TIPS IN ESTATE PLANNING

Smart estate planning involves more than having a will, even a fairly complex one. It takes into account a realistic assessment of your net worth, intelligent use of the marital deduction, and gift-giving programs that can reduce future taxes. It should also include trusts that will keep your estate out of probate, and the use of other trusts to minimize or avoid taxes.

Determine Net Worth First. The starting point begins with an assessment of your actual net worth. This assessment will also give you a fair indication of how much of your estate is potentially taxable.

Once you know the size of your estate and the potential estate tax, you can take specific steps to eliminate tax in some cases, minimize it in others, and insure that there's money on hand to pay what's due.

The Gross Taxable Estate. For valuation purposes, your gross taxable estate includes every type of property you own "to the extent of your interest in it." For citizens and legal residents, this includes all property, wherever it's located. Also included is property that you may have disposed of legally, but have continued to control during your lifetime. And your gross taxable estate may include transfers of property with a retained life estate, transfers that take effect at death and transfers that are conditional on survivorship.

Marital Deduction. You can leave an unlimited amount of your estate to your spouse, free of federal estate tax. During your lifetime, you can make a gift to your spouse without any gift tax consequences. (There are restrictions on gifts to spouses who aren't US citizens, although careful planning can avoid many of these taxes.)

Death of First Spouse. Tax problems generally will not arise until your spouse dies. Then, unless you've planned ahead, anything you own over $2,000,000 [1] will be subject to progressively steep taxes (see tax rate tables).

With proper planning, you and your spouse can shelter so much as $4,000,000 from federal estate taxes with a fairly simple device – a revocable living trust. Using a revocable living trust, you and your spouse can each pass along $2,000,000 free of federal estate taxes.

Here's an example of how to shelter your estate: First, divide your property equally between yourself and your spouse, with you and your spouse each owning $2,000,000 worth of property; you can accomplish such an allocation with a trust.

Use of Trust During Your Lifetimes. Because the trust instrument is revocable – that is, you can change it – you will not have to file any additional tax returns. As a matter of fact, you will be able to use your property much the same way you now use it. The primary difference in owning property in trust is this – title to the property will be in the name of a trustee (for example, Sam Jones, Trustee). You will still be able to use the property, just as you now do.

When one of you dies, one part of the trust (valued up to $2,000,000) will pay the other spouse income for life. The trust can also allow the surviving spouse to use the assets, if necessary.

Meantime, the surviving spouse also has the unlimited use of the other $2,000,000 during his or her lifetime. On the death of the surviving spouse, the money in both trusts would go to your beneficiaries (your children, for example), without any federal estate taxes.

The same idea can be used for larger estates. For example, on a $5 million estate, if the money were simply left to your spouse, with no tax sheltering trusts, and the surviving spouse then willed the estate to the children, the federal and state death taxes would total approximately $1,380,,000.

By using a trust arrangement, you would cut the tax bill to $465,000, which represents a savings of about $460,000, which represents a savings of about $920,000.

Trust Benefits. There are many benefits to owning property interest. Here is a list of some of those benefits:

• Because you can change a living trust whenever you wish during your lifetime, it can adapt to changes in your needs and those of your family. The provisions of a trust do not become irrevocable until death.

• In addition, such trusts can also save on fees and administrative expenses after your death, and save time and trouble for the beneficiaries. Assets can be paid out quickly after death, because trusts sidestep the sometimes costly and time-consuming probate process.

• Furthermore, in most instances, a displeased relative cannot contest the trust's provisions (as they can if you use a will – a will contest could hold up distribution of your estate for months or even years in probate court). To contest a trust, a disgruntled relative would have to file civil suits against each of the beneficiaries, who already have received your property which was previously held in the trust. As a practical matter, such a lawsuit would be difficult in most cases.

• To set up the trusts you pay a one-time fee. Unless you later decide to change them, there are no further costs.

• Trusts also are strictly private affairs, unlike probate proceedings, which are matters of public record.

• If you later become incapacitated and unable to handle your affairs, a correctly drawn trust can take care of your needs and those of your family without having to go through the court system to establish a guardianship of your estate. This means that many of your financial affairs can be handled far more expeditiously. For example, if a stock you own is failing, it can be sold quickly, rather than waiting for days or weeks until a court gives its approval. This, of course, can mean the difference between profits and losses.

The Trustees. You'll undoubtedly name yourself as trustee of your living trust, but you'll also have to choose one or more successor trustees to handle affairs if you can't.

You may want to name your spouse, if he or she has a good head for business, but you'll still need someone else to take over if you both die in a common accident. The first consideration, obviously, is that the person must be trustworthy, whether a family member, close friend, or professional, such as your bank's trust department.

If you'd like to name a relative but fear there may be too much pressure and quarreling within your family, it's probably a good idea to name an institution or a professional to handle the job.

As a safeguard, the trust should contain a provision that allows you to remove any successor trustee, for whatever reason, and name another at your discretion.

Funding the Trust. To avoid probate – which is a highly desirable objective – the Settlors (sometimes referred to as Grantors or Trustors – in other words, the persons establishing the trust) of a revocable living trust must transfer all right, title and interest to their property, to a Trustee. The probate court only has jurisdiction over your property if it is titled in one of three ways: (a) in an individual name; (b) as a tenant in common with another; or (c) whenever a life insurance policy, an interest in a pension or retirement plan, or an IRA, designates the death beneficiary as being "my estate". All other types of property – life insurance which designates a beneficiary other than "my estate", property owned as joint tenants with right of survivorship (or tenancy by the entireties), or property held in trust – escape the jurisdiction of the Probate Court.

Thus, to avoid probate, title to your property must be transferred to a Trustee.

In a properly drawn revocable living trust, there are certain assets which are listed, which are deemed to be property belonging to the trust estate – without any other specific document of conveyance to a Trustee. For instance, personal property owned by the Settlor at the time of his or her decease, unless specifically excluded, should be regarded as being a trust asset. Clothes owned by the Settlor would fall within the category of tangible personal property, and such property would belong to the trust estate (due to the conveyance made to the Trustee under the terms of the trust). Similarly, household goods would fall within the list.

Real Estate. The problem of funding the trust becomes a bit more complicated with respect to real estate. In all instances where a trust is prepared, and the Settlor owns real property, a quit claim deed is usually furnished, in which title is conveyed from the Settlor to the Trustee. If the Trustee dies, then the Successor Trustee will sign an affidavit and file it with the Registrar of Deeds. Such an affidavit should be sufficient evidence to satisfy a title examiner that the trust was not revoked prior to the Settlor's death and that the duties of Trustee are now being carried on by a Successor Trustee. By analogy, the resignation by the president of a corporation, and the election of a successor president, provides a means whereby the successor president assumes the duties of the office of president. Similarly, a Successor Trustee assumes the duties of the office of Trustee, when the original Trustee no longer serves in that capacity.

In most instances, the Settlors will record the quit claim deed with the Registrar of Deeds (i.e., the County Clerk). Once the deed is recorded, the County Tax Assessor might argue that the homestead exemption of the Settlor is lost because title in the real estate is being held by a Trustee, not a homesteader – however, in Oklahoma, because the trust is a revocable living trust, and because the Settlor is the beneficiary of the trust during his or her lifetime, the homestead exemption is not lost.

In addition to real estate, the Settlors should also convey title to any interest in mortgages (and the notes which are secured by the mortgage), and oil and gas interests to the Trustee..

Stocks and Bonds. But what about title to other types of properties? Several years ago, a Settlor owned several million dollars in securities. The Settlor died without first transferring title to the securities by separate instrument to the Trustee. During the process of transferring the trust estate from the Successor Trustee (the decedent was the initial trustee) to the beneficiaries, the question arose as to whether or not the decedent Settlor's securities had been transferred to the trust. The stock transfer agents had no record of the transfer, and the problem was, did the Settlor make an effective transfer of his securities to the trust? If an effective transfer were not made, then the decedent Settlor's estate would have to be probated.

To resolve this issue, the trust instrument stated that it was the Settlor's desire to avoid probate and that the Settlor intended to transfer all right, title and interest in and to all of the property mentioned in a "catch all" phrase. This "catch all phrase" included the category of intangible personal property; certainly securities were within that definition.

After several months of corresponding with the stock transfer agents, most of the stock transfer agents agreed to accept a letter from the Successor Trustee that the trust was not revoked before the Settlor's death, that title to the stock was held by the Successor Trustee, and that the stock be transferred to the beneficiaries of the trust. The stock transfer agents only required a tax release and a stock power, in order to effectuate the transfer to the beneficiaries. They acknowledged that the securities were held pursuant to the terms of the trust, and that title to the stock could be transferred to the beneficiaries without probate. However, there was a considerable delay before all of the transfer agents completed the transfers, not to mention the legal expenses involved in dealing with each transfer agent.

To avoid this sort of problem, the Settlor should at least sign a stock power or an allonge (which is an endorsement to the stock certificate, and works much the same way as a stock power) as part of the trust closing documents – and the signatures of the Settlors (as shown on the stock power or allonge) should be guaranteed by an officer of a national banking institution, using the Medallion Guaranty program (a nationally recognized guaranty program). In addition, it would be helpful if the Settlors maintained a list of all of the trust assets, including all stock certificates, bonds, life insurance policies, by date of issue and registration or policy number, etc., as well as a list of title certificates for automobiles, horses, airplanes, mobile homes, boats, bank accounts, or anything else that has a registration number. Such a list would be additional proof of what assets were included in the trust. The list would not necessarily have to be a part of the trust instrument, so long as it was clearly identified as being a list of trust property.

As an alternative means of avoiding the probate process, the stock certificate or brokerage account might contain a "transfer on death" designation (this requires contacting the stock transfer agent or stock broker and completing additional forms), and indicate that upon the death of the owner, the security or brokerage account will be "transferred on death" (TOD) to the acting trustee of the trust.

Bank Accounts. All bank accounts and bank account numbers, regardless of the style of the account, should be included in the trust, as being part of the trust assets. It is advisable to change the style of the account at the bank, and this can be accomplished as follows: (a) the Settlors can re-title their account as being a trust account – new checks will not have to be printed, because the account will not be regarded as a “new” account; or (b) the Settlors can add a POD (pay on death) designation to the account, with "the acting trustee of the Smith Revocable Living Trust" as being the POD beneficiary (this method is permitted by most banks and credit unions) – again, no new checks will be required. The taxpayer identification number for the account will be one of the Settlors’ social security numbers.

IRA's and Retirement Plans. Because there are income taxes to be paid on retirement plans (except Roth IRA's), even in the event of death, there may be adverse income tax consequences to the beneficiaries if a death beneficiary has been improperly designated. Normally, the plan participant will name his or her surviving spouse as the primary death beneficiary, with the children named as contingent beneficiaries. If the IRA or retirement benefits are substantial in size, the trust will usually be named as the primary beneficiary through the use of special election forms.

Insurance. The beneficiary of insurance policies will normally be the acting trustee of the trust (in some instances, the other spouse will be the primary beneficiary, with the acting trustee as a contingent beneficiary).

Power of Attorney. Another estate planning instrument you'll need is a durable power of attorney that names the person you've selected as your successor trustee. A power of attorney, which creates an agency relationship between the principal and his or her attorney in fact, isn't a magic document that will take the place of wills and trusts, because it's automatically revoked at death and during periods of disability. However, a "durable power of attorney," if permissible where you live (it is permitted in Oklahoma) will allow the person you've chosen to act for you (i.e., as your agent), if you're unable to do so yourself. This is especially helpful if you or your spouse must go into a nursing home or some other institution.

Living Will. You may also want to have a "living will" that says you don't want to be kept on a life support system if you're terminally ill and there's no hope of recovery. Most states allow this choice. These documents may also permit donation of body parts to science.

Business Owners. If you own a business, you have still more planning to do, because control of the business must be carefully planned, and your family cared for in the manner you want them to be. You'll probably have to answer some hard questions. For example, do you have:

• A procedure, acceptable to IRS, to value the stock in your closely held business?

• A buy-sell agreement with a potential purchaser of the company stock?

• Life insurance that is earmarked specifically to fund the buy-sell agreement?

• A "key man" insurance policy that will help your company procure new management?

• An asset that will provide cash to pay estate taxes that will be due on your death?

SUMMARY

The probate of an estate is not an evil undertaking, which should be avoided at all costs. However, it is time-consuming and in many instances, very expensive for the heirs. Hopefully some of the thoughts shared in this short article will be of assistance in the estate planning process.

[1] The Estate Taxes have been repealed, effective in 2010, but until that time, the unified credit will be increased, on a phased-in basis, over a nine year period. The applicable amounts are: $1,000,000 for decedents dying in 2002-2003; $1,500,000 in 2004 and 2005; $2,000,000 in 2006, 2007 and 2008; $3,500,000 in 2009. Due to the design of our tax legislation, however, the estate taxes will be reinstated in the year 2011, unless Congress agrees to extend the repeal of the estate taxes at that time.

Oklahoma Estate taxes pose a different problem. Although there are no estate taxes for surviving spouses, there are such taxes for "lineal heirs" (i.e., children, grandchildren), if the taxable estate exceeds $1,000,000. If the beneficiary of the estate falls outside the classes of surviving spouses and lineal heirs, they are taxed as "collateral heirs", and there is no $1,000,000 exemption provided for such beneficiaries.

©2006 James H. Beauchamp

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