IMPORTANT FAMILY DOCUMENTS, IDEAS AND TERMS

(A BRIEF OVERVIEW FOR DISCUSSION PURPOSES)

 WILL

A WILL is a document that directs the disposition of your assets at death as you designate.  Having a valid WILL in place is critically important to everyone.  Without a WILL, your assets will be distributed as prescribed by state law, which may not be in accordance with your desires. 

Under laws of most states, you can leave your assets to whomever or whatever you like, any individual, association, corporation, group, trust, government entity, etc.  You usually are able disinherit your children or anyone you want, except that most states will not allow you to wholly disinherit your spouse.  A WILL can be used in conjunction with other estate planning tools such as Living Trusts, Bypass Trusts, etc.

A WILL becomes effective only upon the death of its maker.  At any time until death or incompetency of the maker, the WILL can be modified or revoked.  A WILL only affects property owned by a person at his/her death which does not automatically transfer to another, such as assets held in joint tenancy which automatically pass to the joint tenant, insurance proceeds which automatically transfer to the designated beneficiary, Living Trust assets that are transferred to the Living Trust before death, “Totten Trust” assets, such as bank accounts titled as John Doe, as Trustee for Jane Doe, and “POD” payable on death or “TOD” transfer on death accounts.

A WILL can also be used to appoint persons legally entrusted with the care of minor children, a “guardian”.  A person who dies having made a valid WILL is said to have died “testate,” while a person dying without a will is said to have died “intestate.”

A person making a WILL is called a “testator” (masculine) or “testatrix” (feminine).  Persons entitled to the inherit property through a WILL, trust, life insurance policy, or other contract are called “beneficiaries.”  The person or organization named in the WILL who is in charge of administering the WILL, and settling, and/or managing an estate is called the “executor” or “personal representative.”

A WILL does not mean your estate will avoid the Probate process or be exempt from estate taxes.  A WILL does direct the Probate Court to distribute your estate as you choose, not as the Probate Court by state law chooses.

LIVING WILL

A Living Will is NOT a WILL.  A Living Will is a separate document that specifies whether life-sustaining measures should be undertaken to preserve life when the maker is not expected to recover.  A Living Will is limited in scope and authority.  A Medical Durable Power of Attorney for Health Care covers a broader range of health decisions and is recommended instead.

ESTATE TAXES

Estate taxes are imposed on “taxable estates” over $1,500,000 for 2005, and the exemption is scheduled to increase over time to $3.5 million in 2009 and repealed in 2010), except for those utilizing the Martial Deduction (see below).    This initial $1,500,000 or larger amount is referred to as the Unified Credit and every individual is entitled to this credit amount.  If there is less than $1,500,000 in an estate, there will be no estate tax unless part of the $1,500,000 has been previously utilized through reportable gifting, see Gifts and Gifting.  The estate tax rate starts at 18% and increases quickly to 48% for taxable estates exceeding $3,000,000, with the first dollar above $1,000,000 taxed at 39%.  The highest rate is scheduled to decline during each of the next few years to a level of 45% in 2009.

MARITAL DEDUCTION

The Marital Deduction for estate tax purposes allows unlimited amounts of assets to be transferred from one spouse to another during life or at the death of the first spouse with NO gift or estate tax liability whatsoever.  As an example, if a husband and wife own a residence, rentals, stocks and other investments that total $2,500,000, when the first spouse dies, the entire estate can be transferred to the surviving spouse and there is NO Federal Estate tax owed on the transfer.  Some states may impose inheritance taxes.  In the above case, the estate taxes are calculated and due based on the value of the estate when the second spouse dies.  Tax planning before the death of the first spouse can reduce the taxes at the time of the death of the second spouse, which is what estate planning is all about.  If the surviving spouse spends or makes non-taxable gifts assets sufficient to reduce the remaining estate to $1,500,000 (for 2005) at the time of death of the surviving spouse, then no taxes are ever due on that estate.

UNIFIED CREDIT

The Estate Tax and the Gift Tax are part of a unified transfer tax system.  Under this unified system, a single set of tax rates are applied to cumulative lifetime and at death transfers of taxable property.  The unified system ensures that a transferor pays the same amount of tax regardless of whether the transfer is made during life or at death.  The Unified Credit is currently $1,500,000 per individual, with increases scheduled through 2009.  As an example, if a person makes “taxable” gifts of $1,000,000 during his lifetime, he uses up $1,000,000 of his Unified Credit but still no $500,00 in credit available to reduce estate taxes at his death if occurring in 2005.  If only $300,000 of the Unified Credit was used through taxable gifting during his lifetime, $1,200,000 would remain available as a credit toward reducing any estate taxes.  There is an entirely new set of regulations scheduled to be imposed on January 1, 2010, with only a lifetime $1 million gift exemption before gifts are taxed to the Donor.

PROBATE

Probate is a court proceeding in which a determination is made that a WILL submitted to the court is a correct valid WILL, assets are inventoried, notice is published inviting creditors to make claims, legitimate creditors are paid, and the balance of assets are distributed as provided for in the WILL.  Only property that is owned by the person at the time of death goes through Probate.  There is typically a cost for the Probate process which is often established by state law since an attorney is often required for probate through the courts. 

If a person dies without a WILL, “intestate,” then Intestate Administration by the courts takes place.  Administration is a court proceeding to determine how property should be distributed.  The process is similar to Probate.  After inventorying the assets, inviting creditors to make claims, and paying claims of legitimate creditors, the property is distributed to those entitled to it based upon the laws of the state which specify the “heirs” or persons entitled to receive the property and the proportions to which they are entitled.

GIFTS AND GIFTING

Spousal transfers during life are never taxable gifts.  Any person can give another person $11,000 or less in any calendar year and there is no gift or income tax to either the donor or the recipient.  The recipient of a gift is not ever taxed on the receipt of the gift, although a donor may be subject to gift taxes under certain circumstances.  A husband and wife can EACH give $11,000 or less in any calendar year to the same person, such as a son, daughter, niece, or anyone, with no gift tax liability.  Gifts totaling over $11,000, $22,000 if by husband and wife, in one year to any one person need to be reported to IRS, although the donor uses part of his/her lifetime Unified Credit of $1,000,000 and again there is no gift tax liability until that threshold is exceeded.  Use of the Unified Credit means that the taxable amount of the gift exceeding $11,000 reduces dollar for dollar the $1,500,000 estate tax exemption at the death of the donor. 

Gifting is a significant estate planning and estate tax reduction tool.  You can give $11,000 a year to each child, each child’s spouse and each grandchild to reduce your taxable estate.  As an example, a single person who has two married children each with two children, can gift $88,000 per year, with each of the eight people receiving $11,000.  A married couple can double that amount to $176,000 a year.  This can be repeated each calendar year.  No gift tax would be due and the Unified Credit is NOT reduced, remaining at the $1,500,000 level.

Gifting can also be made through trusts such as a Charitable Remainder Trust (CRT) whereby the donor makes a gift but receives income in return for a period of time, which can be for a lifetime. CRTs can be arranged through colleges, other charities or privately structured by you.  You make a gift, get a limited charitable contribution deduction, and then collect the income from the gifted asset or an assets acquired by the gifted asset.  If you donate any appreciated asset such as appreciated stock, you avoid the capital gains tax that is normally due on a stock sale by making the gift to charity before the sale.

As an example, you donate to the CRT stock currently worth $100,000, for which you paid $10,000.  The CRT sells the stock for $100,000.  You pay no tax on this sale and you receive some credit for a tax deductible contribution based upon a complex annuity tax formula.  The CRT then pays you 8% a year on the money, $8,000 a year, which you declare as ordinary income.  At your death, the $100,000 remains with the charity, but you have received the income for a period of time and avoided the tax on the gain of the sale of the stock.  This area is very complex area and requires precisely drawn documents and a clear understanding of the short and long-term cash and tax benefits and costs.  Knowledgeable professional advice and document drafting is critical.

LIVING TRUST

A Living Trust is a trust created during your lifetime.  It is “revocable,” which means it can be amended or terminated by you anytime while you are alive and competent and is also referred to as a Revocable Inter Vivos Trust.  A Living Trust becomes “irrevocable” upon your death which means the assets placed in the Living Trust will then be absolutely controlled subject to the terms of the Living Trust agreement established prior to your death.

A Living Trust DOES NOT save taxes, either estate or personal taxes.  A Living Trust is used primarily to avoid probate and manage property and assets.  Assets must be transferred into the Living Trust PRIOR to death to avoid Probate.  Income from assets held in a Living Trust during your lifetime are included in your personal income for income tax purposes.  Assets held by the Living Trust at the time of your death are included in your estate and may be subject to estate taxes depending on the size of the estate.  A Bypass Trust or similar trust can be established as an estate tax reduction vehicle.

Many professionals believe the benefits of a Living Trust are being oversold.  Even though a Living Trust may save your heirs time and the cost of Probate, one major trade-off is the time you will need to spend to transfer title to your existing assets to the Living Trust and to then continually keep new assets properly titled in the name of the Living Trust.  If you transfer your home into the Living Trust, it may be very difficult to obtain a mortgage on the property or refinance an existing loan.  Anything you leave out of the Living Trust will be subject to Probate.  Some assets such as life insurance policies, IRAs, annuities and pensions do not need a Living Trust to avoid Probate since they are paid directly to beneficiaries.  A Living Trust can be of value if there are minor children involved and the assets can be managed for them until they reach majority.

BYPASS TRUST

A Bypass Trust, which is also sometimes referred to as a Credit Shelter Trust or Exemption Equivalent Trust, is a trust designed to take advantage of the lifetime $1,500,000 (for 2005) estate tax unified credit.  The Bypass Trust is the most universally used method of saving estate taxes in family situations.  By using a Bypass Trust, estate taxes of up to $435,000 can be saved on an estate that has total assets exceeding $2,000,000.  The Bypass Trust does not save any taxes on estates with assets under $1,500,000 since there is normally no tax liability.

Operationally, up to $1,500,000 of estate assets are placed into the Bypass Trust, with the surviving spouse entitled to receive the trust income for life plus limited principal distributions from the Bypass Trust.  No new assets can be added to the Bypass Trust nor can assets removed be later reinvested in the Bypass Trust.  The Bypass Trust assets transfer to the next beneficiary at the death of the surviving spouse and bypass that estate and are not subject to estate taxes in the surviving spouse’s estate.

OTHER TRUSTS

There are many other types of trusts that are used for specific purposes or estate tax planning.  These would include Charitable Remainder Trust (CRT),  Charitable Remainder Unitrust (CRUT), Charitable Remainder Trust with Life Insurance Replacement Trust, Charitable Lead Trust, Grantor Retained Income Trust (GRIT),  Grantor Retained Annuity Trust (GRAT), Grantor Retained Unitrust (GRUT), Irrevocable Life Insurance Trust, Irrevocable Trust, Personal Residence Trust (PRT), and many others.  Each trust has to be analyzed as to its use and benefit and risk.

POWERS OF ATTORNEY

A Power of Attorney is a document that authorizes another person to act for you and may take many forms.  The person to whom the power is given is called an “attorney in fact.” A Power of Attorney terminates at death.  A Power of Attorney also terminates on disability, unless it is a Durable Power of Attorney.  A Power of Attorney can also be structured to become effective only upon the occurrence of a specific event, such as disability, which is known as a “springing power.” 

A General Power of Attorney authorized the attorney in fact to act unrestricted in all matters on your behalf.

A Special Power of Attorney authorizes an attorney in fact to act only on restricted or specific matters as you specify, such as sale of a real estate property, specific stocks, etc.

A Durable Power of Attorney remains effective after a disability, and can be worded to only become effective upon the occurrence of disability or specific event.  A Durable Power of Attorney is an important tool to ensure that your wishes are carried out during incapacitation.  It can eliminate the imposition of a court appointed guardian or conservator.

ADVISORS AND REFERENCE MATERIAL

The information provided above is a very brief overview of some areas of the complex legal and tax area of wills, trusts and estates and is believed to be accurate at the time of preparation of this overview.  Each situation is different and requires individual attention.  Professional tax and legal advice is critical in each individual situation.