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Estate Planning for Second Marriages and Blended Families Maximizing Tax Benefits, Incorporating Pre- and Postnuptial Agreements, and Meeting Obligations to Children and Spouses

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TUESDAY, NOVEMBER 13, 2012

Presenting a live 110-minute webinar with interactive Q&A

Bridget K. Sullivan, Member, Sherman & Howard, Denver

John T. Midgett, Shareholder, Midgett & Preti, Virginia Beach, Va.

Kristin A. Pace, Partner, Fitzgerald Abbott & Beardsley, Oakland, Calif.

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5

Estate Planning for Second

Marriages and Blended Families

Crafting Estate Plans to Incorporate

Pre- and Post-Nuptial Agreements

John T. Midgett

[email protected]

6

Overview

“Marriage is the triumph of imagination over

intelligence. Second marriage is the triumph

of hope over experience.” – Oscar Wilde

7

Challenges and Issues

Ethical Issues of Joint Representation

Titling of Assets

Beneficiary Designations

Choices of Fiduciaries

8

Ethical Issues of Joint Representation

Model Rules of Professional Conduct

Rule 1:7 – a lawyer shall not represent a client if

the representation involves a current conflict of

interest.

ACTEC Commentaries

RE: MRPC 1.7: Some conflicts of interest are so

serious that the informed consent of the parties is

insufficient to allow the lawyer to undertake or

continue the representation (a “non-waivable

conflict).

9

Some Indications of Potential Conflicts of

Interest

Pre-Nuptial Agreement

Post-Nuptial Agreement

Either or both spouse has a child or children

from a prior relationship

Great Disparity in Assets of the Parties

Great Disparity in the Ages of the Parties

Past Representation of a Single Party

10

Issues the Lawyer Should Consider

Laws of Intestate Succession

Elective Share Laws

Statutes favoring “Omitted Spouses”

Joint Tenancy issues

Beneficiary Designations on Life Insurance

and Annuities

Beneficiary Designations on Qualified

Retirement Plans

11

Laws of Intestate Succession

Statutory “will”

Is the share for the surviving spouse too little

or too large?

How are children to be treated?

Children from prior relationships

Children with surviving spouse?

The spouse’s children from prior relationships?

12

Elective Share Laws

Surviving spouse may be entitled to a

percentage of the TOTAL estate, including

non-probate assets

Usually involves litigation to determine

Expensive

Divisive

13

“Omitted Spouse” statutes

Testator made a will (avoiding intestacy) but

subsequently marries

Invokes statutory presumption that Testator

did not intend to disinherit spouse

14

Joint Tenancy Issues

Joint Tenancy with Surviving Spouse

With Rights of Survivorship

Without Rights of Survivorship

Joint Tenancy with Children

With Rights of Survivorship

Without Rights of Survivorship

15

Beneficiary Designations – Life Insurance

Coordinates with Pre or Post Marital

Agreements?

Who is in control of proceeds?

Balancing economic needs

Each policy must be examined and the

beneficiary changed, if needed

16

Beneficiary Designations – Qualified

Retirement Plans

Consider Pay-out options available to

surviving spouse

Who controls balance, if any, at survivor’s

death

Trusts as beneficiaries

“Oldest Beneficiary” rule for measuring lives

Marital deduction issues – Battle between RMD

and mandatory income payout. See Rev. Rul.

2006-26.

17


Presence and Effect of Pre- and Post-Nuptial

Agreements

Presence and Effect of Divorce Decrees and

Property Settlement Agreements

Buy-Sell Agreements

18


Family Dynamics

Putting the “fun” in dysfunctional

“What we have here is a failure to communicate!”- from

the movie Cool Hand Luke

Jealousy and Greed

Control and Management

Balancing the interest of “Yours, Mine and Ours”

November 13, 2012

Bridget Sullivan, Esq. Sherman & Howard L.L.C.

633 17th Street, #3000

Denver, CO 80202

(303) 299-8130

Discussion of Prenuptial and Postnuptial Agreements

Estate Planning for Second Marriages and

Blended Families

20

Bridget Sullivan is a Member in the Tax & Probate Department of Sherman & Howard’s Denver office. She practices in the areas of estate planning, wealth transfer planning, estate administration, trust administration, and litigation related to trusts and estates. Ms. Sullivan focuses on sophisticated estate planning techniques and prenuptial agreements. She has counseled clients on a variety of wealth transfer strategies and charitable giving techniques to accomplish family giving objectives while minimizing the impact of gift, estate, generation-skipping transfer, and income taxes. Ms. Sullivan graduated from Yale Law School in 1990. She is named in Best Lawyers in America for Trust and Estates and is named as a Colorado Super Lawyer.

Bridget K. Sullivan, Esq.

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1. INTRODUCTION

• The principal purpose of a marital agreement is to

alter the rights otherwise provided by law of one or

both spouses to the property of the other spouse,

whether upon termination of the marriage by

divorce or by death or both.

• Many states have a marital agreement act, which

determines the rights of parties who have entered

a marital agreement, the types of matters that

parties may agree to and the enforceability of

marital agreements.

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2. REASONS FOR HAVING A MARITAL AGREEMENT

• Create certainty with respect to the disposition of

property at the end of a marriage.

• Protect family legacy assets and provide assurance

to the senior generation which may have built the

family wealth.

• Protect family owned or closely held business

interests.

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• Protect the interests of children from a prior marriage.

• Protect family trusts in a divorce.

• Provide security and certainty to the less wealthy

spouse.

• Simplify and reduce the expense that often

accompanies divorce or litigation upon death of the

spouse.

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• Waivers of Surviving Spouse Rights

– A marital agreement may govern the rights of the

parties in the event of the termination of the

marriage by death of either party.

– The agreement may include a partial or complete

waiver of property rights arising at death.

– The agreement may also include a promise to

provide for a substitute transfer of property to the

waiving spouse.

3. RIGHTS OF SURVIVING SPOUSE UPON DEATH OF

OTHER SPOUSE

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– While both parties to a martial agreement may agree to waive – in whole or in part – their respective property rights arising at death, each party remains free to leave more property to the other than would be required by the agreement.

– A release and waiver of “all rights upon death” or equivalent language in a marital agreement encompasses the waiver of several statutorily granted spousal rights and priorities.

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• Status as Surviving Spouse

– A person who is divorced from a decedent or whose

marriage has been annulled is not a surviving

spouse.

– However a decree of separation does not terminate

the status of husband and wife for death purposes.

A husband and wife are considered married

regardless of whether a divorce action has been

instituted.

– A marital agreement can modify these provisions,

stating specifically that a separation decree or the

filing of an action for divorce terminates all surviving

spouse rights.

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• Intestate Share of Surviving Spouse

– If a person dies without a will, the decedent’s property will be distributed in accordance with the applicable statute of intestate succession.

– Under many states, the surviving spouse’s share of the intestate estate is dependent upon the circumstances of the parties, including whether there are adult or minor children of the marriage and whether the decedent has adult or minor children from another relationship.

– Under the law of many states, the surviving spouse receives the entire intestate estate (1) when the decedent has no surviving descendants or ancestors or (2) when all of the decedent’s surviving descendants are also descendants of the surviving spouse and there are not other descendants of the surviving spouse who survive the decedent (i.e., it was likely a first marriage for both spouses).

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• Spouse’s Elective or Statutory Share

– Dower refers to the legal right or interest that a wife acquired in the estate of her husband. It consists of the right to one-third of the husband’s real property. Curtesy is the common law life estate given to a husband in the real property of a deceased wife. Many states have abolished dower and curtesy, replacing these common law rights with statutory rights to an elective or forced share.

– Absent a marital agreement, the surviving spouse has the right to an elective share of the augmented estate. Uniform Probate Code states, such as Colorado, have adopted a right to elect an amount not greater than 50% of the “augmented estate”). Under the Uniform Probate Code, the percentage of the augmented estate to which the surviving spouse is entitled is determined by the length of time the spouses were married, but is essentially as follows:

29

If the Decedent and the Spouse The Elective Share

Were Married to Each Other: Percentage Is:

• Less than 1 year Supplemental amount only

• 1 year but less than 2 years 5% of the augmented estate









• 10 year or more 50% of the augmented estate

30

• Augmented Estate

– The augmented estate is comprised of property owned by

the decedent at death as well as certain pre-death gifts to

the surviving spouse and to third parties. The augmented

estate is a statutory concept created to prevent

disinheritance of a spouse through transfers to others

while at the same time equitably accounting for inter vivos

and testamentary transfers to the spouse.

• Pretermitted Spouse

– Absent a marital agreement, if a married person dies

having executed his or her will prior to the marriage, and

such will does not provide for the surviving spouse, then

the surviving spouse has the right to take a share of the

estate as a “pretermitted spouse.” The pretermitted

spouse’s share of the estate is generally equal to the

spouse’s intestate share.

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• Family and Exempt Property Allowances

– Absent a martial agreement, in many states a surviving spouse is entitled to the family and exempt property allowances. These allowances are in addition to the intestate or elective shares. These are generally modest amounts.

• Priority to Serve as Personal Representative or Executor

– In many states, the priority to serve as personal representative or executor is established by the decedent’s will. However, in the absence of a will or if the will fails to nominate someone who can act in such position, the surviving spouse has priority to act. This priority to serve can be waived in a marital agreement.

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• Federal Law Rights to Retirement Plan Assets

– The survivorship rights in and benefits under qualified retirement plans are governed by federal law, including ERISA and other provisions of the Internal Revenue Code, it is federal law, and not state law, that governs when and how a participant may obtain a valid waiver of survivorship rights and interests in such plans.

– A participant in a retirement plan cannot obtain a valid waiver of spousal survivorship rights prior to the parties’ marriage. Thus, the general waivers of “all rights upon death” or even a specific waiver of rights to a retirement plan, will not constitute an effective waiver of spousal survivorship rights in a retirement plan.

– Waivers in a prenuptial agreement must be coupled with mutual promises to execute separate retirement plan waivers after the parties are married.

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5. WAIVERS OF SURVIVING SPOUSE ENTITLEMENTS IN

MARITAL AGREEMENTS

• Waiver of statutory and common law rights upon

death.

– A release and waiver of “all rights upon death” or

equivalent language in a marital agreement

encompasses the waiver of statutorily granted spousal

rights and priorities.

– Such waivers can be done in a general waiver or in a

more specific laundry list of waivers.

34

– My laundry list (covering Colorado law) generally appears

as follows:

• “Specific Waiver. Upon the death of either of us, the

other waives the following:

– The right to take an intestate share under Colo. Rev.

Stat. 15-11-102 or 15-11-301;

– The right to an elective share under Colo. Rev. Stat.

15-11-201, and to take any interest in the

augmented estate under Colo. Rev. Stat. 15-11-202;

– The right to an exempt property allowance under

Colo. Rev. Stat. 15 11-403;

– The rights of an omitted spouse under Colo. Rev.

Stat. 15-11-301;

– The right to a family allowance under Colo. Rev.

Stat. 15-11-404;

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– The right to a homestead interest under Colo.

Rev. Stat. 38-41-201 and 38-41-204 (as to each

other, but not as to third parties);

– The right to act as a personal representative or

trustee of the estate or trust of the other, unless

specifically nominated or designated by the other;

– All rights to any pension plan, profit sharing plan,

deferred compensation plan or retirement benefits

and cash accumulations in life insurance which

have or might have accrued for the benefit of the

other, unless specifically designated as

beneficiary; each of us agrees to execute the

documents necessary to effectuate that waiver as

required by the terms of the pension plan, profit

sharing plan, deferred compensation plan or

retirement benefit plan, state law or federal law;

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– Any rights to contest any disposition of property by

the other by any inter vivos trust;

– Any provisions of the Colorado Marital Agreement

Act, Colo. Rev. Stat. 14-2-301 through 310 in

conflict with this Agreement; and

– Any rights either of us might have to claim any

portion of the estate of the other under the laws of

any jurisdiction other than Colorado which are of

like or similar purpose to the enumerated Colorado

statutes that provide dower, curtesy, forced

heirship, community property or marital property

interests or any other right to claim against the

estate of a deceased spouse by a surviving

spouse.”

37

• Limitations on Waivers If There Are Children of the

Marriage

– Note, in cases of young couples marrying with family

wealth who do not have children from previous marriages,

sometimes these waivers of rights upon death are

appropriate only if there are no children of the marriage.

– However, if there are children of the marriage, it may not

make sense to have the less wealthy spouse waive “all

rights upon death.” If the wealthier spouse fails to follow

up with estate planning or with proper estate planning, the

less wealthy spouse, now the parent of the children of the

marriage, may be disinherited.

38

• Community Property Waivers

– I practice in Colorado, which has adopted the Uniform

Probate Code state and is not a community property

state. An exhaustive discussion of community property is

outside the scope of this outline.

– Generally, community property is owned by both spouses

equally. Community property does not include property

owned by a spouse prior to marriage, property gifted from

one spouse to the other, property inherited by a spouse

or property which was separate property prior to the time

the spouses moved to the community property

jurisdiction. The titling of property is not determinative of

its status. Earned income of the spouses is community

property. Income from separate property is community

property in some jurisdictions and not in others.

39

– Frequently, parties execute a marital agreement in one state

and move to another jurisdiction. All practitioners should be

careful to draft waivers of rights upon death broadly enough

to cover rights granted in any jurisdiction. A well drafted

waiver of rights upon death will include a specific waiver of

any property rights based on the laws of community property.

– From an estate planning perspective, one benefit of

preserving community property is that the entire property

receives a step-up in basis at the death of the first spouse.

I.R.C. § 1014 (b)(6). Under Section 1014(b)(6), even though

only the decedent spouse’s one-half interest is includable in

his gross estate, the entire community property obtains a

stepped up basis. This is perhaps the greatest advantage of

community property. Because of this advantage, a lawyer

preparing a marital agreement for clients in a community

property state or clients who have migrated from a community

property state will want to consider whether to retain the

community property character of certain assets.

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6 SUBSTITUTE TRANSFERS IN EXCHANGE FOR

WAIVERS OF SURVIVING SPOUSE RIGHTS

• It is common for parties who enter into mutual

waivers of rights upon death to agree to make

substitute transfer to each other, either during the

marriage or at the time of death. Like most

provisions of a marital agreement, the wealthier

party may seek complete waivers from the less

wealthy party in exchange for certain promised gift

transfers during marriage and/or certain transfer

upon death.

41

– Federal Gift Tax Marital Deduction Issues

• Gifts to a Spouse During Marriage. Transfers to the spouse during the marriage will qualify for the unlimited deduction for gift tax purposes, so long as such transfers are made outright to the surviving spouse or to a qualifying trust. I.R.C. § 2523.

• A gift of a life estate or terminable interest will not qualify for the gift tax marital deduction, unless such transfer is a qualified terminable interest as described in I.R.C. § 2523(f).

• Outright gift transfers are obviously simplest from the perspective of qualifying for the gift tax exclusion. However, clients may be adverse to such outright transfers and may wish to make transfers in trust for the spouse.

• If an inter vivos trust is created for the spouse, be sure the trust qualifies as a QTIP trust. If a QTIP trust is created and funded during the marriage, be sure to make a timely QTIP election. The IRS provides no relief for a late filed QTIP election for an inter vivos QTIP trust.

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There are several significant advantages of a lifetime

QTIP trust in a marital agreement setting.

- It allows the wealthier spouse to provide an income

stream to the less wealthy spouse during the marriage,

after the wealthier spouse’s death, and in the case of a

divorce (as maintenance).

- At the death of the beneficiary spouse, regardless of

the order of deaths, the trust assets will pass to the

beneficiaries selected by the wealthier spouse

(presumably the children from the first marriage).

- The unified credit and GST exemption of the less

wealthy spouse can be fully utilized, saving the

wealthier spouse’s beneficiaries estate tax.

43

• Cautions. Be wary of provisions which transfer a property to the less wealthy spouse during the marriage, such as title to a residence, but provide that if a divorce were to occur the residence shall revert to the wealthier spouse. This may be attractive from an estate planning perspective and it may be attractive to the less wealthy spouse because she will hold the residence outright (rather than in a marital trust) at the wealthier spouse’s death. However, this arrangement may not qualify for the gift tax deduction as an outright transfer to the less wealthy spouse. Rather it will likely be treated as a terminable interest because the interest transferred to the less wealthy spouse will terminate or fail upon an event (the divorce) and because the donor retains in himself an interest in such property (the right of the property to revert to the donor upon a divorce). I.R.C. § 2523(b).

44

– Also be wary of drafting provisions which require the

wealthier spouse to make transfers during the marriage

or upon termination of the marriage to the children of the

less wealthy spouse. Such contemplated gifts should

qualify for the gift tax annual exclusion (currently

$12,000 or $24,000 if the spouses will gift split) or the

exclusion for payment of certain educational or medical

expenses. I.R.C. § 2503.

45

– Gift Splitting. A marital agreement may request the less

wealthy spouse to agree to gift splitting during the

marriage, thereby allowing the wealthier spouse to

maximize gifting to descendants. Be specific about

whether the less wealthy spouse is consenting to gift

splitting for annual exclusion gifts only or whether he/she

is also consenting to use of his or her lifetime gift tax

exemption.

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• Federal Estate Tax Marital Deduction

– The substitute transfer of property described in a marital

agreement should qualify for the federal estate tax marital

deduction. If the form of the transfer qualifies for the

unlimited marital deduction, the property transferred will

pass free of the federal estate tax at the transferring

party’s death. When a martial agreement provides for a

marital deduction qualifying transfer, such as a QTIP trust,

the agreement should explicitly allocate liability for the

estate tax arising at the survivor’s death (presumably from

the assets of the QTIP trust).

– The following common forms of testamentary spousal

transfers will qualify for the unlimited marital deduction.

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• An outright, unrestricted transfer of property;

• A transfer for a qualified terminable interest property

(QTIP) trust;

• A transfer to an estate trust or a power of appointment

trust;

• A transfer to a qualified domestic trust (QDOT) for a

non-citizen surviving spouse;

• A transfer of the right to unitrust or annuity payments

from a charitable remainder trust.

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• QTIP Trusts

– Estate planners frequently use QTIP trusts to provide for

a second spouse, particularly when a party wishes to

preserve wealth for children of a prior marriage. A

testamentary marital trust, created under the decedent’s

will or revocable trust will qualify for the marital deduction

as a QTIP trust if:

• Property passes from the decedent to the QTIP trust;

• The governing instrument requires all income to be

distributed at least annually to the surviving spouse;

• No other beneficiary may have any rights in the trust during

the surviving spouse’s lifetime; and

• The personal representative or executor makes the

corresponding election on the federal estate tax return filed

for the decedent’s estate. I.R.C. § 2056(b)(7).

49

• The obvious benefit of the QTIP trust is that the

surviving spouse need not be given a general power of

appointment over the trust and therefore may be

prevented from disinheriting the remaindermen of the

trust (presumably, the deceased spouse’s children from

a prior marriage).

• Another advantage of the QTIP trust is that if the

surviving spouse has a minimal estate of his or her

own, the unified credit of that less wealthy surviving

spouse can be utilized for the benefit of the wealthier

spouse’s beneficiaries. The same is true of the less

wealthy surviving spouse’s generation skipping transfer

tax (GST) exemption.

50

– Standards and Guidelines for Principal Distributions.

Provided that the surviving spouse is entitled to the

income from the trust, at least annually, the surviving

spouse need not be given any other beneficial interests to

the principal of the trust. Additional access to principal,

however, is frequently given to the surviving spouse for

health, support, and maintenance. Many times the marital

agreement will specify under what circumstances principal

may be accessed by the surviving spouse.

51

– Selection of Trustees.

• The marital agreement may specify that a third party will serve as sole trustee or as co-trustee with the surviving spouse to ensure better protection to the trust assets for the remainder beneficiaries.

• “Neutral” trustees and successor trustees are generally advisable. The surviving spouse as sole trustee generally provides less protection to principal than the deceased spouse may want.

• On the other hand, a child of the decedent (the step-child of the surviving spouse) as trustee may cause family discord.

• A surviving spouse might be allowed to select a trustee among a group of mutually agreeable potential trustees.

• Or, a surviving spouse could be authorized to appoint an institutional trustee.

52

– Selection of Assets.

• The marital agreement may provide specific directions

with regard to what assets will be directed into the

QTIP trust for the benefit of the surviving spouse.

• If there is a closely held business, both spouse’s may

favor terms prohibiting such closely held stock from

passing to the QTIP trust.

• If the wealthier spouse holds promissory notes from

children, the less wealth spouse may want to include a

provision specifically prohibiting those types of assets

from being used to fund the QTIP trust.

53

– Residence.

• Frequently, the marital agreement will address the use

and disposition of the residence by the non-owner

spouse after the death of the owner spouse.

• If the residence is transferred to the QTIP trust, it will

be important to include provisions in the QTIP trust so

that the surviving spouse’s rights to the residence will

constitute the necessary qualifying income interest (i.e,

the surviving spouse must have the right to demand

that unproductive property be made productive).

54

• Use of Life Insurance in Conjunction with a Marital

Agreement

– Some parties to a marital agreement favor a waiver by the

less wealthy spouse of all rights upon death of the

wealthy spouse coupled with a death benefit paid to the

surviving spouse pursuant to a life insurance policy.

– If the wealthy spouse owns the policy and designates his

or her spouse as the beneficiary, the policy proceeds will

be included in the decedent’s estate, by will qualify for the

estate tax marital deduction.

– If the surviving spouse is both the owner and the

beneficiary of the policy, the policy proceeds will not be

included in the decedent’s gross estate.

55

– The parties to the marital agreement may want to address

specifically what type of policy is to be acquired to satisfy the

provisions of the agreement. Term insurance vs. permanent

insurance.

– The parties to the agreement also may want to specify that

the beneficiary spouse be the owner of the policy.

– The agreement should specifically address which party will

have the obligation to pay the premiums.

56

– If you represent the beneficiary spouse, consider drafting

a backstop provision which will give the surviving spouse

a right to claim against the decedent’s estate if, for any

reason, such insurance is not in place at the death of the

spouse whose life was to be insured.

– Consider using a QTIP trust or an irrevocable life

insurance trust as the beneficiary of the insurance policy if

the wealthy spouse wishes to have the policy proceeds

remaining after the surviving spouse’s death pass to his or

her children from a previous marriage.

57

• Joint Tenancy

– Clients should be advised regarding the implications of joint

tenancy and the possibility of defeating all of the careful

planning for death in the marital agreement by holding

property as joint tenants with rights of survivorship.

– Consider including a provision in the marital agreement

which gives the wealthier spouse credit for joint tenancy

transfers against any required devises to the surviving

spouse. I generally include the following language:

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• “Effect of Jointly Held Property, Beneficiary

Designation Property, or Transfer on Death Property

Payable to Joe. If Jane predeceases Joe, the

obligation to provide Joe with an outright disposition of

cash or marketable securities having a fair market

value of $500,000 under paragraph ______ shall be

deemed satisfied to the extent of the date of death

value of any cash or marketable securities passing by

beneficiary designation or transfer on death

designation and to the extent of one-half of the date of

death value of cash or marketable securities passing

by joint tenancy or tenancy by the entireties as a result

of Jane’s death.”

OR

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“If Jane predeceases Joe, the obligation to provide Joe

with $2,000,000 in a marital trust under paragraph ____

shall be deemed satisfied to the extent of the date of

death value of any property passing by beneficiary

designation or transfer on death designation and to the

extent of one-half of the date of death value of joint

tenancy or tenancy by the entireties property passing to

Joe as a result of Jane’s death. If the value of property

passing to Joe by beneficiary designation, transfer on

death designation, joint tenancy or tenancy by the

entireties should exceed the required amount payable to

Joe pursuant to paragraphs _____, then Jane’s estate

shall have no further obligation to Joe under this

Agreement, nor shall Joe have any obligation to return

funds to Jane's estate.”

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7. DIVORCE AND TRUSTS – PROTECTING TRUSTS IN

A MARITAL AGREEMENT

• The development of the law in most states regarding

treatment of interests in trusts as property for

purposes of property division in a dissolution

proceeding has been quite varied and, at times,

inconsistent.

• It is critical that the drafter of prenuptial agreements

understand the law of his or her state which governs

treatment of trusts in divorce.

61

• Best to address all trusts of which your client is a

beneficiary (even a remainder beneficiary) in the marital

agreement to ensure that those trust interests are not

subject to litigation if the marriage ends in divorce.

Bottom Line: Your client should have a prenuptial

agreement if he or she is the beneficiary of trusts.

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8. DISCLOSURE OF ASSETS, LIABILITIES, INCOME,

AND BENEFICIAL INTEREST IN TRUSTS

• In order for a prenuptial agreement to be

enforceable, each of the parties to a marital

agreement will need to make full financial disclosure.

Each party should prepare (or have prepared) the

following:

– A net worth statement, detailing with reasonable

accuracy all assets, liabilities, financial obligations,

and net worth. Hard to value assets such as closely

held business interests, should be valued on a

reasonable basis if no formal valuation exists. The

basis for such “reasonable estimate” should be

provided to the other party and his or her counsel.

63

– Income information for the last three years.

– All beneficial interests in trusts should be disclosed, even

if your client is a remote or remainder beneficiary. A

copy of the trust agreement and a detailed statement

regarding the assets of the trust should be included.

• These should be provided to each party and the

attorneys. They will also be attached as exhibits to the

prenuptial agreement.

• Failure to disclose adequately is a significant ground

for challenge of marital agreements. Err on the side of

over disclosure.

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9. TREATMENT OF DEBT

• Generally, prenuptial agreements define separate

and marital debt, so that if there were to be a

divorce, it is clear how debt should be allocated.

– Generally, all debt which one party enters the

marriage with is defined to be his or her separate

debt, and vice versa.

– You would then want to define debt which is incurred

during the marriage as either separate debt or joint

debt, depending on the nature of the debt, and the

clients’ expectations for how that debt will be treated.

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10. COORDINATION OF ESTATE PLANNING

DOCUMENTS WITH THE MARITAL AGREEMENT

• Maintenance of Testamentary Documents

– If the marital agreement requires that wills, trusts,

beneficiary designations, deeds, or other documents be

prepared to reflect the agreement reached, this can be

done by one of two methods: (1) the marital agreement

can be drafted as a specific roadmap which will contain the

essential terms of the documents that will be prepared at a

later date, or (2) the marital agreement can include

concurrently prepared and executed documents as exhibits

to the agreement.

– If the parties execute a marital agreement which provides a

general waiver or “all rights upon death” or similar

language, be sure to advise your client to maintain updated

estate planning documents after the marriage if your client

does in fact wish to leave property to the spouse.

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• Enforcement for Breach

– If the marital agreement requires a spouse to devise

property to the surviving spouse, the agreement constitutes

a contract to devise property.

– Be sure to consult your state laws regarding contracts to

make a will or devise to ensure that the marital agreement

satisfies any specific requirements.

– The surviving spouse would then be treated as a claimant

against the decedent’s estate and would have to comply

with the claims statutes.

– If you represent the spouse who is to receive the devise in

accordance with the marital agreement, consider including

language which extends the surviving spouse’s time for

making a claim and which reimburses the surviving spouse

for attorney’s fees incurred in connection with the claim.

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• New Estate Planning Clients – Verify Whether a Marital

Agreement Exists

– New estate planning clients may not mention the existence

of an old marital agreement. Estate planning attorneys

should specifically confirm with clients whether or nor a

marital agreement exists, and if one does, obtain a copy.

– Have a discussion with both spouses about whether a joint

representation makes sense in light of the marital

agreement or whether one party may want to engage

separate counsel to review the estate planning documents

on his or her behalf.

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• Estate Planning Clients with Grown Children

– When preparing estate planning documents for wealthy

clients with grown children, consider having a discussion

with those clients regarding whether the children have or

should have marital agreements in place. This may

affect whether a client decides to leave property outright

or in a lifetime trust to an adult child.

ESTATE PLANNING FOR SECOND

MARRIAGES AND BLENDED FAMILIES

Tax Issues Unique to the Blended Family

and Structuring Estate Plans Using Trusts

Kristin A. Pace, Esq.

Fitzgerald Abbott & Beardsley LLP

1221 Broadway, 21st Floor

Oakland, California 94612

(510) 451-3300

[email protected]

November 13, 2012 #483564

Tax Issues Unique to the Blended Family

Where we today now that the election

is over?

• President Obama’s Estate / Gift Tax

Wish List

• Working with What We Have

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Tax Reform Act of 2010 (the “Act”)

• Increased Exemption

• Portability – Is this still a viable

planning option?

• Planning for the sunset of the Act at the

end of 2012

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Increased Exemption

• Formula funding problems

• Under-funded spouse

• Gift splitting

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Increased Exemption

• Formula funding problems

Beware of unintended results

Depending on who the beneficiaries of the bypass

trust are, spouse or children could wind up with a

reduced share of the trust estate

Economic volatility can affect beneficial interests in

the QTIP trust and the bypass trust depending on

type of funding formula utilized (i.e. pecuniary

marital vs. pecuniary bypass)

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Increased Exemption

• Under-funded spouse

Outright gift to spouse during lifetime does

not work well in the blended family setting

Transmutation Agreements

Lifetime QTIP trust as an alternative

Ethical issues

75

Increased Exemption

• Gift splitting

Annual exclusion planning

Exemption planning

Ethical issues

76


Portability

• Very limited applicability, but could work well if

underfunded spouse dies first

• Remarriage: portability only applies to the last

deceased spouse’s unused exemption

• Expires December 31, 2012

• Need to file 706 in order to take advantage of

portability regardless of estate value

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Planning for the sunset of the Act at the

end of 2012

• Planners should revisit the use of formula

clauses to avoid unexpected results

• In the immortal words of Yogi Berra, we

may be facing “déjà vu all over again”

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Planning for the sunset of the Act at

the end of 2012

What “déjà vu all over again” could look

like:

December 2012 may look a lot like

December 2010

Polarization in Congress could also result

in delays

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Use of Trusts in Creating Blended

Family Estate Plans

• QTIP trusts: testamentary and lifetime

• Bypass trusts

• Alternative trusts

• Who should act as trustee?

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Family Estate Plans

• QTIP trusts: testamentary and lifetime

All income to surviving spouse: accounting income vs. net taxable income

Disadvantage: No other current beneficiaries allowed

Funding issues: partnership interests, IRAs, non-income producing assets

Should surviving spouse be given limited power of appointment?

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Family Estate Plans

• Bypass trusts

Who should be the beneficiaries? Spouse

Children

Sprinkling trust

Funding issues Legacy assets if children are beneficiaries

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Family Estate Plans

• Alternative trusts

Spousal Limited Access Trusts

Irrevocable Life Insurance Trust

Non-Charitable Unitrust

Charitable Planning

Intentionally Defective Grantor Trusts:

Planning for the Family Business

• Spousal lifetime access trust (“SLAT”) provides one method to “lock-in” at least one spouse’s $5 million gift tax exemption

Consider Spousal Lifetime Trust for 2012 Planning for Second Marriages

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Spousal Lifetime Access Trust

SMITH FAMILY 2012

IRREVOCABLE TRUST (“Bucket”)

Distributions can be made for

benefit of Spouse, Children,

and their Descendants

Lifetime 2012

Trust for

Child #1

Upon termination of the Smith Family

2012 Trust, property would be divided

into equal shares for Children

Lifetime Trusts

for Child #1's

Descendants

Lifetime 2012

Trust for

Child #2

Lifetime Trusts

for Child #2's

Descendants

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• One spouse (in this example, Husband) would be the creator (“settlor”) of the SLAT

• The SLAT would be established primarily for the benefit of Wife and the Children

• For a second marriage, it is recommended that a person other than Wife would be Trustee of the SLAT for purposes of making distributions to Wife; Wife could be Trustee of the SLAT for purposes of making distributions to the Children

Structure of the SLAT

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• Trustee has the sole and absolute discretion to make distributions to Wife during her lifetime

• Trustee would be prohibited from making distributions that would satisfy Husband’s support obligation (which attaches by reason of their marriage)

• Trustee would be prohibited from making distributions to wife if marriage terminated by divorce


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• Distributions could also be made to the Children or Grandchildren

• The trust instrument could give Wife a testamentary special power of appointment, but only among Husband’s descendants


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Benefits of Using a SLAT

• Husband “locks-in” the use of his $5,120,000 gift and GST tax exemptions while still giving Trustee significant flexibility in distributing assets for the benefit of Wife

• By using the gift tax exemption now, all future income and appreciation attributable to the SLAT is also removed from Husband’s gross estate

• SLAT can grow tax free, as it is a grantor trust, so husband will pay the SLAT’s income tax liabilities.

• As a grantor trust, husband can substitute assets between himself and the SLAT with no capital gain

• As a grantor trust, husband can pay rent for the use of SLAT assets with no income tax consequences.

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• Though the gifted assets would be held in trust, such assets would still be available to Wife if a financial need arose

• Flexibility is maintained through Wife’s Power of Appointment


89

• The trust could be structured, if desired, as a “grantor trust;” if structured this way, the SLAT assets will grow, from the Children’s point of view, tax free

• Husband could also allocate his $5 million federal GST tax exemption to the SLAT


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Risks & Other Considerations

• A SLAT is not tax-efficient if cash flow from the gifted assets is needed for day-to-day living

• A SLAT should typically be funded only with assets a couple is comfortable giving away

• No distributions may be allowed to Husband

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• Is it possible for both Husband and Wife to create SLATs?

• Technically possible to create two SLATs, but it is generally not advisable because of “reciprocal trust” doctrine


92


Mortality

• If Husband and Wife create a SLAT, Wife’s mortality risks should be considered

Divorce

• Similarly, the potential effects of a future divorce should be carefully considered before creating a SLAT

• Draft for termination of Second Wife’s rights if a divorce occurs

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Alternative Trusts

Irrevocable Life Insurance Trust

• Create an inheritance for spouse or children

• Especially useful when second spouse is

close in age to children from first marriage

• Advantage: No estate tax on proceeds if

trust is properly structured

• Disadvantage: Inflexibility if spouse is

named as beneficiary

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Alternative Trusts

Non-Charitable Unitrust

• Advantage: Can help to alleviate tension

between income and remainder

beneficiaries

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Alternative Trusts

Non-Charitable Unitrust Sample

Provision:

“The Trustee shall pay to or apply for the benefit of

the Surviving Spouse each year the greater of (a)

the entire net income from the Marital Trust or (b)

four per cent (4%) of the fair market value of the

Marital Trust determined as of the end of the

preceding year, in monthly or other convenient

installments as the Surviving Spouse may request,

but in no event less often than annually.”

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Charitable Planning

• Charitable Lead Trusts: “Jackie O Plan”

• Charitable Remainder Trusts

Alternative Trusts

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Intentionally Defective Grantor Trusts:

Planning for the Family Business

• Can be used for succession planning (i.e. transfer

of business to the next generation)

• Advantages:

Spouse is entitled to income stream from

Promissory Note

Spouse’s status is reduced to that of a creditor

Children are left to manage the business without

interference from spouse

Alternative Trusts

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Intentionally Defective Grantor Trusts

• Disadvantages

Complex planning transaction

Business must have cash flow to support the

Promissory Note

Alternative Trusts

100


Family Estate Plans

• Who should act as Trustee?

Need to consider the purpose of the

trust

Need to consider the make up of the

trust beneficiaries

Consider corporate or professional

fiduciary

101


Family Estate Plans

• Who should act as Trustee?

Why is this important?

Trustee chooses the team

Lawyer

Investment advisor

CPA

Trustee makes tax elections

Trustee funds the trust

Trustee invests trust assets

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Issues Relating to Children

Title to Assets

Joint Tenancy

Without survivorship

With survivorship

Payable on Death or Transfer on Death

Provisions

John T. Midgett, Shareholder

Midgett & Preti


Gifting

Does the creation of a post-marital agreement

binding the surviving spouse to provide for the

decedent’s child create a gift transaction?

See PLR 201116006 and 201216005

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Beneficiary Designations

Life Insurance

Annuities

Qualified Retirement Plans

Outright payment

Conduit Trusts


Midgett & Preti

105


“Anti-Vulture” Distributions

Leaving assets to children at death may eliminate

potential conflict between the children (especially

those from a prior marriage) and the surviving

spouse by minimizing the necessity for the

children to circle the spouse like vultures awaiting

his/her death to “get our rightful inheritance”.


Midgett & Preti

106


Outright Distribution v. Use of Trust

Structuring Distributions in Trust

“Pot” or Common Trusts v. Separate shares

Handling great diversity in ages of children

Distributions upon attaining certain age

Distributions at specified dates

Who should control?


Midgett & Preti

107


Child as an Agent under a Durable Power of

Attorney

Conflicts with surviving spouse

Conflicts with other siblings – Whole/Half/Step

Compensation Issues

Communication/Reporting


Midgett & Preti

108


Child as an Agent under Advance Medical

Directive

Conflicts with surviving spouse

Conflicts with other siblings – Whole/Half/Step

Dealing with the Emotional Issues

Communication/Reporting


Midgett & Preti

109


Child Acting as Trustee of Trust

Control over the surviving spouse’s share?

Conflicts of Interest?

Contempt?

Communication issues

Compensation Issues


Midgett & Preti

110


Child as Executor

Many of the same problems as serving as

Executor

Requires resident of state where Decedent lived

Probate as a public forum for family disharmony


Midgett & Preti