Choosing a Fiduciary-Part II of II

As you are choosing a fiduciary, it is also important to name successor fiduciaries. What if the executor or trustee you choose is unable or unwilling to serve when the time comes? What if that person is sick, deceased or incapacitated when it comes time for them to serve? What if they move far away, making it difficult to perform important duties?

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Choosing a Fiduciary-Part I of II

Good estate planning requires serious thought when making "fiduciary" (e.g., power of attorney, executor, and trustee) appointments. Black's Law Dictionary describes a fiduciary relationship as "one founded on trust or confidence reposed by one person in the integrity and fidelity of another."  These appointments will dictate who controls, manages and distributes your assets when you are incapacitated or have passed away.

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Western U.S. Estate Tax Returns 50% Higher Than IRS Projections

At a California Tax Bar Conference on November 2, 2007, IRS Territory Manager for estate and gift taxes in the western United States, Charles Morris, noted that a much higher than anticipated number of estate tax returns are being filed. The IRS had anticipated approximately 33,000 returns would be filed in 2007. It now appears likely that about 50,000 estate tax returns (a 50% increase) will be filed.

The increase in filings occurs in the same year in which the IRS has substantially reduced the number of estate tax attorneys and other staff. As a result, the IRS is necessarily going to focus on specific areas that involve potential compliance issues.

The areas for compliance focus are the following:
  1. The family limited partnership and discounts for lack of marketability and minority interest.
  1. Sec. 2036(a)(1) retained control or enjoyment of transferred assets - Mr. Morris notes that the IRS has won "decision after decision" in that area.
  1. Valuation - partial interests in real estate continue to be a contentious area.
  1. New Sec. 6695A appraiser penalties - the substantial appraiser penalties will be assessed in 2008. Mr. Morris reminded tax advisors that there is no statute of limitations on the appraiser penalty.

EGTRRA Effect on Federal Estate Tax Returns

An article in the summer 2007 issue of the Statistics of Income Bulletin shows how recent changes in the estate tax exemption level have significantly reduced filings of estate tax returns. Remember, the current estate tax scheme introduced by Congress under the Economic Growth and Tax Relief Reconciliation Act of 2001 ( EGTRRA) gradually increased the federal estate tax exemption ($1,500,000 for 2004-2005 and $2,000,000 for 2006-2008) and decreased the highest federal estate tax rate (48% in 2004, 47% in 2005, 46% in 2006, and 45% in 2007-2009).  This article highlights the changes from 2001 to 2005 in the number of federal estate tax returns filed, the total value of the assets reported on these returns, and the federal estate taxes paid on these returns.  Specifically:

  • the total number of estate tax returns filed fell by 58% to about 45,000 in 2005 from about 108,000 in 2001;
  • the total amount of assets represented by these returns fell by 14% to $185 billion in 2005 from $216 billion in 2001;
  • however, net estate taxes reported on these returns declined by only 8%.

It is interesting that the number of returns filed fell by 58% but the amount of tax paid only fell by 8%.  Because the article just examined the differences in the numbers from 2001 to 2005 and we have since entered into another higher level of federal estate tax exemption and a lower federal estate tax rate, I wonder what the numbers will reflect in the next report.  Stay tuned for more to come.

Divorce and Transfer Tax Consequences

Some unique gift, estate, and generation-skipping transfer tax issues surround divorce or separation. The following issues should be taken into account.

Gift taxes

Property settlements must be reviewed in light of the possible imposition of a gift tax. The Internal Revenue Code provides for an unlimited marital deduction for transfers between spouses. However, transfers after divorce do not fall into this exception.

The tax laws do provide some gift tax protection for property settlements entered into after a divorce is finalized. For example, transfers for settlement of property rights or child support are exempt from gift tax if:

  • The parties enter into a written agreement. The agreement does not need to be approved by the court.
  • The transfers are payments of cash or property in settlement of spousal martial rights and a “reasonable allowance” of support rights of a minor child of the marriage.
  • The agreement must be entered into within a period beginning two years before the divorce and one year after the divorce. The agreement, but not the transfer of assets, must occur during this three-year period.

Also, the Supreme Court has ruled that divorce-related transfers founded on a court decree are involuntary and, therefore, are not voluntary taxable transfers for gift tax purposes. However, if the divorce decree merely declares the marriage terminated but does not approve the property transfer, the IRS could still argue that the transfer is a gift.

If the parties fail to enter into a written agreement, but make the transfers prior to a final decree of divorce becoming effective, the gift tax marital deduction may eliminate any gift tax on the transfer.

If a divorce agreement requires that one spouse fund the college education of the couple’s children, care should be taken to make sure the payments are made in a manner that does not produce a taxable gift. For example, instead of reimbursing an ex-spouse for the cost of tuition, the payment should be made directly to the institution, for which the tax code allows an unlimited gift tax exclusion for tuition only. Other payments for the child’s education may be covered by the $12,000 annual exclusion. As part of a divorce decree, the couple might also consider pre-funding college costs for children (especially younger children) by using Section 529 Plans. The rules permit donors to pre-pay up to five years of annual exclusion gifts to fund a Section 529 Plan.  


Estate Taxes

Divorce agreements often do not pay sufficient attention to the estate tax implications. The Internal Revenue Code provides for an unlimited marital deduction for death transfers to a spouse, but it does not provide any marital deduction for transfers to an ex-spouse. A liability accruing pursuant to a divorce settlement agreement is not necessarily a deductible debt of a decedent’s estate. It is important to make sure the divorce documents create an enforceable debt against the estate to generate an estate tax deduction, rather than a taxable transfer.

If the decedent’s obligations are based on a court decree,the post-death obligations would be deductible. However, if the court did not require the property transfers (e.g., transfers to support a step-child),the post-death transfers may not be deductible for estate tax purposes, unless they were entered into for “adequate and full consideration.”

Transfers satisfying the gift tax requirements listed above will be treated as an expense of the estate. Thus, if former spouses have a written agreement that satisfies the three-prong test, testamentary transfers to a former spouse pursuant to the agreement are treated as deductible claims against the estate.


Gift splitting

The law permits a spouse to elect to be treated as the donor of a gift, even when the other spouse is the sole transferor. In order for the “gift splitting” to apply, the donor must file a gift tax return, on which the spouse consents to the treatment of the gifts as made one-half by that spouse. The return must be filed by the donor spouse, even if a gift tax return was not otherwise required (e.g., when only annual exclusion gifts were made). Gift splitting for any year applies to all gifts and cannot be made on a gift-by-gift basis. If gift splitting is elected, the spouses have joint and several liability for any gift tax that may be due.

Because of this rule, consenting spouses should be very careful to assure that the value of the gifts are accurate.

If gift splitting was anticipated early in the year, divorce before year end will terminate the right to split gifts.

Using The Unified Credit

The unified credit should be viewed as an asset of a couple’s divorce estate when it comes to estate planning. For example, assume a wealthy wife agreed to or is required to make a significant property settlement for the benefit of a less wealthy second husband. She wants the funds to eventually revert to her children from a prior marriage. She could create a lifetime trust during the marriage for the benefit of the soon to be ex-spouse. Properly created, the trust would create no gift taxes. At the ex-husband’s death, his unified credit (which he might not otherwise have used in full) benefits her children by reducing the overall transfer taxes. A similar arrangement could be made through a generation-skipping trust and annual exclusion gifts using the couple’s combined generation-skipping and annual exclusion exemptions.


Divorce and Your Estate Plan

Dissolution of a marriage raises a number of complicated issues. There is more involved than obtaining a property settlement and divorce decree. The impact of a pending divorce on your estate plan should be considered as a part of the divorce process. The following issues relating to your estate plan should all be reviewed if you are separated from or divorcing your spouse.


You should discuss with your estate planner the possibility and benefit of executing a new will in contemplation of the divorce. Although Texas provides statutory rights to a surviving spouse, notwithstanding the terms of the decedent’s will, a new will can still provide for the maximum allowable benefits to go to your children or other heirs instead of to the other spouse. This may also be a time when it is particularly important to provide for a trust for your children’s inheritance.

Likewise, this is an important time to re-think the persons whom you have named as the executor of your estate and the trustee of any trusts you may have provided for in your will and change your will accordingly.  

Once divorced, Texas law provides that the divorce results in the ex-spouse being treated as a predeceased heir of the maker of the will. However, “updating” your will by means of relying on the inflexibility of statutory law is not generally the best solution. Therefore, if you did not execute a new will in contemplation of a divorce, then it is certainly advisable to do so once the divorce is final.

If a divorce or legal separation has occurred and results in financial obligations placed upon you, your will should reflect the terms of the agreement that must be carried out. Your new will should also be careful to provide that any bequests to an ex-spouse are in satisfaction of your legal obligations and are not meant to be in addition to those obligations. For example, assume the divorce decree provides that a payment of $100,000 be made to an ex-spouse in ten years. Your will says, “If my ex-spouse is alive in ten years, I convey to her $100,000.” As a result, the ex-spouse may receive a double benefit of both the bequest and divorce settlement rights.


Retirement Plans

You may also need to explore the possibility and benefit of executing new beneficiary designations for your retirement plans in contemplation of the divorce. Federal law generally provides that the retirement benefits of a qualified retirement plan must pass to the surviving spouse even if separated or if a divorce is pending, unless the spouse waives those rights. However, federal law does not require a spouse to be the designated beneficiary of an IRA.

Once divorced, Texas law provides that a designation made prior to divorce of the other spouse as a beneficiary under an individual retirement account, employee stock option plan, stock option, or other form of savings, bonus, profit-sharing, or other employer plan or financial plan of an employee or a participant in force at the time of divorce, the designating provision in the plan in favor of the former spouse is not effective, and the proceeds of the policy are payable to the named alternate beneficiary, unless:

  1. the decree designates the other former spouse as the beneficiary;
  2. the designating former spouse re-designates the other former spouse as the beneficiary after rendition of the decree; or
  3. the other former spouse is designated to receive the proceeds or benefits in trust for, on behalf of, or for the benefit of a child or dependent of either former spouse.


Life Insurance

You should discuss with your estate planner the possibility and benefit of executing new beneficiary designations for your life insurance in contemplation of the divorce. Although Texas law provides that a designation of an ex-spouse as beneficiary becomes void upon divorce, if your spouse is the named beneficiary and you are merely separated or if a divorce is pending at the time of your death, the beneficiary-spouse will receive the life insurance benefits.

Similar to retirement plans, Texas law provides that a designation made prior to divorce of the insured’s spouse as a beneficiary of a life insurance policy is not effective, and the proceeds of the policy are payable to the named alternate beneficiary, unless the decree designates the insured’s former spouse as the beneficiary; the insured re-designates the former spouse as the beneficiary after rendition of the decree; or the former spouse is designated to receive the proceeds in trust for, on behalf of, or for the benefit of a child or a dependent of either former spouse.

 If a divorce has occurred and results in your obligation to name a certain person as the beneficiary of a life insurance policy, you should execute a new beneficiary designation form to reflect the terms of the agreement to be carried out.


Other Beneficiary Designations

Don’t forget to review your annuities, bank accounts, brokerage accounts, and any other assets that may have a beneficiary designation. However, in certain circumstances Texas law requires notice be given to the other spouse or may require both spouses to sign the beneficiary change form.


Powers of Attorney

Many couples have executed powers of attorney naming each other to provide for the handling of medical and property issues in the event of incapacity. In many cases, estranged spouses do not focus on revising these important documents during or after divorce. In Texas, divorce terminates the powers granted to a former spouse under a durable power of attorney, but it does not do so until the divorce is granted. Having a soon-to-be ex-spouse in charge of medical and property decisions is usually not advisable. Therefore, you should consider changing your powers of attorney on the first hint of divorce. Alternatively, your documents can provide that if divorce or legal separation proceedings are initiated, the spouse’s right to serve as power holder immediately terminates and the next named successor is automatically appointed.


Your Parents’ Estate Plan

If you are separated from or divorcing your spouse, your parents may need to review their own estate plans as well. For example, your parents’ wills may provide gifts or other benefits for your spouse or may name your spouse as an executor or trustee. Your parents’ powers of attorney may also name your spouse as an agent to make medical and property decisions.  Though Texas laws may automatically “revise” your documents to read as though your ex-spouse predeceased you, they do not revise your parents’ documents.

A key element to planning for the potential divorce of a child or heir is flexible drafting. Every plan needs to address the possibility that a child or an heir will face a future divorce. The use of spendthrift trusts for the intended beneficiaries is oftentimes a good solution. Basically a spendthrift trust is any trust that restricts the ability of any trust beneficiary to assign or otherwise transfer his or her interest in the trust. It also restricts the right of a beneficiary’s creditors (which may include an ex-spouse) to demand payment of income or principal to satisfy the beneficiary’s obligations.

How To Stay In Your Grandparent's Will

I have revised many estate plans and wills in my 30 years of law practice. There are many reasons that one changes a will. Taxes. Financial success. Financial reversal. Marriage. Divorce. But no event seems to occur more often than a change to delete a beneficiary or reduce his or her gift because of conduct, or lack thereof, which causes one to lose his or her place in a grandparent’s heart.

I have often given programs on estate planning. Sometimes I think the best advice might be to beneficiaries rather than to the estate planning client. So, I offer a few basic hints.

Seek Their Wisdom. Your grandparents are the ones who brought your parents into this world, and if that had not happened, you would not be the subject of this article. No matter who your grandparents are or what they are like, they will have life experiences and wisdom from which you will profit. Their lives are an important part of your character foundation.

Remember Important Days/Events. Call, write, and visit your grandparents on the important days of their lives. They have been doing the same for you. Nothing shows one more how much you care than your sincere remembrance of them.

Try. Demonstrate to your grandparents, and most importantly, to yourself that you can make and earn the substances of life on your own. Rely on the foundations they have provided by their teachings and examples (not their money), and their love and support, to create your own significant existence. Your efforts will be what make you strong, not granddad’s cash.

You Are Not Entitled. There is not a right in this state to inherit. No cut of the pie was reserved for you at your birth. Your grandparents can add you or delete you from their wills with the stroke of a pen. Do not live your life with foolish hopes of entitlement to wealth you did not create.

Don’t Count Your Chickens Before They Hatch. I promise that if your grandparent finds out that you have started a new house, ordered a new car, and set up a Caribbean cruise betting on the inheritance to come, you have just taken one of the top 3 steps to be written out of your grandparent’s will. Nothing seems to upset a grandparent more than your expecting what is to come, and worse, making your financial plans based on his or her dying.

Save (Buy Used Cars). The number one cause for deletion of a beneficiary from a will is that he or she is a total and hopeless spendthrift. I often hear one say, “Why she has never saved a dime, nor will she ever!” If you are a spendthrift, admit it, change your ways or get someone to help you do so. All of those around you, including you, will be better for it.

Live Responsibly. All of my comments above boil down to the hope of all grandparents, and that is their grandchildren will have a life rewarded by his or her own responsibility. Wealth, no matter how much, is a serious responsibility. We must all use our resources wisely, so that the management of wealth will support and nurture ourselves, our families and our fellow human beings.

Please understand that the comments above are my observations. They are not recipes for inheriting from grandma. Followed, however, your reward will be great.