1. What is a Will?
2. What is Probate?
3. What occurs During a Probate Administration?
4. How may Probate be Avoided?
5. Why Use a Trust or Other Device when Jointly Owning Property Works Just as Well?
6. What is a Trust?
7. What is a Revocable Inter Vivos Trust?
8. Does a Revocable Inter Vivos Trust Avoid Federal Estate Taxes as Well?
9. What is a Testamentary Trust?
10. What is the Federal Estate Tax?
11. What is the Federal Gift Tax?
12. What is the Annual Gift Tax Exclusion?
13. Are there any Income Tax Considerations in Making Gifts?
14. What About the Income Tax Consequences of Property Received upon Death?
15. Irrevocable Life Insurance Trust: If a donor permanently and irrevocably makes a gift, the assets given away are removed from the donor’s estate.
16. What is a “Living Will”?
17. What is a “Durable General Power of Attorney”?
18. What is a “Health Care Power of Attorney?
Wills are written documents used to transfer property at death to the beneficiaries named in the document. A Will is a written set of instructions as to how the author of the document intends for his or her property to pass at death. Furthermore:
A. A Will must be in writing, and it must be witnessed and executed with the formality required by law. I will make certain that this takes place with respect to any Will executed by you in my office. A Will has no legal significance, however, until you die. Assuming a Will was property drawn and executed in the proper fashion, it will be effective to pass title to the property owned by the author of the Will (referred to as the “Testator” if the author is male; or “Testatrix” if the author is female) at the time of his or her death.
B. A person only has one Last Will and Testament in existence as of any given moment in time. Any copies of a Will are not admissible in probate or valid as a general rule. Rather, only the original of the last document executed by the Testator or Testatrix with the intention that it constitute that person’s Last Will and Testament will have the desired effect. If the original Will can’t be found, the presumption the law follows is that the maker of the Will deliberately destroyed it.
C. A Will may be amended or revoked at any time prior to death. No person acquires any rights to your property just because you name him or her as a beneficiary in a prior version of your Will. Again, you may change that Will at any time prior to your death. The last valid Will written by you prior to your death becomes your “Last Will and Testament” and becomes the one which governs the disposition of those terms of your property subject to it.
D. It is important to note that only certain assets owned by you at the time of your death will be subject to disposition by Will. Jointly owned property passes with a “right of survivorship” outside of a Will, and the Will has no effect thereon unless the other joint tenant or tenants all have died prior to your death. Also, life insurance passes outside of a Will and regardless of the instructions contained in the Will unless your probate estate is made the beneficiary of the life insurance policy.
E. An amendment to a Will is called a “codicil.” A Will may be amended at any time before your death or wholly revoked and replaced with a new version. The concept of revoking a Will is an important one. It is fairly easy to revoke a Will in that virtually any overt act which indicates your intention to revoke your Will can be construed as a revocation. Thus if you decide that you do not like one particular clause in your Will, and draw a line through it, you will have revoked at least that provision if not the entire Will. You may not, however, make a codicil or amendment to your Will except by following the same procedure you did in executing your Will in the first place. The same type of ceremony is involved. You should not make any marks on your Will unless you intend to revoke the entire document. You may not amend a particular clause, by, for example, by lining through the name of one beneficiary and writing in above that name the name of the replacement beneficiary. You should always check with a lawyer before taking such a step. You may inadvertently revoke your entire Will and adversely affect your estate plan by making any hand-written changes to your Will.
F. A Will, to be valid and effective, must be “admitted to probate.”
The word “probate” is derived from a Latin word meaning “to prove.” The idea behind the probate courts is that all expenditures and actions taken with respect to a decedent’s property should be carefully supervised and approved by the court. probate courts in Missouri concern themselves only with the estates of decedents and the estates of incompetents. In other words, the probate courts are concerned with supervising property being managed for the benefit of others. However, probate courts usually do not become involved with trusts unless a lawsuit over the trust is filed.
A. All Wills must be subjected to the jurisdiction of a probate court if they are to be effective. A Will is just a piece of paper until the probate court admits it to probate as the “Last Will and Testament of the Decedent.” Thus any property owned by you which is to be given to someone else by reason of a provision in a Will must first be subjected to the probate court’s jurisdiction.
B. “Avoiding probate” has become a frequently heard expression. Why are people anxious to avoid probate? The history of the probate courts shows the extreme need for these courts. In the past, both in England and in this Country, when a person died, the property owned by the decedent at the time of death frequently “disappeared.” Persons in charge of the property often “appropriated” assets for their own personal use, instead of seeing that they were distributed to the proper beneficiaries. This was particularly true when the beneficiaries of a decedent’s estate were minors or aged or ignorant persons who were not able to look out for their own best interests. Accordingly, a system was developed whereby experienced and learned judges would supervise the administration of each decedent’s estate to make certain that all funds were properly accounted for, and that all property was eventually distributed to the proper beneficiaries. These probate courts also functioned to assure creditors an opportunity to get paid for loans or goods acquired by the decedent prior to his or her death on credit. So the purposes for which the concept of probate came into being were all valid, and in many cases the probate administration of an estate worked for the benefit of all concerned.
C. All probate records are public, and everyone has an opportunity to scrutinize the assets and liabilities in a probate estate to make certain that there is no dishonesty being practiced. However, probably in less than 1% of the probate estates of decedents is there any active dishonesty or misappropriation of funds for which actual supervision of the court is necessary. The overwhelming majority of probate estates are routine matters requiring minimal attention by the court. The mistakes caught by probate courts tend to be clerical and arithmetic mistakes rather than mistakes caused by fraud and chicanery. But the fact remains, if a person leaves his property to his intended beneficiaries by means of a Will, a probate estate must be opened.
D. The major beneficiaries of the probate system have come to be attorneys. Probate matters are rarely complex, but in most cases a probate administration results in a fee payable to an attorney which is usually adequate (if not more than adequate) to compensate the attorney for the amount of time spent. The probate court charges court costs, and the records associated with a probate administration may be examined by any nosy person, regardless of his or her relationship to the decedent.
E. How much may be saved by avoiding probate? The fees charged by attorneys and the courts are usually a function of the size of the estate as opposed to the amount of work involved in setting it. As a general rule, of course, the larger an estate, the more work there will be involved in closing and the greater the lawyer’s responsibility in handling it. However, this is only true to a certain extent, and it is probably not going to be any more difficult for a lawyer to handle an estate which has $1,000,000.00 worth of General Motors Stock in it than it will be to handle an estate which has $100,000.00 worth of General Motors Stock. Nevertheless, the fees associated with the larger estate will be at least five times greater than that of the smaller estate in this example. The probate laws of Missouri establish a “minimum fee schedule” which is based on the size of the estate. Section 473.153 of the Revised Statutes of Missouri provides:
“. . . (There) shall be allowed as the minimum compensation for [an attorney's] services the following percentages of the value of the personal property administered and of the proceeds of all real property sold under order of the probate court:
- On the first $5,000.00 5%
- On the next $20,000.00 4%
- On the next $75,000.00 3%
- On the next $300,000.00 2 ¾%
- On the next $600,000.00 2 ½%
- On the next $1,000,000.00 2%
. . . The court shall allow such additional compensation as will make the compensation of the (attorney) . . . reasonable and adequate.”
F. In addition to the attorney’s fees involved, the executor or administrator (Missouri calls these people “Personal Representatives”) is entitled to the same “minimum” fee set forth in the above statute for handling the estate. Thus where the personal representative and the attorney are different persons, two fees for handling the estate come out of it. The fee is primarily based upon the amount of personal property in an estate, and not real property, unless it is sold by the estate. For example, the fee for handling an estate consisting of one million dollars worth of stocks, bonds, and other securities would be approximately $20,000.00. However, the attorney’s fees associated with handling an estate consisting of one million dollars worth of real property, but very little personal property, might only be two or three thousand dollars. Furthermore, as the above statute prescribes, the attorney and the personal representative are free to petition the probate court for additional fees if extra work is required on behalf of the estate, and frequently these additional fee requests are approved if the court believes the “minimum fee” authorized by law is inadequate.
G. Thus, to answer the question: “How much is saved by avoiding probate?”, one must make a whole series of assumptions to provide an explicit answer. Your estate may change in content and form, to say nothing of valuation between now and the date of your death. Nevertheless, as a rough rule of thumb, a reasonable estimate of the fees associated with handling an estate through the probate process would be approximately three percent (3%) of the gross valuation thereof.
3. What occurs During a Probate Administration?
The probate process begins with the filing of a will in the typical probate estate involving a decedent. Thereafter the court issues letters authorizing an individual to act as the “Personal Representative” of the decedent for the purpose of the administration of the estate. For at least six months, little is done other than publishing a newspaper notice informing the public as to the existence of the estate. This is because during this six month period, any creditor may file a claim against the estate seeking to be paid. All such claims are barred after an estate has been open for one year. But the court usually will not permit any closing of an estate for probate purposes until after this one year period has elapsed. Furthermore, if a federal estate tax return is required to be filed, the probate court usually will not permit a probate estate to be closed until the Internal Revenue Service has indicated its acquiescence to the return filed by the estate and the fact that all taxes property due and payable have been so paid. The IRS does not audit an estate tax return until at least six months after it has been filed, and sometimes longer. The estate tax return is not due until nine months after the date of death of the decedent, and is usually not filed before then for a variety of reasons usually associated with valuing the assets. Thus the typical probate estate involving the possibility of a federal estate tax return takes at least a year and a half to close, and typically two and one-half years. During this period, all bills of the decedent are paid, and the property left over in the estate is distributed to the beneficiaries at the close of the estate administration.
4. How may Probate be Avoided?
The most common method of avoiding probate is to own property as joint tenants with right of survivorship or as tenants by the entireties. Property owned by a joint tenant at his death, so long as he or she is survived by other joint tenants, is not part of the probate process. Life insurance, and certain other gifts made during your lifetime, even if they are to take effect only at death, occasionally avoid the probate process. This is because only property owned only by the decedent as an individual as of the date of his or her death is subject to probate.
One of the principal means of avoiding probate for relatively wealthy individuals is to establish revocable inter vivos trusts, i.e., separate legal entities to own property so that an individual’s property is not titled in his or her own name at death.
5. Why Use a Trust or Other Device when Jointly Owning Property Works Just as Well?
Owning property jointly, or making gifts immediately prior to death, only work for people who do not have federal estate tax problems. Owning property jointly with another individual inhibits and prevents certain federal estate tax avoidance techniques. As a general rule, any property that you own jointly with another person, with the right of survivorship, and any property which you give to another person but which gift is not to take effect until your death, will be fully included in your estate for federal estate tax purposes. Thus while you will have avoided probate with respect to this property, you may not have taken advantage of methods otherwise available to legally avoid the estate tax. Furthermore, joint ownership may cause numerous other estate and gift tax problems. Thus jointly owning property is a tool which has certain applications, but it is far from a universal technique in estate planning.
A trust is a custody device. In owning any piece of property, the law creates two separate types of title: “legal” and “equitable.” The concept of legal title involves the registration or formal ownership of property. The concept of equitable title involves the person who is entitled to the benefits of the ownership of that property. In most cases, legal and equitable title are vested in the same person. For example, an automobile may have a legal title which is issued by the State of Missouri. If the person named on the legal title is also the equitable owner as well, then that person may operate the automobile for such purposes as he or she sees fit. If the legal owner of the automobile is a trust, however the legal owner may not necessarily be able to operate the automobile without restrictions.
A. A trust involves the separation of the legal and equitable titles with respect to the property held by that trust. Legal title is held by a person designated as the “trustee”, but the trustee holds the property for the benefit of the beneficiaries of the trust, i.e., the person or persons for whose benefit the trust was created. Equitable title to the trust assets is considered as being vested in these beneficiaries, and the trustee manages the assets held in trust for the benefit of these beneficiaries. Usually the trustee may not use the assets in the trust for the trustee’s benefit. The legal title to these trust assets is vested in the trustee, but not the equitable title.
B. A trust may be created by a variety of devices, but the most frequent method is the creation of a written document known as a “trust agreement” which is created by the person desiring to do so, who is known as the “grantor.” The grantor executes a trust agreement, and delivers to the trustee named in the trust agreement certain assets to be held by that trustee, in trust, for the uses and purposes delineated in the trust agreement. The creation of the typical inter vivos trust involves giving the trustee extensive instructions as to his or her duties, and as to the application of funds and assets coming into the trustee’s possession. The trustee also is instructed as to when the trust is to terminate. On the day of termination, the trustee must convey legal title to the trust assets either back to the name of the grantor (if the trust is revocable) or to other beneficiaries named in the trust agreement. The trustee also has to take the other steps necessary to wind up and terminate the trust. If a trust has not been revoked as of the date of the death of the grantor, the trust continues as prescribed by the trust agreement for the benefit of the named beneficiaries. The successor trustee assumes the duties which were being performed by the trustee if the first trustee was the grantor. Such an arrangement permits the assets in the trust to avoid a probate administration and to be delivered into the hands of the intended beneficiaries shortly after the grantor’s death. Of course, the trust also can establish a federal estate tax savings scheme.
C. Upon its creation, a trust becomes a separate legal entity, but a revocable trust does not become a separate taxpayer for income tax purposes because all income is taxed to the grantor during his or her lifetime. However, upon the death of the grantor, any income generated thereafter is taxed to the income beneficiary or beneficiaries of the trust, or to the trust itself, depending upon the provisions of the trust agreement.
7. What is a Revocable Inter Vivos Trust?
A “revocable inter vivos trust” is a trust which has been created during the lifetime of the grantor, and hence is referred to as an “inter vivos” trust. The words “inter vivos” are from Latin words meaning “during lifetime.” The adjective “revocable” as applied to this type of trust means that the grantor has retained certain powers to revoke, cancel, amend, or terminate the trust during the grantor’s lifetime. Nevertheless, unless the trust has been revoked prior to the grantor’s death, the trust still will be a separate legal entity as of the date of the grantor’s death. The property owned by the trust is not considered under the law as being owned by the grantor at the time of the grantor’s death. Accordingly, it is not subject to the jurisdiction of the Missouri probate courts. A substitute or successor trustee takes over the management of the trust assets upon the first trustee’s death or resignation, and is responsible for seeing that these assets are held for or distributed to the proper beneficiaries. Of course, such a trust may have numerous other purposes as well, but a primary motivation behind establishing an revocable inter vivos trust is usually the avoidance of probate. You should note that this “probate avoidance” only works with respect to those assets owned by and titled in the name of the trust, however. Just creating such a trust does not avoid probate unless all of your assets are conveyed to and are retitled in the name of your trust.
8. Does a Revocable Inter Vivos Trust Avoid Federal Estate Taxes as Well?
The answer to this question is “no” in the sense that property held by a revocable inter vivos trust during a grantor’s lifetime is considered to be totally controlled by the grantor so long as the grantor has the power to revoke or modify the trust. Thus property in a revocable inter vivos trust will be included, usually to the extent of its full value, in the grantor’s estate upon the death of the grantor for federal estate tax purposes. This does not mean that a revocable inter vivos trust cannot accomplish estate tax savings purposes as well as (or better than) any other technique (such as a Will, gifts taking effect at death, etc).
Perhaps the best way to visualize a revocable inter vivos trust and all the other techniques of transferring property at death is to recognize that a trust is merely another vehicle for the transfer of title. Just as you may walk, drive, take a bus, or fly to a given destination, so you may choose to transfer property owned by you to another individual by any number of different means. One method available would be by means of a revocable inter vivos trust.
9. What is a Testamentary Trust?
A “Testamentary Trust” is one which is established by a Will. The testamentary trust comes into being after the death of the person who wrote the will that describes such a trust (the “Testator”) The personal representative of that probate estate transfers assets to the trustee named in the Will as trustee of the testamentary trust for the purposes set forth in the Will. A common use of a testamentary trust would be for a young married couple to prescribe in their Wills that property owned jointly by them would be held by a testamentary trust for the benefit of their minor children if both parents die.
10. What is the Federal Estate Tax?
A. Overview: The Federal Estate and Gift Tax is an “excise” tax, i.e., it is a tax on the transfer of property by gift or inheritance to another person or persons. The tax is computed based on the fair market value of the property on the date of the gift or on the date of death. The cost of the property when it originally was purchased is irrelevant except for federal income tax purposes.
To fully appreciate the Federal Estate Tax, you must carefully differentiate it in your mind from the other types of taxes that you pay. The federal income tax is one of the main ways in which the federal government raises revenues. It also raises revenues through various types of sales taxes, licenses, etc. In the past, the federal estate tax did not raise substantial revenues for the government, but inflation has changed this over the years. Although the tax tends to apply only to the larger estates, its impact usually is “selective”, i.e., it must adversely affects those persons who do not plan their estates. For many persons, the impact of the estate tax can be considerably lessened. For this reason, the tax has been criticized in the media as being almost an “optional” tax in that only those who choose not to do some estate planning are adversely affected by it. This is an oversimplification, and it is possible that your death may generate some estate taxes. However, with proper planning, a substantial portion of the estate tax which otherwise would have been payable can be legally avoided.
There is another important principle which must be kept in mind in planning your estate: it is a sacrifice on your part. The tax does not become payable until your death. It is your heirs or descendants who have the most to gain from your estate planning. Yet the fact remains, you must spend money currently in the form of attorney’s fees and insurance premiums in order to save the money your heirs otherwise would have to expend on paying estate taxes, but these savings will not materialize until after your death.
B. Computation of the Estate Tax: The federal estate tax is computed in steps.
(1) Properties Included: The first step is to determine what properties are properly to be included in the “gross estate.” Generally, all assets in which the deceased had an interest are included at their respective fair market values on date of death. Some of the types of properties which are required to be included (but about which there are popular misconceptions) are as follows:
(a) Life Insurance: Life insurance proceeds payable as a result of the death of a decedent are part of the decedent’s gross estate for federal estate tax purposes if the deceased owned the policy at the time of his or her death and retained control with respect to the policy. Basically, any control retained over an insurance policy potentially makes the full amount of the death proceeds includable in the gross estate for estate tax purposes.
(b) Jointly Owned Property: Bank accounts and real estate are frequently titled with others as “joint tenants with the right of survivorship.” However, for Federal Estate Tax purposes, if the deceased contributed all of the purchase price for the jointly owned asset, then the full value of that jointly owned asset will be included in his or her estate for Federal Estate Tax purposes. Parents frequently own bank accounts with their children, who are listed as joint owners. They do this as a probate avoidance device. For small estates which are not subject to federal estate taxation, jointly owning assets with children or grandchildren may be a good idea. For larger estates, however, it is rare that jointly owning property with children or grandchildren can be integrated into a well designed estate plan. Furthermore, the creation of a joint ownership with a person who did not contribute towards the purchase of any asset may be construed as a taxable gift under the gift tax laws. The effect of jointly owning property may be to subject that property to both a gift tax and an estate tax, and thus to double the tax on the property. The titling of certain types of property (real estate, stocks, bonds, and other securities, in joint names with right of survivorship) usually has adverse consequences for larger estates.
(c) Transfers Taking Effect at Death: Discussed above is the technique of transferring title to property to the next generation automatically by various transfers that take effect on the death of the grantor. If the grantor reserves the right to use that property until the date of death of the grantor, a gift of the assets has not occurred. This technique may avoid probate insofar as the transfer is concerned, but the full value of the property controlled by the grantor until the time of death is required to be included in the grantor’s estate for federal estate tax purposes. Furthermore, additional complications may arise if the remainder beneficiary (the person who will own the property upon the death of the grantor) dies before the date of death of the grantor. In this event, the remainder interest might come back to the grantor, or might be inherited by some person other than the beneficiary desired by the grantor. For example, assume that a father titled certain real estate in the name of his daughter, but retains a life estate in the property. On the daughter’s death, her Will provides that all of her property should be left to her spouse. That spouse then remarries, and the grantor is faced with the prospect of knowing that on his death, the real estate he formerly owned will become the son-in-law’s property. The grantor probably would have preferred under these circumstances that the property be left to grandchildren or other desired beneficiaries. However, that would not be possible under this hypothetical. Because of the lack of flexibility involved in this technique, it is rare that it is recommend. Its only advantage is avoidance of probate, and there are other better techniques which give more flexibility while at the same time accomplishing this probate avoidance.
(d) Revocable Transfers: A transfer which a grantor specifies may be revoked by the grantor during his or her lifetime is treated by the federal estate tax laws as though the grantor still owned the property on the date of his or her death. Thus the fair market value of the gift property subject to this right of revocation is included in the grantor’s estate at its full value on date of death.
(e) Annuities and Retirement Benefits: The full amount of all annuities and retirement benefits which are payable with respect to a decedent are included as a part of a decedent’s gross estate. It does not make any difference whether the retirement plan was a “qualified” or “nonqualified” type of retirement plan. In other words, with respect to your estate, any Keogh retirement benefits, IRAs, qualified retirement plans (profit sharing plans, pension plans, etc.) will be included up to the full amount thereof at the time of your death. The amount which is paid to the recipient of these funds also will be subject to federal income taxation as well. Thus, because retirement benefits are subject to double taxation (federal estate taxation and income taxation), it usually is not a good idea to leave excessive retirement benefits to a succeeding generation.
(f) Powers of Appointment: A power of appointment is an authority created by some document permitting another person to direct how property will be paid or distributed. For example, property held in trust may be subject to a power of appointment granted to a person other than the grantor. A husband might grant this power of appointment to his wife, to a child, grandchild, etc., upon the occurrence of a certain set of circumstances. If this power of appointment is sufficiently broad, the property which is subject to this power may be a part of the estate of the person who has this power of appointment, even though the property was not originally the property of the person possessing the power of appointment. Inclusion in the gross estate is required if the power of appointment is a “general power of appointment”, i.e., a power authorizing the holder of the power to appoint the property to that person, or that person’s estate, or the creditors of his estate. A power of appointment is a sophisticated estate planning technique. Nevertheless, it has its definite advantages. Its major function is to permit a trusted person other than the trustee to have some discretion over property held in trust and to take into account any change in circumstances occurring after the death of the grantor of the trust.
(2) Deductions: Once the gross estate has been determined, certain deductions are permitted in determining the “taxable estate.” Some of these permitted deductions are as follows:
(a) Expenses of Administration, Debts, and Taxes: The estate is permitted to deduct any indebtedness of the decedent at the time of death, any expenses associated with the administration of the estate, and any income taxes payable at the time of death by the decedent.
(b) Losses: The gross estate may be reduced by any losses incurred during an administration period, such as casualty losses, theft losses, etc.
(c) Charitable Contributions: Any transfers for the benefit of a charitable institution or association are permitted deductions from the gross estate. These transfers may be outright, or in trust.
(d) Marital Deduction: The deduction known as the “marital deduction” is the most frequently encountered method of reducing an estate. However, it requires that the decedent’s spouse survive. The deduction is equal to the amount in value of property transferred to the surviving spouse. Obviously if there is no surviving spouse, there can be no deduction.
(3) Tax Rate Schedule: Once the gross estate has been determined, and the deductions have been taken therefrom, the “taxable estate” is said to have been determined. To this “taxable estate” is applied the tax rate schedule in order to determine the “tentative tax.” The following is the federal estate tax rate schedule for a decedent whose death occurs in 2011 or thereafter:
If the amount with respect to which the tentative tax to be computed is: See Table below.
The tentative tax is:
Computation of a tentative estate tax by reference to the above table may be illustrated by the following example: Assume a decedent dies with a gross estate of $2,100,000.00, and that his estate is entitled to deductions totaling $500,000.00. Accordingly, a taxable estate of $1,600,000.00 results ($2,100,000.00 minus $500,000.00). Referring to the tax rate schedule above, we can see that this taxable estate falls in the bracket of “over $1,500,000.00.” Thus the tentative tax is computed by adding $555,800.00 to 45% of the excess of the estate over $1,500,000.00, i.e., $555,800.00 plus $45,000.00, for a total tentative tax of $600,800.00.
(4) Unified Credit: Once the tentative tax has been determined, the next step is to apply the unified credit. The unified credit is a credit against both the estate tax and the gift tax. The credit may be consumed during a person’s lifetime by applying the credit against any gift taxes which otherwise would be payable. To the extent that the credit is not so consumed, any available credit may be applied against that person’s federal estate tax liability upon his or her death. This credit is like other credits which you may be familiar (for example, the investment credit). It is a dollar for dollar offset against the tax liability. Unless Congress changes this law after the date this information was prepared, the 2011 unified credit will be sufficient to “shelter” (pay the estate or gift tax) on $1,000,000.00 worth of property.
The application of the unified credit can be observed by referring to the previous example of the decedent with a gross estate of $2,100,000.00. As noted above, the tentative tax on that estate would be $600,800.00. The net estate tax payable would be $255,000.00 because of the unified credit amount of $345,800.00.
c. Payment of the Estate Tax: The federal estate tax is due and payable in full, in most cases, nine (9) months after the date of death. However, depending upon the nature of the assets in the estate, an installment payment privilege may be elected. If most of the estate consists of a closely held family business, and other family members continue to operate the family business, it may be possible to reduce the taxes payable by up to an additional $150,000.00, and to pay the federal estate tax over a period of up to 15 years. The interest rate on this 15 year installment option may be as low as 4%. Relatively few estates qualify for this privilege, however. Certain other estates are eligible to pay the estate tax, in whole or in part, over a ten year period, but the interest rate tends to be the “market rate” then charged on unpaid taxes. These installment methods have their own disadvantages, not the least of which is that the IRS maintains a lien (which is equivalent to a mortgage) against the property of the estate for as long as a portion of the estate tax remains unpaid. Decisions concerning the manner of payment of the estate tax are made by your fiduciaries (either the trustee of an inter vivos trust or your personal representative), and the decisions are based on the financial circumstances as they exist at that time.
11. What is the Federal Gift Tax?
The federal gift tax is closely related to the federal estate tax. The federal estate tax would raise very little money if it could be avoided by the simple expediency of giving property away before death. Accordingly, the federal gift tax fills this gap by providing that virtually the same amount of tax is payable regardless of whether a gift is made during lifetime by means of a present transfer, or at death by means of a Will, trust or inheritance. Set forth above are the tax rates which apply to the Federal Estate Tax. These same rates apply to the Federal Gift tax, i.e., the value of the property on the date of the gift determines where it falls in the tax brackets. Furthermore, gifts made in previous years are aggregated with current gifts to determine which tax bracket applies. For example, if $500,000.00 of taxable gifts have been made previously and $100,000.00 is to be given currently, the $100,000.00 gift will be taxed in the 37% tax bracket. The tax is computed by hypothesizing a gift of $600,000.00, but allowing a credit against the tax equal to the amount of previously reported Gift Tax. The effect of this computational technique is to tax the most recent gift in the highest possible tax bracket.
12. What is the Annual Gift Tax Exclusion?
The gift tax has one important exception, i.e., the annual gift tax exclusion. The first $13,000.00 of gifts made in each calendar year to a particular person usually may be excluded for gift tax computation purposes. Thus if a gift of $15,000.00 is made by a donor to a donee in a calendar year, only $2,000.00 of this gift is subject to the gift tax. The following calendar year, another $13,000.00 may be given by that same donor to the same donee, without gift tax consequences. If a donor has several children or grandchildren or beneficiaries, then this $13,000.00 per donee exclusion may amount to a substantial sum. For example, ten beneficiaries times $13,000.00 equals $130,000.00 of gifts which may be made each calendar year to these ten beneficiaries without tax.
A husband and wife can treat a gift as being made jointly, even though only one spouse furnishes the property which is the subject of the gift. This has the effect of doubling the annual gift tax exclusion application to a gift. In the example above, if a married couple had a total of 10 children and grandchildren they wanted to benefit, the husband could give $260,000.00 away in one year without gift tax cost by treating these gifts as having been made half by him and half by his wife.
13. Are there any Income Tax Considerations in Making Gifts?
The general rule with respect to lifetime gifts is that the donee takes the donor’s tax basis in the gifted property. If the gift is of cash, this rule is unimportant. But if the gift is of corporate stock, land, or any other asset which has appreciated substantially in value, this rule is very important. For example, assume that a donor purchased some General Motors stock at a time when it was selling for $10.00 per share. The donor desires to give $13,000.00 of this stock to his daughter, the donee. However, at the time of the gift, General Motors is selling for $70.00 per share. The number of shares given, let us assume, is 150, and therefore the total gift is less than $13,000.00 in total value ($10,500.00). The annual gift tax exclusion would prevent this transfer from being taxable for gift tax purposes. However, the daughter would take the same income tax basis in the stock as the father had in the stock when it was purchased, i.e., $10.00 per share. Thus when the daughter sells the General Motor’s Stock, she will have to pay income taxes on the resulting gain. If she sells the stock for $10,500.00, her basis of $1,500.00 in the stock would therefore produce a taxable gain of $9,000.00. Whether gifts of this type are advantageous will depend at least in part upon the relative income tax brackets of the donor and the donee.
14. What About the Income Tax Consequences of Property Received upon Death?
Certain property received through an estate upon the death of the donor which is fully included for federal estate tax purposes in the estate of the donor acquires a new income tax basis equal to its value as of the date of death. Thus, in the previous example involving the gift of the General Motors stock, if the donor had instead bequeathed this stock to his daughter by Will, she would have received the stock with a tax basis of $10,500.00 (the fair market value of the stock on the father’s date of death). Accordingly, the sale by her of the stock after the father’s death would have produced no income tax consequences. However, under this scenario the stock would have been subject to the federal estate tax in the estate of the donor. If the estate is subject to tax at all, it may be subject to tax at a higher or lower estate tax bracket than the income tax bracket of the donee. Thus, an examination needs to be made as to whether the donee will be better off receiving the property through the estate after estate taxes have been paid or as a gift with the donee paying income taxes on a subsequent sale. If the donee is in a low income tax bracket, the sale of the property by the donee taking the donor’s basis may make the most sense. If the donee is in a high income tax bracket, it may be that the estate tax rates will be lower and thus it might be better for the property to pass through a taxable estate before being received by the donee. Thus any well designed estate plan must take into consideration its Federal Income Tax consequences as well as its Federal Estate and Gift Tax consequences.
If an insured retains control over an insurance policy which insures his or her life, the amount of the death proceeds paid on the insured’s death will be included in the insured’s estate for federal estate tax computation purposes. Thus owning an insurance policy in the wrong manner can have the effect of dramatically increasing the deceased insured’s estate tax liability. One way of avoiding this expensive result is to have an insurance policy owned by an independent trustee pursuant to an irrevocable life insurance trust. A trust of this type must be “irrevocable” (not subject to change) in order to make certain that the gift is treated as having been completed and not being subject to revocation or change. Under these types of trusts, the donors (who usually are the insureds as well) contribute cash to the trustee of an irrevocable trust. The trustee then uses this cash to obtain one or more life insurance policies on the life or lives of the donor or donors. For example, a husband and wife might choose to establish a joint irrevocable life insurance trust with a “second-to-die” policy. This type of insurance policy pays only the death of the last spouse to die. It would only be in the event of the death of the second spouse to die that a substantial estate tax would be due in most circumstances. This is precisely when the need for liquidity and cash is the greatest. A “second-to-die” type of policy often can be procured relatively inexpensively. With an irrevocable life insurance trust, the donor(s) give cash to the trustee who then buys a second-to-die policy on the lives of the husband and wife. After the death of the second spouse, the insurance proceeds are paid to the trust, but because the gifts were made and completed before the donors’ deaths, the insurance proceeds are not a part of the estates of either spouse for federal estate tax computation purposes. This type of trust can prescribe that in such event, the trustee of the trust would continue to hold the proceeds and use the proceeds to pay to or for the benefit of the grantor’s children. Using an irrevocable life insurance trust avoids the result which applies in some cases where people recognize that they might have an estate tax problem and buy life insurance to provide liquidity in cash to pay this tax. However, if they do not plan the ownership of these additional insurance policies properly, the new policies increase the size of the taxable estate, and more than 50% of the additional insurance proceeds collected has to be paid out the federal government in the form of increased estate tax. Thus acquiring any life insurance requires a careful look at the effect this insurance will have on the potential federal estate tax payable.
A “Living Will” is sometimes referred to as a “Medical Directive.” This document was prompted by some well publicized cases involving parents or spouses keeping comatose persons alive only in a technical sense and long after all brain activity had ceased. To avoid being kept alive in a permanent state of unconsciousness, some people give physicians and relatives the clear instruction to not keep them alive by artificial means when all hope of recovery and consciousness has gone. You may consider it to be a good idea to have signed this type of document so that your loved ones know that you are comfortable with end of life decisions being made for you if you are unable to make them for yourself. Such a document can prescribe that you authorize your care givers to withhold medication, food, hydration, and to give you palliative care if hope of recovery and regaining useful consciousness is not probable. This document also provides for organ donations. Although you need to be comfortable with the provisions of this document, most hospitals appreciate it if some form of this agreement is executed. I believe the attached form is comprehensive and grants the necessary authority to the care givers to make them comfortable in withholding treatment in the appropriate circumstances.
17. What is a “Durable General Power of Attorney”?
A durable general power of attorney is a grant of authority to someone to act on your behalf. This is a “powerful document” in that signing it means you would be giving someone else the authority to deal with your property and assets in the same manner you might personally deal with those assets. Thus this document would authorize the person designated as holding your power of attorney to sell anything you own, to enter into contracts to which you would be obligated, to make investments, and even to modify your estate planning documents. Obviously you would not grant this authority to anyone in whom you did not have complete trust. Even though there are risks associated with a document granting this authority, however, it can be extremely useful. For example, if all of your assets are supposed to be held in trust in order to effect your estate plan, but it is discovered that you have assets titled in a different manner, those assets can be converted by the person holding a power of attorney into assets held by a trust or trusts so as to avoid probate or otherwise conform to your estate planning.
The term “durable” in the title of this document is intended to refer to the fact that this power of attorney is not revoked even though the person who grants the power of attorney becomes incompetent. The normal rule is that a power of attorney is automatically terminated when the grantor of that power becomes mentally incompetent. A durable power of attorney survives and remains effective even though the person who granted the power of attorney, although competent at the time the power of attorney is signed, thereafter becomes incompetent. As a practical matter, it is very rare for a durable general power of attorney to be needed unless and until the person who granted the power of attorney becomes incompetent. Sometimes they are needed when the grantor is out of the country and cannot be reached or if there is some uncertainty as to whether they are alive or dead. Most of the time, however, this document enables successors to act for the grantor in an emergency situation, and when the grantor cannot act for themselves.
Some attorneys write these powers of attorney so that they only are effective when the grantor becomes incompetent. However, it is very difficult to prove incompetence in the absence of a judicial declaration to that effect. Therefore, just when your agent might need the use of the power of attorney the most, your agent would be unable to use it if, in order to do so, he or she had to prove that the grantor of the power was incompetent. It may be preferable that these agreements be effective immediately upon signature so that the person to whom the power is granted would immediately have the power to act as agent for the grantor of the power. But this is a trade off, i.e., utility and expedience in use may be preferable to the agent designated having the authority to act only if you cannot act for yourself. The risk is that because the power of attorney is effective immediately, the person to whom the power is granted could do something with your property that you would not want done. Thus you take a risk in granting this authority because you might be disappointed. Only you can make this choice, and an attorney can draft this particular agreement any way you want.
18. What is a “Health Care Power of Attorney?
The purpose of a health care power of attorney is to allow the authorized person(s) named in this document to make health care decisions for you if you are unconscious. These health care decisions could include surgery, medication, and other treatments that otherwise could not be performed in the absence of your consent. By signing this document, you authorize someone to act on your behalf in giving the hospital or physician involved permission to undertake the surgery or treatment deemed appropriate. This document authorizes someone to proceed on your behalf to make these decisions for you if you cannot make them for yourself.