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Estate planning When I meet with clients to discuss their estate planning needs, there are three general topics that need to be covered. First and foremost, we need to understand the clients' goals and objectives. Second, we need to understand the effects, if any, of federal estate tax. The third relates to probate and whether it is necessary to take steps to avoid probate, which is usually the case. As to personal goals, normally that is fairly simple. As it relates to husbands and wives, on the death of the first, they generally want to provide for the other. When they are both gone, they want to provide for their children. However, there are situations where this can be more complex, such as where there may be elderly parents who need to be provided for, children from a prior marriage, or children who have special needs, such as a mental or physical disability or drug or alcohol dependents, or the like. Obviously, we need to know the particulars of the clients' needs in order to prepare an estate plan that achieves their goals. FEDERAL ESTATE TAXES I say federal estate taxes because California does not have a death tax. As it concerns the federal estate tax, the basic concept is that the federal government has an opportunity to look at your estate when you die and determine whether an estate tax should be assessed. There are two key components in the estate tax calculation. The first is referred to as the "unlimited marital deduction" and the second is the "unified credit." As it concerns the unlimited marital deduction, that is exactly what it sounds like; whatever one spouse leaves to another passes estate-tax free. There may be an estate tax assessed on the death of the second spouse, but at least, as it concerns the husband and wife, they can rest assured that no tax would be due while either of them is living. The unified credit relates to a concept that the federal government does not want to tax all estates but only what it considers to be "large" estates. As of this date, the estate tax law is somewhat influx and it is not uncommon to see articles where there is discussion about a repeal of the estate tax. But, as it stands now, the unified credit is increasing on the following basis:
2006, 2007 and 2008.........................$2,500,000 In reviewing the above chart, you probably have two comments. First, "Geez, it would probably be a pretty good idea to die in 2010 since there is no estate tax." Second, "Why in the world would the unified credit be $3,500,000 in 2009 and only $675,000 in 2011?" The answer is that the current tax law expires at the end of 2010 and, if no changes are made, we go back to the tax law as it existed in 2001, which would be a unified credit of $675,000. Virtually no one thinks we will get to 2010 with no changes to the tax law. However, what that change will be, everything from a repeal to a fixing of the unified credit at a set amount (perhaps somewhere between $1,000,000 and $3,000,000) is anyone's guess. But, for our purposes at this time, let us assume a unified credit of $1,500,000. With no estate tax planning, an estate of $1,500,000 will pass tax free. However, with fairly simple estate tax planning, an estate worth $3,000,000 will pass estate tax free, even with only a $1,500,000 credit. A few examples will explain this.
Look at figure 1. In figure 1, the family has an estate worth $3,000,000. This being California and a community property state, the husband and wife each own one-half of that $3,000,000 or $1,500,000 each. In figure 1, the husband passes and leaves the entirety of his estate to his wife. There is no estate tax on the death of the husband due to the unlimited marital deduction. However, when the wife later passes, she is able to use her $1,500,000 credit, there is a tax assessed which would total $715,000, and the balance, being $2,285,000, would pass to the children.
However, now see figure 2. In figure 2, when the husband passes, he does not leave his property to his spouse but instead leaves it to what we will call a "Credit Shelter Trust" ("CST"). So the first question is: Is there any tax on the death of the husband? The answer is no, based on the unified credit of $1,500,000. Then, when the wife later passes, she has only $1,500,000 worth of property which also passes estate tax free based on the unified credit, $1,500,000, and the children receive the entire $3,000,000 estate with an estate tax savings of $715,000. However, this is normally where the wife says, "But, wait a minute, in figure 1, I had an estate of $3,000,000 and in figure 2, I only had an estate of $1,500,000. What happened to my other $1,500,000?" The answer is, it was placed in a CST. At this point, you need to remember that the primary goal of the husband and wife was that the survivor benefit from the estate. What the CST does is remove the property from the wife's estate yet still allows her some level of benefit from the CST while she is living. It is that level of benefit that is the key. The wife will be entitled to the following rights as it concerns the CST: (1) She will be entitled to receive all income generated by that trust; (2) she will be entitled to demand up to 5% of the principal on an annual basis; and (3) she will be entitled to receive additional principal "as needed" for health, maintenance and support. Therefore, while the wife does not have unlimited access to the amounts in the CST, she does have certain rights to that property. Whether the use of a CST will be of benefit to a particular estate depends on the particular needs of the clients. First, of course, they need to have an estate large enough that would be subject to tax if estate tax planning was not performed. Second, in my opinion, the age of the clients plays a role. If people are in their 40's, the creation of a CST may be of a significant burden in that, if one spouse were to die unexpectedly, it would be presumed that the other spouse would live his or her natural life, which might be an additional 30 to 40 years. Is there really a benefit to establishing a CST for a 45 year old to avoid estate taxes several decades in the future when we don't even know what the estate tax will be at that time? Yet, on the other hand, if the clients are in their 60's or 70's, the establishment of a CST may not appear to be as much of a burden. These are the types of things I discuss with clients when I meet with them to discuss their estate planning needs. PROBATE AVOIDANCE The concept of probate is very important. Probate is the process followed when individuals die to make sure that their debts and taxes are paid and that the balance of their estate is distributed as they had intended. The problem with probate is that it is expensive, time consuming and intrusive. It is expensive because both the attorney and the executor are entitled to be paid a fee based on a formula. That formula is 4% of the first $100,000, 3% of the next $100,000, 2% of the next $800,000, 1% of the next $9,000,000, and 1/2% of the next $15,000,000, with amounts in excess of $25,000,000 subject to determination by the court. The amount is calculated on the gross value of the estate, not the net. If we assume a gross estate value of $3,000,000, then the attorneys' fees would be $43,000 and the executor's fees would be $43,000 for a total of $86,000. (It is common for family members to act as executors and they will often waive their fees. However, the attorneys' fees alone are significant.) It is time consuming and intrusive for similar reasons. It is intrusive in that we need to account to the court all of the property (assets and liabilities) that the decedent owned at time of death. It is time consuming because, due to the fact that, as a court process, everything simply takes time; in my experience, the simplest probate takes at least 9 months to one year, and most take much longer than that. Due to these factors, many people have sought ways to avoid the cost and expense of probate, which will lead to my discussion of living trusts, as set forth below. However, before discussing living trusts, it is important for husbands and wives to understand that, in most instances, probate is avoided on the death of the first of them since oftentimes the property they own is not subject to probate, which includes the following:
Even when probate is necessary in a husband and wife situation, there are court procedures that make such probates simpler. As a result, probate avoidance is not necessarily critical in a husband and wife situation but, eventually, there will be a need to avoid probate on the death of the second spouse. Therefore, from a planning standpoint, it is generally advisable to take steps while both spouses are living so that probate can be avoided at a later date. The most common way to avoid probate is through the use of a living trust. As I begin to discuss living trusts, let me start by saying that most of the law makes common sense, but living trusts do not. " A regular trust" is fairly easy to understand. In a "regular trust," by way of example, a grandfather (the creator or trustor of the trust) gives money to a bank (the administrator or trustee of the funds) and the bank is instructed to hold the money for the benefit of a grandchild (the beneficiary) so that there is money available for the grandchild to go to college. We have all heard of these types of trusts and they make common sense. All trusts have these three parties involved: The creator or trustor of the trust, the administrator or trustee of the trust, and the beneficiary. In a living trust we have those same three parties but, at least upon creation of the trust, they are the same three parties: Husband and wife, as creators and trustors, form the trust and transfer the property to themselves as administrators or trustees of the trust for their own benefit. Again, this may not appear to make common sense, but it exists only because we have over 600 years of trust law that allow the concept in the first place. Let me also say that living trusts have very little legal effect. They are ignored for income tax purposes, they do not protect you from creditors, etc. Their main purpose is to avoid probate. From a purely legal standpoint, the husband and wife are no longer "owners" of the property, but the trustees are the owners. It is almost easier to think of the trust as a corporation. The husband and wife transfer all their property to the corporation (the trust) so that, when they die, they no longer own the property and it is not subject to probate. Similar to a corporation, when the president of a corporation dies, the corporation simply appoints a new president. When the trustee of the trust dies, the trust document sets forth who the successor trustee will be. Should the situation arise where the trust document fails to name a successor trustee, then there is a simple court procedure for getting a new trustee appointed. As a result, for probate avoidance purposes, most people utilize a living trust. A living trust also has other benefits which might come into play. One of those is "secrecy." A living trust, by its very nature, is a private document. A will, on the other hand, is filed with the court on the death of the individual and is available for anyone to see. For most people, this is not a significant issue. However, in some families, there might be situations that they do not want made public, such as the disinheritance of a child or the fact that they have a child with a drug or alcohol problem that requires special attention. These topics can be covered in detail in a trust without concern that the information will become public. Another potential benefit is that a living trust might help avoid the need for the appointment of a conservator later in life. As we all know, people are living longer these days and some beyond their ability to take care of their own property. The living trust provides that, upon a trustor/trustee being unable to take care of their own property, then the successor trustee steps in to that role. For more information or to discuss your estate planning needs, please contact Ross J. Schwartz |
Practice Areas Civil Trial & Appellate Practice
Business Counseling
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Joint tenancy
property; on the death of the first of the joint tenant, the property
"automatically, by operation of law," passes to the survivor, property held
as community property with right of survivorship.