Planning for what? Part Two-Federal and State Transfer Taxes

On Wednesday, I discussed one of the main objectives of any estate plan, the streamlining of the estate administration process.  For many, ensuring that assets pass in an expedited manner is the sole aim of their estate plan.  But, for people with larger estates, a second and sometimes more important goal is to minimize or eliminate the transfer taxes owed at their death.

Below is a brief explanation of the categories of transfer taxes related to estate planning.  One tax that is commonly discussed but not listed below is the “death tax.”  Despite the claims of many, there is no tax imposed at death simply due to the passing of an individual.  The following taxes are very real and require proper planning.

Federal Estate Tax.  The “death tax” typically refers to the federal estate tax.  In 2010, the federal estate tax was reinstated with a $5 exemption, meaning every individual can pass up to $5 million without incurring a tax (the exemption increases to $5.12 million in 2012).  Assets passing between spouses at death also pass free of estate tax due to the federal marital deduction.  In addition, married individuals who do no use their entire estate exemption may pass the remaining exemption to their spouse using a newly created concept known as portability.

The top federal estate tax rate is 35%.  However, absent action by Congress and the President before December 31, 2012, the exemption will be reduced to $1 million and the top tax rate will increase to 55% in 2013.

State Estate Tax.  Seventeen states and the District of Columbia also impose a state specific estate tax.  In the past, the state and federal estate taxes were linked, but due to the changes to the federal estate tax since 2001, most states have decoupled their estate taxes from the federal tax.

New York, New Jersey and Connecticut all have state estate taxes and New Jersey has an additional tax known as an inheritance tax.  In New York, the current exemption is only $1 million and is unlikely to be increased in the future.  Similar to the federal estate tax, assets passing to spouses pass estate tax-free.

While the tax rate is much lower than federal rate, it is still important for estates valued at or around $1 million to properly structure the estate plans to eliminate, reduce or delay payment of state estate tax.

Federal Gift Tax.  Transfers made to individuals other than a spouse during your lifetime are also subject to the federal gift tax.  There are two ways to avoid gift taxes on lifetime transfers.  First, you may use a portion of your lifetime gift tax exemption, which is currently $5 million (lifetime gifts reduce the amount of assets you can pass tax-free at death as the estate and gift exemptions are considered a “unified credit”).

The second way is by using an annual gift tax exclusion.  Each individual can gift up to $13,000 to as many individuals as they like each year without incurring a tax.  Married couples may combine their exclusions to gift up to $26,000 to each individual beneficiary.

The top tax rate for the federal gift tax is 35%, the same top rate for the federal estate tax.

Federal Generation Skipping Transfer (GST) Tax.  One of the more complicated taxes, the GST tax was created to prevent individuals from avoiding taxation by transferring assets to a descendant two generations or more removed from them.  Currently, the tax is imposed in three situations.  First, when a transfer is directly made to an individual two or generations below the transferor (a “skip person”).  Second, when there is a taxable termination of an interest by a non-skip person.  This typically involves a child with a life interest dying and their interest passing to a grandchild.  Finally, GST tax is imposed on distributions from a trust to a skip person that would otherwise non be subject to gift or estate tax.

The current federal GST exemption is $5 million with a top tax rate of 35%.  As with the federal gift and estate tax, the exemption will revert back to $1 million in 2013 absent action by the government.

Transfer taxes can create many problems for estates and significantly reduce their values.  Proper planning before an individual dies and proper administration after they die are essential to ensuring that the estate’s beneficiaries receive the largest possible portion of their loved one’s assets.

Please contact info@levyestatelaw.com for more information.

Planning for What? Part One: An Introduction to Estate Administration

Over the past few weeks, I’ve discussed the various reasons why estate planning should be a part of every adult’s broader life planning.  I’ve also explained several common techniques used by estate planners and specific groups who have a greater need for estate planning.  But, as important as planning is, it is equally important to understand how an estate is administered after the passing of a loved one.

An estate plan deals with two main administrative considerations: the probate process and the payment of transfer taxes.  On Friday, I will discuss the various transfer taxes related to estates and trusts.  Today, I will explain the basics of estate administration in New York.

The first step in administering an estate is filing a probate petition with a special court in New York known as the Surrogate’s Court.  The petition will list key information about the deceased individual (also known as the Decedent) including their personal information, the names of the beneficiaries of the estate, the assets held by the Decedent at the time of his her death and an estimated value of the estate.  The fee for filing the application will depend on how much the Decedent’s estate is worth at the time of his or her death.

Along with the petition, the Decedent’s last will and testament and death certificate are also submitted.  For people dying without a will, there is a similar application called an administration petition.  The process is slightly different than the probate process due to the lack of a will and additional documents that prove the person filing the petition has the right to the Decedent’s assets will also be required.

After the petition is filed with the Surrogate’s Court, a copy of the petition is sent to each person having a potential beneficial interest in the estate.  To avoid this, the person filing the petition (the Executor of the estate) can have the beneficiaries sign waivers by which each beneficiary waives their right to be served the petition.  Once all the waivers have been filed with the court or service is complete, the Surrogate’s Court will issue a decree and grant Letters Testamentary to the Executor of the estate.

Receiving the Letters Testamentary is only the first duty of the Executor.  After he or she receives the Letters, the Executor will collect all the Decedent’s assets and retitle any personal assets in the name of the estate.  If the Decedent’s assets are not readily known, the Executor may need to contact various banks, brokerage firms and insurance companies to determine if the Decedent had any accounts with them.

With the assets collected, the Executor’s next duty is to pay off any outstanding debts that Decedent may have had.  This includes any income, gift, estate or generation skipping transfer taxes the Decedent’s estate may owe or the Decedent owed personally.  For more complicated estates, the estate administration process may take several years and as the estate is administered, it may continue to receive income.  In these situations, it will be necessary for the estate to file an income tax return for each year it remains open.

The final step is to pay out the remainder of the Decedent’s estate based on the terms of his or her Last Will and Testament.  Depending on the nature of the estate, this may prove somewhat difficult, especially if the estate holds illiquid assets such as real estate and business interests.  If the Decedent has not made specific reference to where certain property goes, the Executor may need to sell the property and distribute the proceeds to the estate beneficiaries.

Administering an estate with cooperative beneficiaries and no complications is a difficult process.  Unfortunately, in some circumstances, complicated family and business relationships make the estate administration process even more complicated and can potentially lead to litigation amongst the beneficiaries or between a beneficiary and the Executor.  Proper estate planning alone can reduce the risk of these problems, but it cannot entirely eliminate this risk.

The weeks, months and years after the death of a loved one can be incredibly difficult and having to go through the estate administration process without help is a burden most would like to avoid.  By working with trusted advisors, the family can focus on their grieving and healing process while the attorneys, accountants and other advisors ensure that their loved one’s wishes are respected.

Please contact info@levyestatelaw.com for more information about estate administration.

Defining Your Legacy

“Legacy” has become one of the more common buzz words used by estate planners to describe the end goal of preparing an estate plan.  This can take on many different meanings, but the essence of what a legacy is revolves around how we will be thought of when we are no longer around.

For some, legacy is attached to something tangible such as a business or a piece of real estate held by their family for generation.  In some cases, legacy revolves around the causes and ideas that one or more family members have passed down to their descendants.  And for others, it may simply mean the financial stability provided to a family by a loved one’s well thought out planning.

As we gather with our families over the next few days, I invite you all to think about how you define your legacy; how the legacies of others have affected you; and what lessons and ideals you would like to pass on to your children and grandchildren.  Though you may not be able to clearly define it, it is helpful to start picturing the legacy you wish to leave and begin building a solid foundation on which you can achieve it.

I wish you all a very happy and healthy holiday season!

Finding Success Through Business Succession Planning

During a recent meeting, the topic of business succession planning was brought up by one of my colleagues.  He mentioned that he recently oversaw the transition of a family business from the third generation of a family to the fourth generation.  Given the poor odds that a business will successfully transition from the first generation to a second, I found this to be very impressive.

65% of family businesses fail to survive the transition from the first generation to the second and 90% fail to survive the transition from the second to the third.  Fortunately, family businesses can increase their odds significantly by preparing a comprehensive succession plan.  A succession plan lays out how the business will be owned and operated once the senior family member or members leave the business.

There are several key questions that a succession plan must answer.  Among them:

1)    Who will own the business?-One of the primary goals of succession planning is to preserve a family business within the family and not require a sale to outsiders.  Beyond this, the original owner must decide if all family members will own the company or only certain family members who are involved in the business will become owners.  Each choice has its own set of problems and challenges that must be addressed.

2)    How will the business be owned?-If the original owner decides to transfer the business to a large group of new owners, they may wish to consider using a trust or another entity such as an LLC to own the business interests.  This can provide both tax and asset protection benefits to the new owners and also allow the current owners to ease the owners into their new responsibilities.

3)    Who will manage the business?-In many family businesses, the original owner will have controlled the business completely for many years and may be hesitant to name a successor.  Nevertheless, picking a proper successor and training them before they take over the business are essential parts of administering a successful succession plan.

4)    How will conflicts be handled? –When a single person controls a business, having a conflict policy is unnecessary.  Once the ownership and management expand, a conflict policy allows both the original owner and his or her successors to prevent conflicts from growing beyond internal disputes.  In businesses without conflict policies, it is not uncommon for disgruntled owners to bring legal action against the business and its owners for failing to protect the interests of the new owners.

5)    How will the original owner be compensated for his interests? –It is common for the original owner’s interest in their company to be their primary asset.  If the original owner retires or wishes to leave the business, he or she will rely on that interest to pay for their living expenses for the remainder of their lifetime.  A succession plan should include a mechanism by which the original owner can be compensated for his or her ownership interests.

Transferring a business to family members is often the goal of the original owner, but in some instances, it is either not desired or not possible.  In these situations, the original owner may instead sell the business for either a lump sum payment or a fixed series of payments.  In these situations, it is important for the original owner to coordinate where the proceeds of the sale will go and how they will be held.  Regardless of how a business is transitioned, it is essential that the business owner coordinate their succession planning with their estate planning to ensure that their assets and family members are properly protected.

A family business lasting four generations is a rarity, but it does not need to be an impossibility.  As with all planning, starting early and working consistently with your advisors will yield the best results for you, your family and your business.

Please contact info@levyestatelaw.com for more information about business succession planning.

The Estate Planning Lessons of “The Descendants.”

Last weekend, my wife and I saw “The Descendants,” the new film by director Alexander Payne (Sideways, About Schmidt and Election).  The film has drawn significant Oscar buzz both for the actors’ performances and the film itself.  Additionally, it has created a buzz amongst estate planning professionals regarding its two main plotlines.

The movie focuses on Matt King, played by George Clooney, who is in the midst of two major life events.  As the film begins, we learn that King is the trustee of one of the largest parcels of land in Hawaii on behalf of himself and his other family members.  The family has decided to sell the land, a move that will produce a significant windfall for the family, but ultimately, the decision of who to sell the property to and whether to sell at is left to King alone.

The other major life event involves a speedboat accident involving Matt’s wife, Elizabeth.  As the film begins, we find Elizabeth in a coma, leaving Matt with even more on his plate. Each of these life events on their own would be difficult to manage, but both simultaneously occurring (and additional drama which I won’t spoil here) leaves King with the weight of the world on his shoulders.

Fortunately, King, his wife and his ancestors successfully prepared for these events and the results of their planning manifest during the film.  The film provides three very important lessons regarding estate planning:

1.  A Health Care Proxy can reduce family friction over the care of an incapacitated loved one-When a loved one falls ill and decisions need to be made about their care, underlying conflicts between family members may get in the way of what’s best for the incapacitated person.  If a health care proxy has been executed, those conflicts can be prevented.  In the film, it becomes clear that Matt and his in-laws do not agree on much.  The one thing that they do agree on is the wisdom shown by Matt and Elizabeth by executing health care proxies.

2. Not all trusts are designed to last forever-We learn early on that the land is being sold because the perpetuities period for the trust is set to expire in five years.  Hawaii, like many other states, has codified a common law rule called the Rule Against Perpetuities, which requires a disposition of property to eventually vest in an individual.  Practically, this prevents a trust from continuing forever.  Some states have modified or eliminated this rule and it has become more common for continuous trusts known as dynasty trusts to hold property permanently in trust.  Currently, New York has retained the common law rule and trusts and other dispositions must end 21 years after the death of a specified individual who was alive when the disposition was created.

3.  It is important to pick a fiduciary who will protect your family’s interests and protect the property you leave behind-Throughout the movie, Matt’s decision regarding the land is a point of interest for not only his family, but for many in the community as well.  In the end, his decision is based on what he believes his predecessors would have wanted for his family and not necessarily what the current generation of beneficiaries wants.  In choosing Matt, his ancestors believed that he would provide for the rest of his family while preserving and protecting the family property.  His personality, intelligence and management capabilities, and not just his status as a relative, made him a good choice to oversee this valuable property.

The estate planning aspect of “The Descendants” helps tie the two life events together and they help to define the character of Matt King.  In many ways, the legacies we leave behind through our estate plans help define how our descendants will remember us after we’re gone.

Please contact info@levyestatelaw.com for more information about estate planning and estate administration.

The Good, Bad and Ugly of the New York’s Marriage Equality Act

On June 24, 2011, Governor Cuomo signed into law the Marriage Equality Act, making New York the sixth and largest state to legalize same-sex marriage.  The new law provided the most significant victory for those seeking full rights for same-sex couples and could lead to more states following suit.

But, with the new rights and obligations granted to same-sex couples wishing to marry, the law also complicated certain aspects of personal and tax planning for these couples.  Additionally, newly wed same-sex couples face new problems due to the lack of full faith and credit typically provided by the federal government and other states.

The Good 

Same-sex couples in New York can now marry and become entitled to the same rights and obligations that heterosexual married couples have.  This includes access to spousal insurance benefits, authority to make decisions for an incapacitated spouse and the obligation of each spouse to support the other

One key right from an estate planning perspective is spousal inheritance rights.  Prior to the enactment of the Act, same-sex couples could only pass property through the use of a will or a trust.  Now, a surviving spouse, regardless of gender, is entitled automatic inheritance rights under New York law even if no will exists.

The state marital deduction for estate tax purposes is also now available to same-sex couples.  Under New York law, a surviving spouse can inherit unlimited assets from their deceased spouse without incurring a state estate tax.  This allows a same-sex couple to fully protect their assets from state estate tax until both spouses die.  Unfortunately, this benefit is limited to New York state estate taxes only.

The Bad

New York requires all married couples to file their income tax returns as a married couple, either individually or jointly.  Because of the federal Defense of Marriage Act (“DOMA”), same-sex couples must file their federal income tax returns as individuals. In addition to preparing both state and federal tax returns, same-sex couples will also need to prepare a draft federal return for a married couple in order to complete their state income tax returns.  This creates a more complicated tax situation and more work for the couple or their accountants.

This discrepancy is not limited to income tax.  As I previously mentioned, in New York, a same-sex surviving spouse can inherit unlimited assets from their deceased spouse.  This is not true for federal estate tax purposes and surviving spouses are limited to the federal estate tax exemption ($5.12 million in 2012).  For couples with illiquid assets, this requires additional planning for when the first spouse dies.

Finally, same-sex couples are also limited regarding lifetime transfers between spouses.  Transfers between same-sex spouses are considered taxable gifts, while transfers between heterosexual spouses are not.  Spouses in a same-sex couple are limited to their annual gift tax exclusion amount ($13,000), using a portion of their lifetime exemption ($5.12 million) or having to pay gift tax on the transfers.

The Ugly

Once a same-sex couple marries, it limits their ability to move outside of New York and still have their marriage recognized.  As mentioned previously, only five other states (Connecticut, Iowa, Massachusetts, New Hampshire, Vermont plus Washington, D.C.) recognize same-sex marriage. DOMA prevents the federal government from providing any federal benefits to same-sex couples.  Additionally, 41 states have “mini-DOMAs” which either ban same-sex marriage or specifically define marriage as being between a man and a woman.

Adoption of a child can be a problem for same-sex couple as well.  While most states allow homosexual individuals to adopt children, less than half of the states explicitly allow a same-sex couple to jointly adopt.  This is also true of some foreign countries, most notably China.

Conclusion

The Marriage Equality Act was an important first step for same-sex couples in New York.  The Justice Department’s recent decision to stop defending DOMA in court may eventually bring additional rights.  Until then, it is important that same-sex couples work with their advisors to ensure that their rights, the rights of their spouses and the rights of their children are protected to the fullest extent possible.

Please contact info@levyestatelaw.com for more information about planning for same-sex couples.

Now or Later: Choosing Between a Will and a Revocable Living Trust

A Last Will and Testament is the most essential part of any estate plan.  It explains who your assets will pass to, how they will pass (outright or in trust), who will be in charge of administering the assets and who will care for your minor children.  For many people, a properly drafted will is sufficient to allow their estate to pass as they wish.

In some circumstances, however, a will is secondary to another document known as a Revocable Living Trust.  A revocable trust is trust established and funded during the lifetime of an individual (the “Grantor” of the trust).  At the Grantor’s death, a short will known as a “pour over will” pays any remaining assets in the Grantor’s estate to the revocable trust.  Revocable trusts have become an extremely popular alternative to the traditional last will and testament plan.

So, which is the better fit for your planning needs?  Consider these ten factors:

  1. Probate-One of the main advantages of a revocable trust is the avoidance of the process known as probate.  During the probate process, a will is submitted to a court (in New York, the court is called the Surrogate’s Court) and the named executor under the will is granted the power to distribute the Grantor’s assets.  The process can take several months and may cost a significant amount in legal and court fees.  A properly drafted and administered revocable trust can minimize or eliminate the need for the probate process.  This is especially important for individuals with property in multiple jurisdictions.
  2. Funding-In order to ensure that a revocable trust works properly, assets must be transferred to the trust before the Grantor dies.  Any assets not in the trust at the date of death will have to pass through the probate process.  This negates one of the main benefits of a revocable trust. A will requires no lifetime transfers or retitling of assets.
  3. Administration-During the Grantor’s lifetime and after they die, a revocable trust must be administered in accordance with trust instrument.  A will requires no lifetime administration.
  4. Cost-An estate plan that includes a revocable trust will typically cost more up front than a plan that includes only a will.  However, the costs after an individual dies may be less for a revocable trust due to the limited or nonexistent probate costs.
  5. Privacy-Once a will is submitted to the court, it becomes part of the public record and the general public can access it. The trust instrument, unlike a will, is not submitted to a court and the beneficiaries of the trust can remain private.
  6. Tax Planning-One common misconception about revocable trusts is that they provide tax planning benefits over wills.  In reality, both wills and revocable trusts can be drafted to minimize or eliminate estate and other transfer taxes.
  7. Revocation and Amendment-Both wills and revocable trusts can be amended or revoked any time prior to the Grantor or individual’s death.  After the Grantor’s death, both become irrevocable and the fiduciaries of the estate or trust cannot change the terms of the will or trust.
  8. Disability-The trust agreement creating a revocable trust will include successor trustees who will serve if the initial trustees can no longer act as trustees.  It is also common to have a second person serve as a co-trustee with the grantor of the trust.  If the grantor becomes disabled or incapacitated, the remaining co-trustee or successor trust can administer the trust’s assets without applying for guardianship over the grantor.
  9. Ability to Challenge-While will contests are more common, it is also possible to challenge the validity of a revocable trust on the basis of a lack of capacity on the part of the grantor and the trust being created due to the undue influence of another party.
  10. Asset Protection-During the Grantor’s lifetime, a revocable trust provides no asset protection from creditor claims.  After the Grantor dies, the Trust can be structured to protect assets from creditor claims.  This is option is also available when drafting wills.

The choice between a will and a revocable should be well thought out and discussed with your advisors.  While a revocable trust does provide certain advantages to a traditional will, it must be properly drafted, funded and administered to ensure that you receive the maximum benefit.

Please contact info@levyestatelaw.com for more information about revocable trusts.