico if John were to predecease with a will leaving everything to his wife, Susan:

45-3-101. Devolution of estate at death; administration on deaths of husband and wife.   

A.   The power of a person to leave property by will and the rights of creditors, devisees and heirs to the person's property are subject to the restrictions and limitations contained in Chapter 45, Article 3 NMSA 1978 to facilitate the prompt settlement of estates.

B.   Upon the death of a person, the person's separate property and the person's share of community property devolves:

(1)   to the persons to whom the property is devised by the person's last will;

(2)   to those indicated as substitutes for them in cases involving revocation, lapse, disclaimer or other circumstances pursuant to Chapter 45, Article 2 NMSA 1978 affecting the devolution of testate estates; or

(3)   in the absence of testamentary disposition, to the person's heirs or to those indicated as substitutes for them in cases involving revocation, lapse, disclaimer or other circumstances pursuant to Chapter 45, Article 2, Parts 3, 4, 10 and 11 NMSA 1978 affecting the devolution of intestate estates.

C.   The devolution of separate property and the decedent's share of community property is subject to rights to the family allowance and personal property allowance, to rights of creditors and to administration as provided in Chapter 45, Article 3 NMSA 1978.  The surviving spouse's share of the community property is subject to administration until the time for presentation of claims has expired, and thereafter only to the extent necessary to pay community claims.

With regards to the John’s separate property in Michigan if John were to predecease with a will leaving everything to his wife, Susan:

A Johns will is valid as long as the following conditions are met, which will allow the Michigan lake cabin to pass to Susan:

700.2501 Will; maker; sufficient mental capacity.

Sec. 2501.

(1) An individual 18 years of age or older who has sufficient mental capacity may make a will.

(2) An individual has sufficient mental capacity to make a will if all of the following requirements are met:

(a) The individual has the ability to understand that he or she is providing for the disposition of his or her property after death.

(b) The individual has the ability to know the nature and extent of his or her property.

(c) The individual knows the natural objects of his or her bounty.

(d) The individual has the ability to understand in a reasonable manner the general nature and effect of his or her act in signing the will.

With regards to the condominium in Florida regardless of which spouse predeceases the following apply:

2013 Florida Statutes - Chapter 689 
CONVEYANCES OF LAND AND DECLARATIONS OF TRUST

689.11 Conveyances between husband and wife direct; homestead.—

(1) A conveyance of real estate, including homestead, made by one spouse to the other shall convey the legal title to the grantee spouse in all cases in which it would be effectual if the parties were not married, and the grantee need not execute the conveyance. An estate by the entirety may be created by the action of the spouse holding title:

(a) Conveying to the other by a deed in which the purpose to create the estate is stated; or

(b) Conveying to both spouses.

(2) All deeds heretofore made by a husband direct to his wife or by a wife direct to her husband are hereby validated and made as effectual to convey the title as they would have been were the parties not married;

(3) Provided, that nothing herein shall be construed as validating any deed made for the purpose, or that operates to defraud any creditor or to avoid payment of any legal debt or claim; and

(4) Provided further that this section shall not apply to any conveyance heretofore made, the validity of which shall be contested by suit commenced within 1 year of the effective date of this law

                                                                              

2013 Florida Statutes - Chapter 689 
CONVEYANCES OF LAND AND DECLARATIONS OF TRUST

689.15 Estates by survivorship.—The doctrine of the right of survivorship in cases of real estate and personal property held by joint tenants shall not prevail in this state; that is to say, except in cases of estates by entirety, a devise, transfer or conveyance heretofore or hereafter made to two or more shall create a tenancy in common, unless the instrument creating the estate shall expressly provide for the right of survivorship; and in cases of estates by entirety, the tenants, upon dissolution of marriage, shall become tenants in common.

Under these conditions either spouse should receive the property through the right of survivorship by tenancy by the entirety.

Additional Considerations if John were to die today? Susan? Both?

A will does not take effect until the testator dies. The testator is generally free to revoke or change his will up until death. A will can provide three types of legacies: Specific, General, and residual.

• A Specific Legacy disposes of a specific piece of pieces of property.
•  A General legacy disposes of a certain amount or value of property.
• A residual legacy disposes of all property that has not been disposed of through               specific or general legacy.
• A legatee is a person who receives a legacy from the testator.

Limitations on disposition of property at death – The surviving spouse is generally given the right to elect to take against the will. This amount is usually one third or one half the estate, but can be as much as all of the estate. This right can be waived by agreement during lifetime. The spouse may also be given a homestead right which would allow the spouse to live in the home during the life of the surviving spouse. Some states give children this right as well. Most states give an allowance for the surviving spouse and the children for a period of time after the decedent’s death.

Some states provide that a will executed before marriage is revoke upon marriage.

A mortmain statute is a statue some states have that restricts the amount that may go to a charity if a decedent is survived by a spouse or child.

Intestate Succession – If the decedent does not have a will, property will pass according to state law. Typically a spouse with children would receive either (1) some dollar amount plus a fraction of the estate, or (2) some fraction of the estate. The fraction received by the spouse is often one third or one half of the estate. The children would receive the balance of the estate.

A will can set out the terms of a trust in which the named trustee can manage assets on behalf of the beneficiaries. Such trust is referred to as a “testamentary” trust. The trust starts to exist at the probate of the will.

                When there are minor children the will can name a “guardian of the person” who provides care and custody of the child and a “guardian of the estate” who manages the child’s estate.

It is important for the client to mention all heirs in a will especially if the client intends not to leave that person any assets.

                Pour Over provision – Provision in a will which transfers and assets not in a trust to that trust when the testator dies.

                At death, federal estate taxes are imposed on property that is transferred to the beneficiaries. However, each U.S. resident has a unified credit that eliminates the estate tax on the first $5,250,000 in 2013 (The amount is adjusted annually for inflation).

                State Taxes need to be estimated as they can cause serious liquidity drain of the estate.

Deductions allowed for estate tax:

·         Marital deduction;

·         Charitable deduction;

·         Debts of decedent;

·         Administration expenses;

·         Funeral expenses; and

·         If a married individual wishes to minimize taxes at his death, his will should provide for all assets in excess of the unified credit exemption above to pass to his spouse or to a trust for the benefit of his spouse, so a marital deduction can be taken for those assets.

·         The law currently provides that that surviving spouses will be able to use the amount of the estate tax exemption which the deceases spouse did not use. This is often referred to as “portability of the estate tax exemption”.

             

Most assets in the decedent’s gross estate receive a new income tax basis equal to the fair market value of each asset at the time of the decedent’s death.  If the assets increase in value that asset receives a “step-up” in basis.

However, any asset that would been taxed as income had the decedent lived long enough to receive it does not receive a step up in basis. These assets are generally termed “income in respect of decedent” and they retain whatever income tax basis the testator had in them.

Advantages of probate – Going through probate involves stricter supervision of the management and disposition of assets. Another benefit of probate is that it has a cut-off period for creditors. As part of the probate process, a notice of death is given to all creditors. With an inter vivos trust, generally these claims are not cut off.

State apportionment statutes – the state law will allocate the burden of the taxes among beneficiaries. Many states require beneficiaries pay a share of estate taxes unless the will provides otherwise. The will should state who pays the tax on probate and non-probate property.

                Who is to pay the tax on a generation-skipping transfer? Some draftsmen will specifically provide that such taxes are not to be imposed on the “skip-person’s” estate.

                Personal property – the client may want to take pictures of personal property and indicate how the property is to be disposed of.

                If an item is not in the will at the time of death has a provision been made to compensate the intended beneficiary with a comparable piece of property or insurance if the property was lost, stolen or destroyed?

                The client should allowing the executor of the estate to take possession of property located in many different locations “as and where is” at the expense of the estate.

                Specific items of tangible property should be mentioned. “All other tangible personal property” should dispose of any residual property.

                A will should not “incorporate by reference” an instrument outside the will as it leads to litigation.

                Does the will make so many specific bequests of cash that the residuary estate doesn’t have enough to pay estate taxes?

                A tangible personal property clause should nearly always be used where the residue of the estate will be paid to a trust.

Residuary clause – (1) transfers all assets not disposed of up to this point, (2) can provide a mechanism for “pouring over” assets from the will to a previously established (inter vivos) trust, and (3) provide an alternative disposition in case a primary beneficiary has dies or the trust to which the assets were to be poured over to was for some reason invalid, revoked or never came into existence. Including “per stirpes” reference insures that if the intended beneficiary dies the bequest will pass to his/her children.

                Marital Deduction formula clause – Such clauses are typically divide the client’s estate into two parts, one “marital” and one “non-marital”. The marital portion passes property to the client’s surviving spouse as part of the marital deduction and may contain an outright disposition or trust disposition. The non-marital portion is designed to set aside property exempt from federal estate tax by reason of the client’s available unified credit and passes property to persons other than the surviving spouse. While assets are passing to a “bypass trust” as opposed to the surviving spouse, this does not mean that the spouse cannot be a beneficiary of the bypass trust.

                For the years beginning in 2011 surviving spouses can use the so-called “portability” provisions which allow them to add the unused estate tax exemption of the spouse who died most recently to their own. This provision, plus an increase in the exemption amount to $5.25 million per person, enables married couples to transfer as much as $10.5 million tax free to their children or other heirs. Particular attention must be paid to not over pack the bypass trust and pay less than expected or desired into the marital trust. Use of the bypass trust will often require that some of the client’s assets be retitled.

                A “savings clause” should be considered that would nullify any power, duty, or discretionary authority that might jeopardize the marital deduction.

                A “common disaster” clause provides the presumption that the testator’s spouse is deemed to survive the testator’s death to prevent a loss of the estate tax marital deduction in the event of a simultaneous death.

                The will should have alternative beneficiaries if there is the possibility that a beneficiary will disclaim an interest in the estate.

Estate Tax:

The federal estate tax is a tax on the transfer of property when a person dies. It is a tax on the right to transfer property to others or an interest in property, rather than a tax on the right to receive property – the basic characteristic of an inheritance tax. The tax is levied on certain lifetime transfers that in essence are tantamount to testamentary dispositions and on transfers over which the decedent retained certain interests or powers.

Computation of the federal estate tax:

(1)    The gross estate is eh total value of all the property in which he decedent had an interest and that is required to be included in the estate either values at the date of death or under limited circumstances, for up to 6 months from the date of death.

(2)    The adjusted gross estate is determined by subtracting allowable funeral and administrative expenses from the gross estate.

(1)    The taxable estate is determine by subtracting from the adjusted gross estate any allowable marital deduction, charitable deduction, or state death tax deduction for state death taxes actually paid.

(2)    The federal estate tax payable before credits (or tentative tax) is determined as follows:  (a) the tentative base (or contribution base) is calculated by adding to the taxable estate any “adjusted taxable gifts”; (b) the tax rate is the applied to determine the tentative tax; (c) the aggregate amount of gift tax which would have been payable with respect to gifts made by the decedent after 1976.

(3)    To determine the federal estate tax, the estate tax is reduced, dollar-for-dollar, by subtracting the amount of any allowable: (a) unified credit, (b) Credit for pre-1977 gift tax, (c) credit for tax paid on  prior transfers (or previously taxed property credit), (d) credit for foreign death taxes.

Ascertaining the Gross Estate – The following equals the gross estate before exclusions for federal estate tax purposes:

(1)    Property owned outright;

(2)    Certain property transferred gratuitously within three years of death and all gift taxes paid on all gifts made within three years of death;

(3)    Certain lifetime transfers where the decedent retained the income or control over the income from the property transferred;

(4)    Certain gratuitous lifetime transfers where the transferee’s possession or enjoyment of the property is contingent on surviving the decedent;

(5)    Gratuitous lifetime transfers over which the decedent retained the right to alter, amend, or revoke the gift;

(6)    Annuities or similar arrangements purchased by the decedent and payable for life to both the annuitant and to a specified survivor (joint and survivor annuities);

(7)    Certain jointly held property where another party will obtain the decedent’s interest at death by survivorship;

(8)    General powers of appointment;

(9)    Life insurance in which the decedent possessed incident of ownership (economic benefits in the policy) or which was payable to or for the benefit of the decedent’s estate;

(10) Qualified Terminable Interest Property (QTIP) in the estate of the surviving spouse.

Except for Qualified Terminable Interest Property in the estate of the surviving spouse, no inclusion is required for property in which the decedent’s interest was obtained from someone else and was limited to lifetime enjoyment.

Generally, gifts made within three years of death are not includable in a decedent’s gross estate, regardless of the size of the gift or the manner in which it was transferred.

Two major classes of exceptions:

(1)    Transfer with retained life estate; transfer taking effect at death; revocable transfer; or life insurance.

(2)    Property given away within three years of death may be brought back into the estate to determine if decedent’s estate qualifies for a §303 stock redemption, §6166 installment payout, or special use valuation.

Jointly held property with right to survivorship held by another – The 50-50 rule provides that on 50% of certain property titled and held jointly by the decedent and a spouse with rights of survivorship or by tenants by the entirety will be includable in the decedent’s estate regardless of the size of his/her contribution. The 50-50 rule applies to both real and personal property.

If a marital deduction (either gift or estate tax) was allowed for the transfer of property in which the decedent had a qualifying income for life, such property must be included in the decedent’s gross estate. This includes Qualified Terminable interest Property (QTIP) unless the decedent spouse made a lifetime transfer of his/her “qualifying income interest for life” (which would have resulted in a gift subject to gift tax).

Valuation Date – Generally, federal estate taxes are based on fair market value (FMV) of the transferred property as of (a) the date the decedent died, or (b) an “alternative valuation date,” (six months after the date of the decedent’s death) if the both the total property value within the decedent’s estate and the federal estate liability both reduce below date of death values. The election must be taken within nine months of the decedent’s death unless an extension is allowed by the IRS.

Property that normally diminishes as time passes, such as an annuity, will not be used in calculating a decrease in property value six months after death. The date of death will be used to determine the value of such property.

Deductions allowed in arriving at the gross estate – (1) funeral and administrative expenses; (2) debts (including certain taxes); and (3) casualty and theft losses.

Determination of the taxable estate - The adjustable gross estate may be reduced by (1) a marital deduction, (2) a charitable deduction, and (3) a state death tax deduction. The maximum allowable marital deduction for federal estate tax purposes is the net value of the property passing to the surviving spouse in a qualifying manner. Otherwise, there is no limit to the marital deduction.

Most terminable interests can qualify for the marital deduction if the executor makes the appropriate QTIP election in a timely manner. A qualifying terminable interest is one which (a) passes from the decedent, (b) gives the surviving spouse a lifetime income payable at least annually, and (c) the decedent’s executor makes an irrevocable election on his estate tax return by listing the property on Schedule M (the marital deduction schedule) of the return.

The value of the principal is included in the estate of the life tenant.

Estate tax payable before credits – Once the taxable estate is found, adjusted taxable gifts are added to arrive at the tentative tax base (or computation base). Adjusted taxable gifts are defined as the taxable portion of all post-1976 gifts. A gift is taxable to the extent it exceeds the sum of any allowable (a) a gift tax annual exclusion, (b) gift tax exclusion for qualified transfers for educational or medical expenses, (c) gift tax marital deduction (similar to the estate tax marital deduction, but for lifetime gifts to a spouse), and (d) gift tax charitable deduction . Gifts that for any reason have already be included in the decedent’s estate.

Adding adjustable taxable gifts to the taxable estate makes the estate tax computation part of the unified transfer tax calculation.

When adjusted taxable gifts are combined with the taxable estate, the result is the computation base, the amount upon which the tax rates are based.

The “applicable exclusion amount” is the sum of the “basic exclusion amount” ($5,250,000 in 2013) and, in the case of the surviving spouse, the “deceased spousal exclusion amount.” The “applicable credit amount is $2,045,800.

Determining the federal estate tax payable – certain tax credits are allowed as a dollar-for-dollar reduction of the estate tax. These credits are (a) the unified credit, (b) the credit for pre-1977 gift tax, (c) the credit for taxes on prior transfers, (d) the credit for foreign, death, taxes.

The unified credit for 2013 is $2,045,800. The required computation process has the effect of reducing the credit by requiring the “add back” of adjusted taxable gifts.

Where a prior decedent (the transferor) transferred property (which was taxed at death) to the decedent and the property is includable in the present decedent’s estate, a credit will be allowed for all or part of the estate on the transferred property.

As long as the property was includable in the transferor’s estate and passed from the transferor to the present decedent, the method of transfer is irrelevant.

There is no requirement that the property actually be in existence at the present decedent’s death or, if in existence, subject to federal estate tax at that time.

The credit is the lower of:

(1)    The federal estate tax attributable to the transferred property in the transferor’s estate, or

(2)    The federal estate tax attributable to the transferred property in the estate of the present decedent.

The credit is reduced by 20% increments every two years, and at the end of ten years after the transferor’s death no credit is allowable.

Gift Tax:

The gift tax is an excise tax levied on the right of an individual to transfer money or property to another. It is not a tax levied directly on the subject of the gift itself or on the right to receive the property. The gift tax is based on the value of the property transferred. The tax rates are applied to total lifetime taxable gifts. Once the lifetime exclusion is used, the gift tax rate is 40%.

Scope – All transactions whereby property or interests are gratuitously passed or conferred upon another, regardless of the means or device employed, constitute gifts subject to tax. The gift tax is imposed on the shifting of property rights, regardless of whether the property is tangible or intangible. Even forgiveness of indebtedness constitutes a gift. A gift can be subject to a tax even if the identity of the done is not known at the date of the transfer and cannot be ascertained.

Tax-Oriented Advantages – Both lifetime and “deathtime” gifts are subject to the same rate schedule and are taxed cumulatively, so that gifts made during lifetime push up the rate at which gifts made at death are taxed. The American Taxpayer Relief Act of 2012 changed the top rate for gifts made

after 2012. Transfers over $500,00 are taxes at 37%, transfers over $750,000 are taxed at 39%, and transfers over $1,000,000 are taxed at 40%.

Significant advantages of making lifetime (inter vivos) gifts –

·         First, an individual can give up to $14,000 (in 2013) gift tax free every year to each person of an unlimited number of donees. A married couple can transfer gift tax free up to $28,000 (in 2013) per year of money or other property, multiplied by an unlimited number of donees. One spouse can make the entire gift if the other spouse consents. This is known as “gift splitting.”

·         Second, if a gift is made more than three years prior to a decedent’s death, the amount of any gift tax paid on the transfer is not brought back into the computation of the gross estate. In the case of a sizable gift, avoidance of the “gross up rule” can result in a meaningful tax savings. (Gross up rule means that all gift tax payable on taxable gifts made within three years of death are included in calculating the value of the gross estate even if the gift itself is not added back.

·         Third, any appreciation accruing between the time of the gift and the date of the donor’s death escapes estate taxation. An excellent way of making use of this advantage is a gift of life insurance to an adult beneficiary or to an irrevocable trust for adult or minor beneficiaries more than three years prior to the insured’s death. If the insured lives for more than three years after the transfer and the premiums are present interest gifts of $14,000 a year or less, there would be no estate tax inclusion and none of the appreciation would be in the insured’s estate.

·         Fourth, there are often strong income tax incentives for making an inter vivos gift. This advantage derives from moving taxable income from a high-bracket donor to a lower-bracket done age 24 or over. Since the property, and not just the income from the property, is transferred, the income tax savings can be even greater after compounding. The year-in year-out income tax savings may far exceed the estate tax savings.

·         Fifth, gifts of the proper type of assets more than three years prior to death possibly qualifying for section 303 stock redemption, 6166 installment payout, and section 2032A special use valuation.

·         Sixth, no gift taxes have to be paid until the transferor makes a taxable gift in excess of the gift tax unified credit exemption equivalent or applicable exclusion amount ($5,250,000 in 2013).

Technical Definition of a gift – Under common law a gift is defined simply as a voluntary transfer without any consideration, but tax law does not specifically define a gift. The regulations dealing with valuation of gifts provide that:

Value of property transferred

Less: (Consideration received)

= Gift

In cases where property is transferred for less than adequate and full consideration in money or money’s worth.

Life insurance or life insurance premiums – These can be the subject of an indirect gift in three situations: (1) the purchase of a policy for another person’s benefit, (2) the assignment of an existing policy, and (3) payment of premiums.

If an insured purchases a policy on his life and

(1)    Names a beneficiary(ies) other than his estate, and

(2)    Does not retain the right to regain the policy or the proceeds or revest the economic benefits of the policy (i.e., retains not reversionary interest in himself or his estate); and

(3)    Does not retain the power to change the beneficiaries or their proportionate interests (i.e., makes the beneficiary designation irrevocable)

He has made a gift measurable by the cost of the policy. All three of these requirements must be met before the insured will be deemed to have made a taxable gift.

If an insured makes an absolute assignment of a policy or in some other way relinquishes all his rights and powers in a previously issued policy, a gift is made. This can lead to a tax trap. If a wife owns a policy on her husband and names their children as revocable beneficiaries the IRS is likely to argue that she has made a constructive gift to her children.

                Reductions on the tax of property transferred as gifts – These reductions include (1) gift splitting, (2) an annual exclusion, (3) a marital deduction, (4) a charitable deduction.

                Gift splitting – The law permits a married donor, with the consent of the non-donor spouse, to elect to treat a gift to a third party as though each spouse has made half of the gift. Couple cannot split gifts in a period before or after they were married. This applies only to gifts by a married donor and only with respect to non-community property. All gifts made during a period must be split.

                The Annual Exclusion – Generally, the annual exclusion allows the donor to make, tax free, up to $14,000 (in 2013) worth of gifts (other than “future interests”) to any number of persons each year. The total maximum excludable amount is determined by multiplying the number of persons to whom gifts are made by $14,000.

                An Annual exclusion is allowed only for present interests and is denied to gifts of future interests. A present interest is one in which the donee’s possession or enjoyment begins at the time the gift is made. A future interest refers to any interest or estate in which the donee’s possession or enjoyment will or might not commence until some period of time after the gift is made. A future interest includes reversions, remainders, and other interests or estates, whether vested or contingent, and whether or not supported by a particular interest or estate, which are limited to commence in use, possession, or enjoyment at some future date or time.

                An easy was to distinguish between future and present interest is to ascertain:

At the moment of the gift, did the done have an immediate, unfettered and actuarially ascertainable legal right to use, possess, or enjoy the property in question?

                If the answer is “yes,” the gift is a present interest. If the answer is “no” the gift is a future interest.

                Summary of Rules for Ascertaining the Amount and Availability of the Gift Tax Annual Exclusion -

(1)    In determining the number of annual exclusions to which a donor is entitled, a gift to a trust is a gift to a trust’s beneficiaries, and not to the trust.

(1)    If the trustee is required to distribute trust income at least annually, the value of an income interest in a trust qualifies for the exclusion even if the value of the remainder interest does not.

(2)    The gift of an interest that is contingent upon survivorship is a gift of a future interest.

(3)    A gift is one of a future interest if enjoyment depends on the exercise of a trustee’s discretion.

(4)    A gift must have an ascertainable value to qualify for the exclusion.

There are three basic means of qualifying “cared-for-gifts” to minors under Section 2504: (1) a § 2503(b) trust, (2) a §2503(c) trust, or (3) the Uniform Gifts to Minors Act (or the Uniform Transfer to Minors Act).

§2503(b) Trust – To obtain an annual exclusion for gifts to a trust, an individual can establish a trust that requires that income must be distributed at least annually to or for use of the minor beneficiary. A distribution does not have to be made by age 21.

§2503(c) Trust – Requires distribution of income and principal when the minor reaches age 21. But it does not require the trustee to distribute income currently. The trust must provide: (1) the income and principal may be expended by or on behalf of the beneficiary; and (2) to the extent not so expended income and principal will pass to the beneficiary at age 21; or (3) if the beneficiary dies prior to that time, income and principal will go to the beneficiary’s estate or appointees under a general power of appointment. It is possible to provide continued management of the trust assets and, at the same time, avoid forfeiting the annual exclusion by giving the done, at age 21, a right for a limited, but reasonable period to require immediate distribution by giving written notice, the trust can continue automatically for whatever period  the donor provided when he established the trust.

Uniform Gifts (Transfers) to Minors Act – The Uniform Act is frequently utilized for smaller gifts because of its simplicity and because it offers the benefits of management, income and estate ta shifting, and the investment characteristics of a trust, with little or none of the setup costs. The Uniform Act is indicated over a trust if the gift consists of stock in an S-corporation. That’s because generally speaking, a trust cannot hold S corporation stock without causing a loss of the election privilege.

Crummy Power – A gift in trust of a life insurance policy or of premiums can be named a present interest by inserting a Crummy Power. A Crummy Power gives the named individual(s) an immediate, unfettered, and actuarially ascertainable right; in short, the absolute right to withdraw a specified amount or portion of the assets contributed to the trust. The withdrawal rights make the gift in trust of a life insurance policy or of premiums qualify for the gift tax annual exclusion.

Gift Tax Marital Deduction – An individual who transfers property to a spouse is allowed an unlimited deduction known as the gift tax marital deduction.

No marital deduction will be allowed where (a) the done-spouse’s interest in the transferred property will terminate upon lapse of time or at the occurrence or failure of a specified contingency, (b) where the done-spouse’s interest will then pass to another person who received his interest in the property from the donor-spouse, and (c) that person did not pay the donor dull and adequate consideration for that interest.

The exception is for a gift of Qualifying Terminable Interest Property (QTIP). If a donor spouse gives a done spouse a qualifying income interest for life, it will qualify for a gift (or state) tax marital deduction. To qualify:

(1)    The surviving spouse must be entitled to all income from the property (and it must be payable annually or more frequently);

(2)    No person can have a power to appoint any part of the property to any person other than the surviving spouse; and

(3)    The property must be taxable at the done-spouse’s death.

A life estate with power of appointment in the done spouse qualifies for the marital deduction.

                Relationship of the Gift Tax System to the Income Tax System – A lack of consistency between the gift and income tax system forces the practitioners to examine five different issues:

(1)    Is the transfer one upon which the gift tax will be imposed?

(2)    Will the transfer constitute a taxable exchange subject to the income tax?

(3)    If the transfer was made in trust, will the income from the transferred property be taxable to the donor, or will the incidence of taxation be shifted to the recipient of the property (the trust of its beneficiaries)?

(4)    If the income is taxable to the beneficiaries, will it be taxable at the parent’s rate or at the beneficiary’s tax bracket (as t would be if (a) the income were earned income no matter what the beneficiary’s age, or (b) the beneficiary were are 18 (or in certain cases 24) or older no matter whether the income was earned or unearned)?

(5)    Does the gift constitute a cancellation of debt which could result in income tax consequences?

The treatment of a transaction for gift tax purposes is not necessarily consistent with the income tax consequences.

The relationship of the gift tax system to the estate tax system – The estate and gift tax system were fully unified in 2011 going forward. The unification correlates the estate and gift tax laws in three essential ways:

(1)    Lifetime gifts and testamentary transfers are taxed by using the same tax rates, rather than separate and different rates. The exemption for 2013 is $5,250,000, and the top rate is 40%.

(2)    The unified credit can be applied to both lifetime and death-time gifts. The unified credit is set at $2,045,800 for 2013.

(3)    The estate tax imposed at death is found by adding the taxable portion of gifts made during lifetime to the taxable estate to arrive at the tentative tax base.

Factors to consider in selecting appropriate subject of a gift – Some of the general considerations in selecting property to give include:

(1)    Is the property likely to appreciate in value? Planners generally try to pick property that will appreciate substantially in value from the time of the transfer. The removal from the donor’s estate of the appreciation in the property should save a meaningful amount of estate taxes. The best type of property will have a low gift tax value and a high estate tax value. Life insurance is a, for example, has a low present value, but a high appreciation potential. If held until the date the insured dies, its appreciation in value is guaranteed.

(2)    Is the donee in a lower income tax bracket than the donor? Income splitting between the donor and a done age 18 or older can be obtained by transferring high income-producing property to a family member in a lower bracket. High income-producing property is best for this purpose. Conversely, if the donor is in a lower bracket than the done the use of low-yield growth type property may be indicated. Typically, gifts to children under age 24 should emphasize growth.

(1)    Is the property subject to indebtedness? A gift of property subject to indebtedness that is greater than its cost to the donor may result in a taxable gain. A gift of such property causes the donor to realize capital gain on the excess of the debt over basis.

(2)    Is the gift property’s cost basis above, below, or approximately the same as the property’s fair market value? Income tax law forbids the recognition of a capital loss if the subject matter if the gift has a cost basis above the property’s current fair market value. Neither the donor nor the done can recognize a capital loss with respect to such property. Sincere there is no appreciation, no gift tax addition would be allowed. Conversely, if the donor’s cost basis for income tax purposes is very low relative to the fair market value of the property, it might be advantageous to retain the property until death because of the stepped-up bass at death rules. A third possibility is that the donor’s cost basis is approximately the same or only slightly below fair market value. The addition to basis is limited to gift tax allocable to appreciation in the property at the time of the gift. One further factor that should be considered is the likelihood that the done will want or need to sell the property in the foreseeable future. If this is not likely, the income tax basis (except for depreciable property) will be relatively meaningless.

Federal Income Tax Issues:

                Income taxation of trusts and estates – general scheme of taxation – Trusts and estates are treated in the tax law as separate taxpayers that are required to file annual federal income tax returns. The general rule is that the trust or estate will pay income tax on the amount it retains. Beneficiaries will pay the tax on the income of the trust or estate actually distributed to them. The mechanics of obtaining this result are obtained through the utilization of the Distributable Net Income (DNI) concept. Thus, taxed only, once.

                The concept of DNI is utilized to achieve three main results. First, it ensures that trust or estate receives a deduction for amounts distributed and provides a limit for that deduction. Second, DNI limits the proportion of distributions that is taxable to beneficiaries. The third function of DNI is to ensure that the character of distributions to a beneficiary remains the same as in the hands of a trust or estate. Tax-exempt interest received by a trust and distributed to a beneficiary retains its character as tax-exempt and is exempt for ordinary income taxation to the beneficiary or heirs. What enters the trust or estate as ordinary income remains ordinary income when received by beneficiaries or heirs. This is known as the “conduit” theory.

                Income taxation of trusts – A trust is a tax paying entity. The taxable income of a trust (or an estate) is computed in basically the same manner as that of an individual. However, given the same amount of income, a trust or estate will pay a much higher tax for income it retains than an individual would pay.

In computing tax liability, multiple trusts are treated as one trust and their incomes are aggregated if the trusts have substantially the same grantor or grantors; and substantially the same primary beneficiary or beneficiaries and if the principal purpose for the existence of the trust is the avoidance of federal income tax. You can’t cut income taxes by creating “cookie-cutter” replica trusts for the same beneficiaries.

                Generally, for tax purposes trusts are treated as separate entities from the grantor, the trustee, and the beneficiary. The basic question in the income taxation of trusts is, “who will be taxed on trust income – the trust, the beneficiary or the grantor?” Generally, the burden of taxation falls on either the trust itself or the beneficiary. But it is possible for the income of the trust to be taxes to the grantor in a so-called “grantor trust” situation where, for income tax purposes, the trust is deemed the alter ego of the grantor.

                Trusts are categorized for income tax purposes as either simple or complex trusts. Either type of trust may also be a grantor trust.

                A simple trust has the following characteristics:

·         The trust agreement requires that all trust income be distributed currently to the beneficiaries;

·         The trust may not make distributions form amounts other than current income;

·         Principal may not be distributed; and

·         No charitable gifts can be made.

If all income does not have to be distributed currently or if the trust can make distributions from principal or if it can make charitable gifts, it will be deemed a complex trust for that taxable year.

A simple Trust is treated as a separate tax entity. As such it has the same deductions an individual has, subject to certain exceptions. It also has a special deduction for income that is distributable to its beneficiaries. The net result is that a simple trust does not pay tax on income it pays out. The beneficiary of a simple trust will report the income that he receives or that is receivable by him.

                A complex Trust is any trust which is not a simple trust, that is, a complex trust in which the trustee either must – or may – accumulate income. The trustee of a complex trust, unlike the trustee of a simple trust, can also distribute corpus (principal) or can also make gifts to charities.

                Complex trust, like a simple trust, is a separate tax entity. It is allowed a special deduction for actual distributions of income, but pays tax on any income it does not distribute. Generally, the same rules that govern complex trusts apply also to the income taxation of a decedent’s estate.

                A trust is not allowed a standard deduction. Further, the personal exemption is limited to $300 for a simple trust and $100 for a complex trust.

                In some cases the trust itself is disregarded as a taxable entity. Generally, in the case of either a simple or a complex trust, the trusts beneficiary will be taxable on the income of the trust. In some cases the grantor is taxed on the trust income whether or not the grantor actually receives the income.

                Substantial Owner Rules – When the grantor of a trust is treated as the owner of a portion of the trust corpus for income tax purposes, those items of income, deductions, and credits that are attributable to that portion of the trust are deemed to be those of the grantor. Accordingly, the grantor

of the trust is deemed the recipient of trust income and is allowed a deduction to the extent there are trust expenses and/or credits.

                Reversionary interest rules – For income tax purposes, the grantor is treated as the owner of that portion of a trust in which the grantor or the grantor’s spouse has a reversionary interest in either the corpus or the income if, as of the date of inception of that trust or at the time of an addition to that trust the value of the reversionary interest exceeds 5% of the value of the property in which the reversion is retained.

                Beneficial Interest Rules – In general, where a grantor of a trust, a non-adverse party, or both can control the beneficial enjoyment of a trust, the grantor is taxed as the owner of the trust for income tax purposes. There are several exceptions to this broad rule, including a power exercisable only by will or a power to distribute corpus or income if limited to an ascertainable standard.

                Administrative powers rules – Powers exercisable by the grantor, or even a non-adverse party, that would cause the income to be attributable to the grantor are:

1)      Powers that would enable the grantor to purchase, exchange, or otherwise deal with or dispose of the corpus or income of the trust for less than adequate consideration in money or money’s worth;

2)      Powers that allow the grantor to borrow trust corpus or income without adequate interest or security or fails to repay money borrowed by the end of the year.

3)      Powers of administration exercisable in a non-fiduciary capacity by any person without the approval or consent of any person in a fiduciary capacity. Powers of administration are such powers as the power to vote stock of a corporation in which the grantor or the trust has a significant voting interest, the power to control investment of the trust funds, and the power to reacquire the trust corpus by substituting other property of an equivalent value.

The power to revoke rules – The grantor is treated for income tax purposes as the owner of any portion of a trust for income tax purposes if he can revoke the trust either acting alone or with a non-adverse party.

Income for benefit of grantor rules – The grantor of a trust is treated as the owner of the trust for income tax purposes if the income of the trust – at the discretion of the grantor or a non-adverse party, or both – is or may be distributed to the grantor or the grantor’s spouse, held or accumulated for future distribution to the grantor’s spouse, or applied to the payments of premiums on life insurance policies on the life of the grantor or the grantor’s spouse.

Person’s other than the grantor – If a person other than the grantor has the power, exercisable solely by himself, to vest the corpus or income therefrom in himself, such a person is treated as the owner of the corpus so that trust income will be taxable to that individual.

Taxation of the estate – As a taxable entity, an estate must pay tax on its income. Because an estate is considered a separate tax entity, it has not only income, but also deductions. An estate is also entitled to a deduction for amounts of income distributed. An estate may take a $600 personal exemption. The “income first” rule requires that all distributions are deemed to be paid out of income first, even if the executor, administrator, or trustee in fact distributes principal in the form of cash or property.

Basis at death – Assets owned by a decedent receive a new federal income tax basis equal to the property’s fair market value for federal estate tax purposes. When the fair market value of the asset is higher than the pre-death basis, the old basis is “stepped-up” to the fair market value. This concept is particularly important in buy-sell agreements where stock is purchased at a shareholder’s death at a pre-arranged price or under a pre-arranged formula. A step down in basis is also possible. In such a situation the beneficiary may not take a loss on the step-down in basis. It may be better to gift loss property prior to death to preserve the higher tax basis, even though the recipient’s basis will be limited to the fair market value of the property on the date of the transfer (plus any gift taxes paid).

No step-up in basis where decedent had acquired property by gift within a year of death if property is left to donor or donor’s spouse – The law currently provides that if (1) the decedent had received appreciated property by gift during the 1-year period ending on the date of death, and (2) that property was acquired from the decedent (or passes from the decedent to)the donor of that property (or to the donor’s spouse), the basis  of that property in the hands of the donor is he adjusted basis of the property in the property in the hands of the decedent immediately before death. However, if the done-decedent lives for more than one year after receiving the gift, or if the gift is left to anyone other than the donor of the donor’s spouse, the property will receive a stepped-up basis.

Effect of step-up in basis rules on stock redemption and cross purchase agreements – Stock includable in the decedent’s estate receives a new basis equal to its value at death. This is usually close to the redemption value, particularly if the stock redemption is promptly carried out. Typically, no (or little) gain is recognized by the estate or other seller of the stock upon the redemption.

Implications and issues in community property states – If the property is held as community property, only one-half the property is included in the estate of the first spouse to die but, equalizing the basis with the separate property arrangement, both halves receive a new income tax basis.

Step-up in basis does not occur if the property is held in joint tenancy-in-common. A couple can take property in co-ownership in four different ways:

1)      As joint-tenants (or tenants by the entirely);

2)      As tenants in common;

3)      As community property; or

4)      As community property with right of survivorship.

With the reinstatement of the stepped-up basis rule, where property has been paid for with community property earnings or if the contribution to the acquisition was otherwise equal, it again affords a significant advantage as to federal income tax to hold such property in community property as opposed to either joint-tenancy or tenancy-in-common.

If there is a buy-sell agreement entered into the stock receives a new basis if it is still held by the share holder at death as long as there is not a binding executed contract that did not depend on death.

John currently has a simple will leaving everything to Susan and Susan has no will. What estate/tax/financial/personal/other advice do you have for John and Susan?

Write a plan of action for them.

                The marital deduction is a deduction for gift or estate tax purposes for property passing to (or in a qualified trust for) a spouse. The unified credit is a credit provided to each citizen or resident of the United States, which can be applied against either gift or estate taxes. The use of the unified credit to reduce gift taxes correspondingly reduces the amount available for estate taxes. The goal typically is to avoid “over qualification” of the estate for the marital deduction because of “underutilization” of the unified credit in the estate of the first spouse to die.

                The most common arrangement for a marital/bypass trust is to place into the bypass trust an amount equal to the estate tax unified credit applicable exclusion (the 2013 unified credit equates to exempting $5,250,000 of assets from the estate), because the tax on those assets will be eliminated by the unified credit. The balance of the decedent’s assets will go to the marital trust tax free because of the unlimited marital deduction. However, assets in the marital trust will be subject to estate tax at the death of the surviving spouse because of the broad powers the survivor is given in the trust.

                In general, the marital deduction can be obtained for property passing outright to a surviving spouse. One type of trust, a general power of appointment trust, gives the surviving spouse a right to the trust’s income for life coupled with a power to appoint the trust property during lifetime or at death to anyone the surviving spouse wishes.

                In a second type of marital deduction trust, an estate trust, the surviving spouse receives income only, has no right to name the recipient of the remaining property during her lifetime, but can name the recipient of the remaining property in her will.

                In a third type of marital deduction trust, a qualifying terminable interest property (QTIP) trust, the spouse is also given a right to income for life, but need not be given a power of appointment over the property. The grantor of the trust specifies the identity of the remainderman.  Thus, with a QTIP trust, the first (original property owning) spouse to die can control where the property goes at the surviving spouse’s death. This is particularly appealing in second and late-life marriages.

                It may be desirable to use a QTIP trust for some or all of the estate to ensure that at least some of the marital deduction property passes to the first decedent spouse’s chosen beneficiaries at the surviving spouse’s death. The balance of the marital deduction property would go to a separate trust (often called “Trust A”) that would be controllable by the surviving spouse as to its disposition. Particularly for community property, where the survivor already owns half, it may be very helpful to obtain the marital deduction for all of the estate in excess of the unified credit equivalent (with the exempt portion going to the bypass (or “B”) trust to avoid tax at the survivor’s death), but to still provide that some of the deducted property will ultimately go to the children.

                Thus, a formula will often provide for putting into the “B” or family trust the amount of the estate tax applicable exemption ($5,250,000 in 2013) at the death of the first spouse.

                If it is desired that the survivor have a power of disposition over only a portion of the assets, then the portion subject to the power can go into the typical marital “A” trust, and the balance can go into a QTIP trust. Both trusts will qualify for the marital deduction and be included in the survivor’s

estate at death. Either or both of these trusts can provide for invasion of principal for the benefit of the survivor, but only the “A” trust will be subject to the power of disposition, called a power of appointment, at the survivor’s death.

                The broadest power which can be provided to the spouse, while still keeping the property subject to this power out of the surviving spouse’s estate is that the spouse can appoint the property to anyone other than the spouse, his/her creditors, his/her estate, and the creditors of his/her estate. Assuming the power of appointment is no broader than that, then such a power could be inserted in and held in either a bypass or a QTIP trust without adverse tax consequences.

                Often the revocable A-B or A-B-QTIP trust takes the form of a life insurance trust coupled with a “pourover will.” Here a revocable insurance trust is created during the grantor’s lifetime. The trustee is named as the beneficiary of life insurance policies issued on the grantor’s life. The grantor’s will contains a provision to the effect that the grantor’s residuary estate, what is left after payments of debts, expenses, taxes, and specific bequests, is to be “poured over” into the living trust. The trust instrument provides that upon receiving the insurance proceeds from the insurance company and the residuary estate property from the pourover will provisions, the total principal will then be divided into two (or three) parts: a portion will go to the marital or “A” trust, a portion will go to the family or “B” trust, and if  appropriate, a portion will go to the QTIP trust, which latter will qualify for the marital deduction, but be distributed at the survivor’s death as provided by the grantor in the trust instrument.

                                                                                                                                         

                When is use of such a device indicated? – If too much property passes to the surviving spouse and thus may be needlessly taxed at the surviving spouse’s death. The reason for this result is that the surviving spouse has “ownership” of all of the family wealth and therefore it is taxable for federal estate tax purposes at the surviving spouse’s death. In 2011 the concept of portability was introduced which allows a surviving spouse to use the unused exemption of the predeceased spouse, or the “Deceased Spouse’s Unused Exemption (DSUS).” While the portability rules provide an important option in estate planning, it may not be the best choice for all taxpayers.

                If the decision is made that it is better to implement a tradition estate plan that incorporates a by-pass trust then the surviving spouse would merely have the benefit of all of the family wealth (i.e., in an A-B or A-B-QTIP trust arrangement) and only the portion that qualified for the marital deduction at the death of the first spouse to die would be subject to federal estate taxes at the survivor’s subsequent death. The B trust assets would pass to family member’s estate tax free at the surviving spouse’s death.

                In order to maximize the utility of this technique, the A-B or A-B-QTIP trust can be designed to pass to the A trust or to the A and QTIP trusts together exactly enough property to reduce the federal estate tax in the estate of the first spouse to die to the lowest desirable amount-even to zero. Any additional property subject to tax at the decedent’s death and passing to the trust would automatically pass into the B (family or non-marital) trust (portion) and escape death taxation at the death of the second spouse to die.

                Over-qualification (underutilization of the unified credit) results in passing more to the surviving spouse in property interests qualifying for the marital deduction than is necessary to keep the federal estate tax at the decedent’s death to the minimum. Over-qualification results in wasting (in whole or in part) the decedent’s unified credit – unless the portability provision can be utilized. A properly designed A-B or A-B-QTIP trust could eliminate or minimize this problem.

What are the requirements? – There are three types of trusts that will qualify for the marital deduction – the “power of appointment” trust, the “estate” trust, and the QTIP trust.

                Power of appointment Trust – Requirements:

·         The spouse must be entitled to all of the income produced by the assets of the trust (note that the law states “all of the income” not “all of the net income”).

·         The income produced by the trust must be payable at least annually.

·         The surviving spouse must be given a general power of appointment (during lifetime, death or both) exercisable in favor of the spouse or the spouse’s estate, or the creditors of the spouse or the spouse’s estate.

·         The power must be exercisable by the surviving spouse in all events.

·         No person may have any power to appoint any part of the trust assets to any person other than the surviving spouse.

The trust property will qualify for the marital deduction if the spouse is given the power to appoint at death. The spouse does not have to be given the power to withdraw the principle during lifetime. A trust should provide that the spouse has the right to demand that the trust be made income producing.

                Estate Trusts – Requirements:

·         The trust must provide for income to the surviving spouse for life (payable to, or accumulated for, the surviving spouse’s benefit).

·         The remainder the trust (both principal and any accumulated income) must be payable to the surviving spouse’s estate at the surviving spouse’s death.

Accumulations will be taxed as part of the surviving spouse’s estate at the surviving spouse’s death along with the original corpus.

                The estate marital trust is indicated where (a) there is a need or a desire to invest in non-income producing property, (b) the survivor will not need trust assets or income during the survivor’s lifetime, and (c) the property placed into the trust is not likely to appreciate substantially in value.

                Qualified Terminable Interest Property (QTIP) Trust – Requirements:

·         The same requirements regarding “all income to the surviving spouse and payable at least annually” that apply in the power of appointment trust apply here. Thus, the survivor must receive all of the current beneficial interest in the trust.

·         This trust need not have any power in the surviving spouse to appoint or control the disposition of the property.

·         There must be no power to shift any of the trust property to anyone other than the spouse during the spouse’s lifetime.

·         The spouse must have the power to require the trustee to make the assets produce income.

·         The executor must elect to have the trust treated as a QTIP trust on the estate tax return by showing its value on schedule M of the estate tax return.

As with the other forms of marital trusts, at the surviving spouse’s death the remaining corpus must be included in her estate.

                In the event of a common accident when it is impossible to ascertain who dies first, the Uniform Simultaneous Death Act would raise a presumption that neither spouse survived the other and

therefore, would defeat the marital deduction. The application of such act can be overcome by inserting into the documents creating a marital trust a survivorship clause that creates a presumption that, for the purposes of the marital deduction, the spouse is deemed to survive if it is not possible to establish the order of deaths.

                The life insurance/pourover will combination – In this arrangement, an individual establishes a trust during lifetime and names the trust as beneficiary of his insurance policies. When the grantor dies, the insurance maintained on his life is paid directly to the trust. The grantor’s other assets pass through probate and are “pour over” by will into the trust. If the trust was an irrevocable life insurance trust and the grantor-insured never had any incidents of ownership over the insurance on his life and didn’t transfer insurance on his life to the trust within three years of his death, the insurance will not be included in his estate.

                The Survivor’s Property Trust or Power of Appointment Trust – The “A” Trust – This trust would provide that all income from the trust be paid to the surviving spouse during his/her lifetime. Where Trust A is used as a marital deduction trust, the pourover trust in many cases would contain a funding formula to ensure that the power of appointment trust together with any QTIP Trust, would receive just enough property to reduce the federal estate tax at the death of the grantor to zero. The surviving spouse will usually be given the right to designate by will or other written instrument who will receive the corpus of the marital trust and such appointment may be made to anyone the surviving spouse chooses, including the surviving spouse’s estate. The surviving spouse may also be given the right to withdraw any part of the corpus of the appointment trust during lifetime.

                The Bypass Trust – The “B” trust – The second trust, often called the “B,” bypass, non-marital, or family trust, is designed to receive property that is not allocated to the power of appointment trust, the estate trust, or the QTIP trust. An amount equal to the estate tax applicable exclusion ($5,250,000 in 2013, assuming no taxable lifetime gifts are made) is place in this trust. Since the life estate terminates at the death of the surviving spouse, the surviving spouse did not create the life estate, and the surviving spouse has no general power of appointment over the trust property, there will be no transfer of property that is includable in the estate of the surviving spouse subject to the federal estate tax at death. Thus, this trust “bypasses” the survivor’s taxable estate and is, therefore, often called a Credit Equivalent Bypass Trust (CEBT) because it is funded with an amount equal to the exemption equivalent of the unified credit.

                To enhance the financial security of the surviving spouse without causing later estate taxation, the surviving spouse can be given a “limited” or “special” power of appointment under this family trust. A power of appointment will not be classified as a “general” power and will not subject the corpus of the trust to federal estate taxes at the death of the holder, so long as the power cannot be exercised in favor of the older of the power, his estate, his creditors, or the creditors of his estate.

                The bypass trust can also safely provide the surviving spouse with a noncumulative limited right of withdrawal. Typically, this provision states that is the A and Q trusts are depleted, he surviving spouse is given the right to make limited withdrawals from the bypass or family trust. The surviving spouse is provided with a noncumulative right to withdraw each year the greater of an IRC specified de minimus amount equal to the greater of (a) 5 percent of the corpus of the trust or (b) $5,000. Although this 5 or 5 power will not cause the entire corpus of the family trust to be subject to estate tax, the amount subject to withdrawal in the year of the surviving spouse’s death will be included in the surviving spouse’s estate.

The most common dispositive provision requires that the corpus of this trust be divided into separate equal trust funds for the benefit of the grantor’s children. Another popular approach is to keep the amounts passing to the children in a “common pot” until the children reach the age at which it is customary to have completed college. As an additional option, and customarily, with large estates, it might be preferable to continue the trusts for the lifetime of the children. These types of trusts are known as “dynasty” or GST Trusts. In this way, the trust assets can pass to the grandchildren and down to the lower generations while remaining out of the descendants’ estates.

                A greater degree of flexibility may be obtained by utilizing a “spraying” or “sprinkle” clause. This provision authorizes the trustees (other than a trustee who is beneficiary), at their discretion, to spray or sprinkle the net income of the bypass trust among the surviving spouse and the grantor’s children or other issue in any way the trustees determine.

                The estate tax at the survivor’s death may be reduced by use of an accumulation provision. Instead of the non-marital income being paid to a surviving spouse, it may be accumulated in a non-marital trust and pass, free of estate tax, at the survivor’s death. Meanwhile, the survivor has been permitted to invade the appointment trust (or the QTIP trust) and consume some of the principal of those trusts. The downside of this technique is using up marital trust assets and building up non-marital trust assets that will pass estate tax free at the surviving spouse’s death is that allowing large amounts of income to accumulate in the non-marital trust may result in adverse income taxation.

                The “spinkle,” “spray,” or “accumulation” clauses should be avoided where the bypass trust will be a recipient of stock in an S corporation.

                QTIP Tusts – the “Q” Trust – When it is desired that an amount of estate in excess of the estate tax unified credit exemption equivalent (applicable exclusion) amount should produce a marital deduction at the death of the first spouse to die, but should not be subject to surviving spouse’s control, a QTIP may be indicated.

                All of the income of this trust must be paid, at least annually, to the surviving spouse. No provision for invasions of the trust can be made for anyone other than the surviving spouse or the marital deduction will be lost. Likewise, it would be lost if there were any condition or power in anyone else that could prevent the surviving spouse from receiving all the trust income for life. Additionally, the surviving spouse should be given a power to require the trustee to make all of the trust assets income producing.

To the extent that the trustee has elected to take a marital deduction at the first spouse’s death for assets going into that trust (usually 100%), the assets remaining in the QTIP (Q) trust at the death of the surviving spouse will be included in the estate of the surviving spouse. Thus, the marital deduction has merely deferred the tax on any assets in this trust that are not used up for the benefit of the surviving spouse

                How do the mechanics of the A-B or A-B-Q trust plan work? – First, an inter vivos (living) trust instrument can be drafted creating the different trusts to be used. Although the terms of the trust are determined during the grantor’s lifetime, it will not become operative until it is funded at the grantor’s death. The trust is revocable because the grantor possesses the power to alter, amend, or revoke the

trust until his death. The grantor will provide in his will that his probate property, after payment of settlement costs any specific bequests or devices, will be added (poured over) to the trust.

                The essential provision in the A-B or A-B-Q trust is known as the marital deduction formula. All property included in the decedent’s probate estate or made payable to the inter vivos trust will be divided in accordance with the formula clause in the trust agreement. The funding clause would also provide that the amount of any such marital portion should be reduced by any property includable in the estate that passes directly to the surviving spouse as a result of the grantor’s death. Insurance on the life of the grantor is typically the most efficient and effective way to insure that cash is available to pay the required tax when it is due.

                Family Limited Partnerships – A family limited partnership is a limited liability entity created under state law. Ownership of the partnership interests is typically limited to members of the same family unit. Most states have adopted the Uniform Limited Partnership Act (ULPA) or some modified version thereof. There is generally a high degree of uniformity among states.

                The partners designate a general partner (or general partners) who will be given management responsibility and who will assume personal liability for debts and other liability for debts and other liabilities that are not satisfied from the assets of the FLP. In return for giving up their rights of management and control over the assets of the FLP, the personal liability of the limited partners generally is limited to the amount of capital that they contribute.

                When is use of such a device indicated? -  Family limited partnerships are often used to fractionalize the ownership of business assets, investment assets, such as marketable securities, or real estate to take advantage of gift and estate tax valuation discounts which significantly reduce transfer taxes. A family limited partnership would be appropriate in the following circumstances: 1) to reduce the value of an estate for transfer tax purposes; 2) when it is desired to shift the income tax burden from a parent who is in a high income tax bracket to a child or other relative who is in a lower income tax bracket; 3) when it is desirable to conduct a family business in a form other than a sole proprietorship; 4)Where a parent desires to maintain control over assets that will be transferred to younger generations through gifts of limited partner interests; 5) Where it is possible to protect assets from creditors of the partners; 6) when retention of assets within the family unit is desired; 7) where a parent desires to protect assets, which are to be transferred to younger generations, from being dissipated through mismanagement or divorce; 8) where flexibility in setting the rules for managing property is desired; 9) to simplify ownership of assets; 10) to ease the distribution of assets at death among family members without having to remove the assets from the partnership; 11) to avoid out of state probate costs; 12) to discourage family members from fighting over Family Limited Partnership assets, and to provide a forum for the resolution of disputes among family members f and when such disputes arise.

                Many practitioners recommend use of a family limited partnership for parents who desire to maintain control of their assets while having transferred away most of the assets’ economic benefits.

                The general partner should have the necessary willingness, knowledge, and experience to do the following:

·         Manage and invest partnership assets.

·         Make decisions as to distributions of partnership income and/or assets.

·         File income tax returns on behalf of the partnership and understand the income tax law.

·         Furnish annual partnership income tax information (Schedule k-1) to the partners.

·         Make necessary filings with the state’s Secretary of State.

·         Give or withhold consent to transfers of partnership interests and amendment of the family limited partnership agreement.

Ensuring family ownership – Continuous family ownership of the family limited partnership is guaranteed by restricting each partner’s ability to sell or otherwise transfer his interest to non-family members. In almost all instances, the FLP agreement should prohibit the partners from selling or transferring their interests in a manner that is disruptive to the continuation of the family asset arrangement plan or disruptive to family harmony.

Protecting Assets – Family limited partnerships provide a limited degree of asset protection to the partners since underlying assets of the FLP generally cannot be attached to satisfy personal debts of the limited partners. Mere threat of tax liability without income to pay that liability is strong incentive for creditors to enter into more favorable settlement with debtor-partners. A debtor-partner is not necessarily guaranteed access to the FLP assets if the judgment creditor is insistent upon collecting its debt. The use of an FLP by itself as an asset protection device is not a guaranteed means of avoiding creditor liability.

Implications and issues in community property states – In New Mexico the income from separate property of one spouse is separate property income. In Texas property of one spouse is community property income. It is in the former group of states where the FLP may require extra vigilance if it is owned prior to marriage, is given or inherited, or is separate property of a spouse for whatever reason. In these instances, it is necessary to make a distinction between the earnings of the manager (which is probably community property) and the income received from ownership of the partnership interest (which is separate property).

Using the separate property income from the FLP to purchase items that are taken in the names of both spouses creates a taxable gift (with the exception of real property taken as joint tenants). This does not create a federal gift tax problem because of the unlimited marital deduction that applies to both separate property and community property. Depending upon state gift tax law, however, it may still create a gift tax problem.

The FLP should consider making an election under Section 754 to obtain a basis adjustment under Section 743 due to the death of either spouse. The election will adjust the income tax basis of the community property interest of both spouses in the FLP. Another frequently encountered problem in an FLP in community property states is the failure to designate in the agreement whether the FLP interest is separate property or community property. In some states, dividends, interest and rents from separate property are separate property. These states include New Mexico.

Summary of the Plan of action:

Basic overview - Because John has separate property from before he married Susan, property from when he inherited from his father as well as a son from a previous marriage I would advise that they set up a marital deduction and by pass trust. More specifically I would recommend a marital deduction A-B-Q trust for John and a marital deduction A-B trust for Susan. Additionally, John can establish a family limited partnership in which to place the ranch owned by John. Limited partnership ownership of the ranch would be placed in a QTIP trust. The John inherited the ranch, therefore it is not

community property even though New Mexico is a community property state. It is would be possible for the ranch to hire the son, Gary, to work on the ranch and allow him to become a limited partner. Limited partnership interest in the ranch can be gifted to Gary, the QTIP trust, and Steve and Mary while John continues as the general partner. This would allow John to gift away most of the value of the ranch to his children while retaining control of the ranch.

First a bypass trust needs to be established in which can be placed an amount equal to the estate tax unified credit applicable exclusion (the 2013 unified credit equates to exempting $5,250,000 of assets from the estate.) The balance of the decedent’s assets will go into the marital trust tax free because of the unlimited marital deduction. However, the assets in the marital trust will be subject to tax at the death of the surviving spouse because of the broad powers the survivor is given in the trust. Two types of marital deduction trusts should be established. A general power of appointment trust, gives the surviving spouse a right to the trusts income for life coupled with a power to appoint the trust property during lifetime or death to anyone the surviving spouse wishes. Also, a QTIP trust where the spouse is given a right to income for life, but need not be given a power of appointment over the property.

The balance of the marital deduction property would go to a separate trust (often called “Trust A”) that would be controllable by the surviving spouse as to its disposition. Particularly for community property, where the survivor already owns half, it may be very helpful to obtain the marital deduction for all of the estate in excess of the unified credit equivalent (with the exempt portion going to the bypass (or “B”) trust to avoid tax at the survivor’s death), but to still provide that some of the deducted property will ultimately go to the children.

The surviving spouse can be given the power to appoint the property to anyone other than the spouse, his/her creditors, his/her estate, and the creditors of his/her estate. Such a power can be inserted in and held in either a bypass or a QTIP trust without adverse tax consequences.

A life insurance trust coupled with a “pourover will” can be set up. Here a revocable insurance trust is created on the grantor’s life. The grantor’s will contains a provision to the effect that the grantor’s residuary estate, what is left after payments of debts, expenses, taxes, and specific bequests, is to be “poured over” into the living trust. The pourover will also passes any other personal property to the trust. The trust instrument provides that upon receiving the insurance proceeds from the insurance company and the residuary estate property from the pourover will provisions, the total principal will then be divided into two (or three) parts: a portion will go to the marital or “A” trust, a portion will go to the family or “B” trust, and a portion will go to the QTIP trust, which latter will qualify for the marital deduction, but be distributed at the survivor’s death as provided by the grantor in the trust instrument. John’s group term life insurance can be changed to have the trust named as beneficiary of the insurance policy.

There should be inserted into the documents a marital trust a survivorship clause that creates a presumption that for the purposes of the marital deduction, the spouse is deemed to survive if it is not possible to establish the order of deaths.

The survivor’s Property Trust or Power of appointment Trust – the “A” trust – would provide that all income from the trust be paid to the surviving spouse during his/her lifetime There trust A is used as a marital deduction trust, the pourover trust in many cases would contain a funding formula to ensure that the power of appointment trust together with any QTIP trust, would receive just enough

property to reduce the federal estate tax at the death of the grantor to zero. The surviving spouse will usually be given the right to designate by will or other written instrument who will receive the corpus of the marital trust and such appointment may be made to anyone the surviving spouse chooses, including the surviving spouse’s estate. The surviving spouse may also be given the right to withdraw any part of the corpus of the appointment trust during lifetime. In this trust can be placed the stock held by the couple. The couple stock is community property so only half of it would be subject to the marital deduction. John’s 401(K) can be placed in here as well. The lake cabin in Michigan can be placed in this trust as well as it is John’s separate property it will get the advantage of the marital deduction.

The Bypass Trust, the second trust, often called the “B,” bypass, non-marital, or family trust, is designated to receive property that is not allocated to the power of appointment trust, or the QTIP trust. An amount equal to the estate tax applicable exclusion ($5,250,000 in 2013) assuming no taxable lifetime gifts are made) is placed in the trust, since the life estate terminates at the death of the surviving spouse, the surviving spouse did not create the life estate, and the surviving spouse has no general power of appointment over the trust property, there will be no transfer of property that is includable in the estate of the surviving spouse subject to the federal estate tax at death. This, this trust “bypasses” the survivor’s taxable estate and is, therefore, often called a Credit Equivalent Bypass Trust (CEBT) because it is funded with an amount equal to the exemption equivalent of the unified credit.

To enhance the financial security of the surviving spouse without causing later estate taxation, the surviving spouse can be given a “limited” or “special” power of appointment under this family trust. A power of appointment will not be classified as a “general” power and will not subject the corpus of the trust to federal estate taxes at the death of the holder, so long as the power cannot be exercised in favor of the older of the power, his estate, his creditors, or the creditors of his estate

In the Bypass Trust the surviving spouse can be provided with a noncumulative right to withdraw each year the greater of an IRC specified de minimus amount equal to the greater of (a) 5 percent of the corpus of the trust or (b) $5,000. Although this 5 or 5 power will not cause the entire corpus of the family trust to be subject to estate tax, the amount subject to withdrawal in the year of the surviving spouse’s death will be included in the surviving spouse’s estate.

The estate tax at the survivor’s death may be reduced by use of an accumulation provision. Instead of the non-marital income being paid to a surviving spouse, it may be accumulated in a non-marital trust and pass, free of estate tax, at the survivor’s death. Meanwhile, the survivor has been permitted to invade the appointment trust (or the QTIP trust) and consume some of the principal of those trusts. The downside of this technique is using up marital trust assets and building up non-marital trust assets that will pass estate tax free at the surviving spouse’s death is that allowing large amounts of income to accumulate in the non-marital trust may result in adverse income taxation.

The vacation condominium in Florida should be held as a tenancy by the entirety. This will allow the property to pass to the surviving spouse without being taxed and cannot be attached by creditors.

The business partnership should be changed from a partnership to a limited liability corporation. To protect the Susan John from any potential liability. Additionally, a buy-sell agreement should be written by the owners of the gymnastics LLC so in the event of the death of an owner, particularly Susan, the ownership interest will be bought out by the surviving owners.

Asset investing as part of the action plan:

Much of the financial assets held by John and Susan are held in the same types of stocks. John and Susan should consider the following method of investing to preserve and promote the growth of their wealth.

John Meyer gives this advice to the individual investor in a 2004 Business Week interview: “First, get diversified. Come up with a portfolio that covers a lot of asset classes. Second, you want to keep you fees low. That means avoiding the most hyped, but expensive funds, in favor of low cost index funds. And finally, invest for the long term. Investors should simply have index funds to keep their fees low and their taxes down.” (Symons, 2oo4)

                In short: Diversify, avoid fees and taxes, index, and take a long term view.

David Swensen, who rebalances to the policy portfolio as often as daily, offers his thoughts in Pioneering Portfolio Management: “Far too many investors spend enormous amounts of time and energy constructing policy portfolios, only to allow the allocations they establish to drift with the whims of the markets…. Without a disciplined a disciplined approach to maintaining policy targets, fiduciaries fail to achieve the desired characteristics for the institution’s portfolio.”

In a tax-sheltered account make a point to review the portfolio yearly, and then rebalance when it strays.

Faber, M.T., & Richardson E. (2009) The Ivy Portfolio: How to Invest Like the Endowments and Avoid Bear Markets. Hoboken, N.J. John Wiley & Sons, Inc.