Wills, Trusts, and Estates

Week 2

Spring 2015

Defining this Course

• Estate = all that a person or entity owns, including both real and personal property; the collective assets and liabilities of a dead person.

• Estate Planning= accumulation, management, conservation and transfer of wealth considering legal, tax, and personal objectives.

History of Estate Planning

Thomas Jefferson

• “The earth belongs in usufruct to the living: the dead have neither powers nor rights over it. The portion occupied by any individual ceases to be his when he himself ceases to be, and reverts to society.” (Letter to James Madison dated Sept. 6, 1789)

Why is Estate Planning important?

• Minimization of transfer taxes

• Providing for family– Guardians– Fiduciaries

• Healthcare directives

• Succession or sale of a family business

Information needed from a client for an Estate Plan:

• “Who”– Personal information– Important people

• “What”– Owned property and how it is titled

• Property one expects to acquire in the future• Liabilities • Anticipated future financial needs

• “Where”– Clients wishes/goals about the disposition of their

property

Estate Planning Process from a CFP standpoint

• Step 1: Establish/Outline Relationship with Client

• Step 2: Collect Data• Step 3: Analyzing the Data and Identify

Influential Factors that will Influence which Estate Planning Techniques should be Used

• Step 4: Selection of Techniques• Step 5: Implement the Plan• Step 6: Monitor the Plan

Unauthorized Practice of Law

• What is meant by the practice of law?– Depends

• Drafting or selecting legal documents?

• Rendering legal advice?

• Representing clients in legal negotiations?

• Informational matters?

Sample Question

• John is a financial planner in the state of Tennessee. Although he attended law school, he never passed the bar exam. What is John NOT allowed to do?

a) Explain the probate process

b) Draft a will

c) Direct a client to seek legal advice

d) Act as a trustee for a client’s trust

The Function and Objective of an Estate Planner

• Function of an estate planner is to develop a plan for a client’s financial holding that will maintain and enhance the financial security of clients and their families.

• Objective of an estate planner is to preserve and enhance the client’s estate.

• An estate planner is an agent of the client and owes a fiduciary duty to the client to act in the clients best interests.

Ethical Concerns for Estate Planners

• Confidentiality– Encourage accurate exchange of information– Cell phones and other medians of communication

• Compensation– Fee for service; Commission on products sold; Packaged billing– Referral fees

• Conflicts of Interest– Multiple representation (husband and wife) – define the relationship in the

beginning• Competence

– Utilize the appropriate experts– Don’t give legal advice

• Compliance– Company, industry and legal rules

• Communication– Full and honest disclosure, integrity, patience

• Cooperation

How it all fits together

• States govern the creation and implementation of wills and trusts

• Both States and the Federal Government levy taxes

Sources of Estate Laws

• Internal Revenue Code (IRC)– Title 26 U.S.C.

• Uniform Probate Code (UPC)– VA Wills and Decedents Estates:

http://law.justia.com/virginia/codes/2006/toc6401000/toc6401000.html

• Uniform Trust Code (UTC)– VA Trust Code:

http://law.justia.com/virginia/codes/2006/toc5500000/toc55000000031000000000000.html

Tax Concerns in Estate Planning

• Internal Revenue Code (IRC)

– Transfer taxes (right to transfer ones property): Estate Taxes (value of decedent’s estate ), Gift Taxes, Generation-Skipping Transfer Taxes

• Individual states’ estate tax

– Connecticut, Delaware, Hawaii, Illinois, Maine, Maryland, Massachusetts, Minnesota, New Jersey, New York, North Carolina, Ohio, Oregon, Rhode Island, Tennessee, Vermont, and Washington

• Individual states’ gift tax

– Connecticut, Tennessee

• Individual States’ inheritance tax (who receives a decedent's property and how the beneficiary is related to the decedent)

– Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey and Pennsylvania

• Income taxes

Property

• Anything capable of being owned

• Having a property interest Includes:

– Actual ownership of material objects

– Right to possess

– Right to enjoy

– Right to use

– Right to transfer

– Right to direct who will enjoy or possess something

– When there is present possession or the right to come into possession of property sometime in the future

– One can own the entire property or a limited portion of it in conjunction with others

– Property can be owned absolutely, with no restrictions or owned subject to condition or limitation such as time or use restrictions in the present or future

Ownership Interests

• Fee Simple Absolute

• Life Estate

• Estate for Term of Years

• Future Interests

• Tenancy in Common

• Joint Tenancy with Right of Survivorship

• Tenancy by the Entirety

Why does this matter?

• You are limited only by your own imaginations as to what property interests you convey either in life or death.

• You can only convey and enforce that property interest that you own.

Real Property v. Personal Property

• Real Property = land or anything permanently attached or affixed to it

• Personal Property = all property other than land or an interest in land

– Tangible = anything touched seen and felt; it represents itself – intrinsic value

• Jewelry

• Car

– Intangibe = object is representative of something else; the value of the intangible exceeds the physical object

• Bonds

• Stock certificates

Fee Simple

• The most expansive property interest allowed by law.

• Holder has the right to sell, gift, or devise their interest without seeking anyone else's consent.

• Fair Market Value (FMV) of the whole Fee Simple is included in the Gross Estate, but if transferred to ones spouse then its FMV is eligible for the unlimited marital deduction

• Included in the Probate Estate

• Fee Simple Absolute: “To A and A’s heirs.”

Life Estate• A life estate gives the owner the absolute right to possess, enjoy, or derive

income from the property for the span of the measuring life.• Holder of Life Estate has a duty to the Remainderman (whoever takes after

the Life Estate) to not create waste:– Fails to pay property taxes– Fails to insure the property against foreseeable losses– Destruction of the property’s income-providing source

• “To A for life.”– A has a Life Estate; Grantor has an indefeasible vested interest since at A’s

death the property interest reverts back to Grantor– If A sells the property for which they have a Life Estate, such property interest

will revert back to the Grantor once A dies• “To A for the life of B”

– A has a life estate as long as B is alive• “To A for life, then to B.”

– A has a Life Estate; B is a Vested Remainder Beneficiary who takes a Fee Simple Absolute upon the death of A

Life Estate Example 1

• Under his father’s will, Adam has been given the exclusive use and possession of his father’s residence for Adam’s lifetime. When Adam dies, the residence will be transferred to the beneficiary named under his father’s will.

• What can Adam do with his property interest in his father’s estate?

Answer to Example 1

• Adam can live in the house until he dies, allow others to live in it, or rent it.

• Adam can sell his life estate interest to another, but the buyer’s interest in the house terminates upon Adam’s death.

Estate for Term of Years

• An interest in property established for a specific duration.

Estate for Term of Years Example 1

• Instead of receiving a Life Estate, Adam was given exclusive rights to the residence for 10 years, but after which the property would go to Bob.

• What happens if Adam dies within the 10 years?

Estate for Term of Years Example 1

• If Adam dies within the 10 years, the right to possess the property for the remainder of the term will be determined by Adam’s will or the state’s intestacy laws.

• If Adam is alive at the end of the 10 years, he no longer has a property interest in the residence.

Future Interests

• Is a present right to possess or enjoy property in the future. – Remainder Interests– Reversionary Interests

Remainder Interests

• Is a present right (property interest) to future enjoyment of property.

• The remainder interest must take effect immediately upon the expiration of another estate. (Ex. expiration of Adam’s 10 years)

• 2 types of Remainder Interests:– Vested Remainder– Contingent Remainder

Vested Remainders

• The right to receive the property in the future is presently fixed and absolute; receiving the property is inevitable by the remainderperson and cannot be taken away by anyone

• Indefeasibly vested

• Presently vested property interest!

Vested Remainder Example

• Testator: “To Don for life, then to Tom in fee simple.”

• Don = Life Estate

• Tom = Indefeasibly Vested Remainder

Contingent Remainders

• May or may not come into effect (possessory interest) at some future date, depending on the occurrence or nonoccurrence of an event or condition.

• Defeasible property interest/defeasible estate– Fee Simple Determinable– Fee Simple subject to a Condition

Subsequent– Fee Simple subject to an Executive Limitation

Contingent Remainder Example 1

• Testator: “To Don for life, then to Tom only if Tom survives Don, then to Ed.”

• Tom will only receive his property interest if he survives Don. If Tom dies before Don, then the property goes to Ed upon Don’s death.

• What property interests does Don, Tom, and Ed have?

Contingent Remainder Example 1

• Don = Life Estate

• Tom = Contingent Remainder (contingent upon surviving Don)

• Ed = Contingent Remainder (contingent upon Tom predeceasing Don)

Reversionary Interests

• Owner/grantor of an estate transfers a lesser estate to another.

• Reversionary interest gives the owner Grantor the right to have all or part of the property that he or she originally owned returned to the Grantor or the Grantor’s estate.

• In other words: a present retained right to future enjoyment.

• Reversions are always vested.• Occurs when less than the estate interest owned is then

conveyed (owner A has a Fee Simple Life Estate to B with no named remainderman)

Reversionary Interest Example

• Testator: “To Sara for life.”

• Sara = Life Estate

• Testator’s estate = Reversionary Interest

Legal v. Equitable Ownership• It is possible to have different types of rights in the same property

held by different parties.• Legal ownership means one holds legal or actual title and has the

rights and obligations connected with the ownership• Equitable ownership is the economic right to enjoy the use of the

property:– Right to use and benefit from the property– Right to enjoy the property– Right to receive income from the property

• In a Trust, the trustee holds legal title and must invest and manage the trust property (fiduciary relationship with beneficiaries). The income generated by the trustee’s efforts is then distributed to or held for the benefit of the beneficiaries who hold equitable title.

Legal v. Equitable Examples

• A mother who takes title as custodian of a bank account established for her child’s benefit under the Uniform Transfers to Minors Act has legal title, but the equitable/beneficial interest is owned by the child.

• If a friend lends you her car while your car is in the shop, you have a beneficial interest in the car without having title.

Complete v. Incomplete Transfers

• A transfer of property is said to be complete and irrevocable when it is no longer rescindable or amendable, i.e., when the transferor has totally relinquished all dominion and control over that property.

• Ex. Buying a car• What about having a time period to back out of a

timeshare?• Revocable v. Irrevocable Trusts

Concurrent Ownership

• Property can be owned entirely by one person. A person can also hold a portion of property in conjunction with others– Tenancy in Common– Joint Tenancy with Right of Survivorship– Tenancy by the Entirety

Tenancy in Common (TC)

• A separate but undivided interest in property (real or personal) shared between two or more individuals.– All cotenants do not have to have an equal share of the property

• Property can be real or personal.• Interest can be sold or transferred (sale, gift or will)

without the consent or even the knowledge of the other cotenants

• No right of survivorship• Included in the Probate Estate

Tax Concerns of TC• Federal Estate Tax:

– Fair Market Value (FMV) of an individual’s interest in property is included in their Gross Estate, but if transferred to ones spouse then its FMV is eligible for the unlimited marital deduction

• Federal Gift Tax:

– If one tenant has received a greater proportionate interest than his contribution to the tenancy, a gift has been made from the cotenant at its creation. A gift may also occur if the property is sold and a cotenant receives a greater share of the proceeds than his contribution .

• Federal Income Tax:

– A cotenant is treated as a separate owner of his share in the property. Each cotenant is entitled to his share of any income generated by the property. If a cotenant sells their interest, they will realize a gain or loss, which is calculated using a basis in the property depending on his proportionate interest in the property and original contribution to attain said property.

– General Rule : Upon the death of a taxpayer, property in the estate gets a new cost basis for income tax purposes.

TC Example

• John and Allison owned a tract of land as Tenants in Common. John contributed $75K and Allison contributed $25K. Assuming Allison died today, what percentage would she include in her Gross Estate for Federal Estate Tax purposes?

• 25% of the FMV of the property would be included in Allison’s Gross Estate for Federal Estate Tax calculations.

Income Tax/Basis Example 1

• Jane owns but one asset at her death: one share of stock. She paid $1 for it. If she sold it for $10 while alive, what is her taxable gain?

• She would have a $9 taxable gain for income tax purposes.

• At Jane’s death, the share of stock was valued at $10 for federal estate purposes. If Jane’s heirs sold it after her death for $10, what is their income tax liability?

• There is no income tax liability because Jane’s cost basis in the stock would be increased (stepped up) on her death by operation of law, from $1 to $10, its date-of-death value.

Joint Tenancy with Right of Survivorship (JT)

• 2 or more Joint Tenants who have an undivided equal ownership interest of the whole.

– Different than Tenancy in Common where tenants can have disproportionate ownership interests (½, ¼, ¼)

• Property can be real or personal.• A Joint Tenancy can be severed by one interest holder without the consent

of the other cotenants. • If one owner dies, that owner's interest in the property will pass to the

surviving owner or owners by operation of law, and avoids probate – The last surviving joint tenant can do whatever they want with the whole property.– In avoiding probate, one avoids issues involving: a spouse’s elective share, will

contests, more fees (executors commission and attorneys fees), time and other problems of probate.

• Property held in JT is potentially seizable on the default or misdeeds of either owner.

• Property held in JT does NOT pass by will.• “To A and B as joint tenants with the right of survivorship, and not as tenants

in common.”• Be aware: “To A, B, and C as joint tenants each owning 1/3 share” is a TC!

Tax Concerns of JT• Federal Estate Tax:

– Full FMV of the property will be included in the last living joint tenant’s Gross Estate. Additionally, prior joint tenants who die before must include their proportionate share of ownership in their estate.

– In regards to two JT who are married (also referred to as Tenancy by the Entirety), the first to die will have to include ½ of the value of the jointly held property in their estate and when the second spouse dies, they will have to include the entire value of the asset in their estate. However, spouses can leave everything they own, including property held jointly with spouses, to their spouses free of the federal estate tax – Unlimited Marital Deduction (no federal estate tax on property held jointly with a spouse when the first spouse dies!

• Federal Gift Tax:– If one joint tenant contributes (actual contribution rule) more than his share to acquire jointly held

property, that joint tenant has made a gift to the other joint tenants (ex. adding another’s name to a title of a house) OR a gift is made to the other joint tenants where one pays more than his share of either mortgage payments, costs of maintenance, or other expenses for the operation of the property.

– Exception: Withdraw Rule, see bank account example• Federal Income Tax:

– If the property is not held between spouses, the step-up in basis generally will depend upon the amount each joint tenant contributed to obtain the property.

– Property held jointly between spouses (JT/TE) does not get a 100 percent step-up in basis for income tax purposes, rather only a 50% step-up because only 50% is included in the estate of the first spouse to die.

Income Tax/Basis Example 2

• If Jane owned the $1 stock jointly with her spouse and died, only half the stock would get a step-up in basis. If Jane’s spouse sold the stock after her death for $10, what would his taxable gain be?

• $4.50 because his starting cost was $.50 (half the $1 paid), his half of the gain would be $5 ($10 price divided by 2). By subtracting his cost of $.50 from the $5, we have a $4.50 gain. He has no gain on Jane’s half because her half got a step-up in basis to $5.

Income Tax/Basis Example 3

• Jane owns the $1 stock in her name (not as JT). Jane dies and leaves it to her spouse. There would be NO federal estate tax since spouses can leave everything tax-free to surviving spouses. What is her spouse’s basis in the stock if it has appreciated to $10?

• He takes the stock with a stepped up basis of $10. If he were to sell the stock for $10, there is no income taxable gain.

Actual Contribution Rule• Property is included in the decedent’s gross estate to the extent of

the decedent’s original contribution percentage.

• Ex. John purchased a piece of real estate and titled the property as a JT with his son Bubba. Bubba contributed no money to the purchase of the property. John has made a gift of 50% of the value of the property to Bubba. When John dies, 100% of the value of the property will be included in John’s Gross Estate because of the Actual Contribution Rule. If Bubba died first, Bubba would include 0% in his Gross Estate.

• There may be Gift Tax consequences here. This can also occur where one Joint Tennant pays MORE than his share of either mortgage payments or the cost of maintenance and operation of the property.

Joint Bank Accounts/Withdraw Rule

• Unlike in the preceding example with Bubba, a gift will not be deemed to have been made at the creation of a joint bank account (JT).

• A gift is made when the donee-joint tenant makes a withdraw from the joint bank account until that time such gift is deemed revocable and incomplete.

Joint Bank Account Example

• If Mrs. Robinson deposits money in a joint savings account that she opens in both her and her son’s name, when has a gift been given?

• She has not made a gift until her son withdraws some of the money for his own use. The donee-joint tenant must receive some benefit from the property before a completed gift is made.

Tenancy by the Entirety (TE)• JT and TE can be referred to as: Qualified Joint Interests• Joint ownership of property only between a husband and wife that cannot be

partitioned without the consent of the other spouse. • Property can be real or personal.• At the death of the first spouse, the property automatically transfers to the

surviving spouse outside of probate.• Property held in TE cannot be reached by any one spouse’s creditors, but

can be by joint creditors (credit in both spouses names)• 50% of the FMV of the property is included in a decedent’s Gross Estate for

Estate Tax purposes and its value is eligible for the unlimited marital deduction regardless of the Actual Contribution Rule (who actually purchased the property).– See JT explanations for other tax concerns – only difference is the

application of the unlimited Estate and Gift tax marital deductions for all TE (as long as spouses are US citizens)

• “To A and B as tenants by the entirety.” “To A and B as married persons with the right of survivorship.”