Estate Planning

(Letter given to Potential Clients. This Letter isn't intended to create an attorney-client relationship or to be construed as legal advice)

Even though the estate tax has been repealed, the repeal is effective only for 2010. The estate tax is scheduled to return in 2011, and may even return before then if Congress reinstates the tax retroactively.

Under the estate tax rules that are scheduled to apply after 2010, insurance on your life will be included in your taxable estate if either:

(1) Your estate is the beneficiary of the insurance proceeds, or

(2) You possessed certain economic ownership rights ("incidents of ownership") in the policy at your death (or within three years of your death).

Avoiding the first situation is easy: just make sure your estate is not designated as beneficiary of the policy.

The second rule is more complex. Clearly, if you are the owner of the policy, the proceeds are included in your estate regardless of who the beneficiary is. However, simply having someone else possess legal title to the policy will not prevent this result if you keep so-called "incidents of ownership" in the policy. Rights that, if held by you, will cause the proceeds to be taxed in your estate include:

... the right to change beneficiaries,

... the right to assign the policy (or to revoke an assignment),

... the right to pledge the policy as security for a loan,

... the right to borrow against the policy's cash surrender value, and

... the right to surrender or cancel the policy

Keep in mind that merely having any of the above powers will cause the proceeds to be taxed in your estate even if you never exercise the power.

Buy-Sell Agreements

Life insurance obtained to fund a buy-sell agreement for a business interest under a correctly and appropriately structured "cross-purchase" arrangement will not be taxed in your estate (unless the estate is named as beneficiary). For example, say Al and Bob are partners who agree that the partnership interest of the first of them to die will be bought by the surviving partner. To fund these obligations, Al buys a life insurance policy on Bob's life. Al pays all the premiums, retains Page 2 of 3

all incidents of ownership, and names himself beneficiary. Bob does the same regarding Al. When the first partner dies, the insurance proceeds are not taxed in his estate.

Life Insurance Trusts

A life insurance trust is an effective vehicle that can be set up to keep life insurance proceeds from being taxed in the insured's estate. Typically, the policy is transferred to the trust along with assets that can be used to pay future premiums. Alternatively, the trust buys the insurance itself with funds contributed by the insured. As long as the trust agreement gives the insured none of the ownership rights described above, the proceeds should not be included in his estate.

The Three-Year Rule

If you are considering setting up a life insurance trust with a policy you own currently or simply assigning away your ownership rights in such a policy please call me as soon as you reasonably can to affect these moves. Unless you live for at least three years after these steps are taken, the proceeds will be taxed in your estate. For policies in which you never held incidents of ownership, the three-year rule doesn't apply.

(Letter given to Potential Clients. This Letter isn't intended to create an attorney-client relationship or to be construed as legal advice) 

Few people realize that, even though they may have a modest estate, their families may owe hundreds of thousands of dollars in estate taxes because they own a life insurance policy with a substantial death benefit. Life Insurance proceeds are generally considered part of your taxable estate and are subject to federal estate tax.

The solution to this problem may be to create an irrevocable life insurance trust that will own the policy and receive the policy proceeds on your death. A properly drafted life insurance trust keeps the insurance proceeds from being taxed in your estate as well as in the estate of your surviving spouse. It also protects the trust beneficiaries from their own "excesses", against their creditors, and in the event of divorce. Moreover, the trust also provides reliable management for the trust assets.

E.G., George has a life insurance policy (L.I.) worth 1 million dollars. In 2011, George passes away with other assets equal to 1 million. The L.I. is included in George’s estate and the government seizes $550,000 (1 mill *55%). If a life insurance trust was used, the L.I. likely would not have been included in George’s estate.

Figures

Other Estate Assets $1million

Life Insurance Estate Asset $1 million

Total Estate Assets $2 million

Estate Tax Credit (Non-Taxed Portion) $1million

Assumed Tax Rate 55%

Tax Liability = $550,000

Potential Result if Life Insurance Trust Implemented: TAX SAVINGS $550,000 Page 2 of 3

Note: (Even though the estate tax has been repealed, the repeal is effective only for 2010. The estate tax is scheduled to return in 2011, and may even return before then if Congress reinstates the tax retroactively.)

How Irrevocable Life Insurance Trusts Work

You create an irrevocable life insurance trust to be the owner and beneficiary of one or more life insurance policies on your life. You contribute cash to the trust to be used by the trustee to make premium payments on the life insurance policies. If the trust is properly drafted, the contributions you make to the trust for premium payments will qualify for the annual gift tax exclusion, so you won't have to pay gift tax on the contributions.

The life insurance trust typically provides that, during your lifetime, principal and income, in the trustee's discretion, may be paid or applied to or for the benefit of your spouse and descendants. This allows indirect access to the cash surrender value of the life insurance policies owned by the trust, and permits the trust to be terminated if desired despite its being irrevocable. On your death, the trust continues for the benefit of your spouse during his or her lifetime. Your spouse is given certain beneficial interests in the trust, such as the right to income, limited invasion rights, and eligibility to receive principal. On the death of your spouse, the trust assets are paid outright to, or held in further trust for the benefit of, your descendants.

If you own a life insurance policy with a significant death benefit, an irrevocable life insurance trust may be of substantial benefit to you. If you have questions, feel welcome to contact me at my office.

It is very important that each person review how their assets are titled to ensure they are titled correctly. Assets can be owned jointly (no survivorship), jointly with right of survivorship, as tenants by the entirety (creditor protection & survivorship), or as tenants in common (no survivorship).

The method of titling the assets will dictate how that asset passes upon your death. If you own property as tenants in common or joint tenants, than the property will pass to your heirs, by devise, or to your personal representative.  If you own property jointly with right of survivorship or as tenants by the entireties, than your property will pass to the survivor. Note that tenancy by the entirety (or as tenants by the entireties) is a favored method of ownership reserved for married persons. Tenancy by the entirety provides significant creditor protection to the surviving spouse.  

Caution!

Virginia abolished the survivorship presumption that existed for any person who owned real or personal property jointly with another (whether married or not). Va. Code 55-20. Thus, unless the proper survivorship language is invoked, and despite the joint tenant language, the property will be owned as tenants in common (no survivorship).

Not many people know how the VA intestacy distribution rules (distribution of estate if no Last Will & Testament) operate and how disastrous they can be. It is important that everyone understand the issues. 

"If no will exists, then a surviving spouse generally only inherits 1/3 of the decedent spouse's probate estate if the decedent had a living child with another person".

If you or your spouse don't have a will, or your will is lost, stolen, destroyed, or successfully contested, then you may find that your probate estate will be distributed according to an intestacy statute. An intestacy statute is a statute that applies when someone dies without a will. In Virginia, if a person dies without a valid will, then the course of distribution may be as follows:
 
1) If children from a prior relationship, 1/3 to spouse and 2/3 to children
2) If no children from a prior relationship, 100% to the surviving spouse
3) If no surviving spouse, but surviving children, 100% to children
4) If no surviving spouse or surviving children, then 100% to the children’s descendants
5) If no surviving spouse, children, or children’s descendants, then 100% to the mother or father (or survivor)
6) If no surviving spouse, children, children’s descendants, or parents, then to the paternal and maternal kindred (very generally stated)
 
Please note that VA law only covers real property located in VA and it’s residents’ personal property (located in any state).

Caution!

Real property located in another state is governed by the law of the state where the property is located.

(In other words, you should have a will if you have property in another state)
 
Practice Tip: People in urgent need of a will because of intestacy laws include the following;
 1) Any person (or their spouse) who has children from a prior relationship
 2) Any person (or their spouse) who has deeded or real property in another state
 3) Any person (or their spouse) who doesn’t have a surviving spouse or children

Stop! Don’t pull the plug just yet?

Should I fund my retirement benefits(e.g., IRA, 401(k)) into my trust?
 

Answer: Sometimes, but even under those occasions, only if you are instructed to do so by an experienced and highly competent estate planning attorney.

(We make no statements or guarantees regarding the advisability of doing so)

Caution!!!
Retirement benefitsfrequently qualify for some type of preferential income tax treatment. However, said favorable treatment comes with many strings attached. Additionally, some plans only allow a participant (and not the beneficiary) to stretch-out the benefits.
 

Generally trusts are impermissible beneficiaries. It is possible to fund particular retirement assets into trust and preserve the tax deferred benefit (stretch-out). However, the trust must be narrowly tailored and drafted with extreme particularity to qualify for see-through trust treatment. 
 

Assuming that your trust has been drafted correctly, you will need to correctly identify it as a beneficiary (typically on the beneficiary designation form). Assuming you do that, you must ensure that you have the correct beneficiaries named within the trust. Failure to correctly choose allowable beneficiaries (designated beneficiaries) or to craft the terms of their rights to, and succession in, the benefits, will likely invalidate or unnecessarily waste the tax deferral benefits. In addition, there are many other rules that could result in very negative tax consequences.
 

In sum, if you are considering funding your trust with your retirement benefits, you should immediately seek counsel from an experienced and highly competent estate planning attorney. Never go it alone. Never draft the trust yourself and never fund it without precise and express supervision by an experienced and competent estate planning attorney. 
 

Drafting and funding a trust with retirement assets, while simultaneously preserving and maximizing the stretch out, is an enormously complicated task that should be reserved for only very skilled estate planning attorneys. If you have any questions, please don’t hesitate to contact our office and we can schedule a consultation.
 

How much does an estate planning attorney cost?

Answer: It’s not cheap, but the costs of not planning (or improper planning) can be devastating.
 

Just consider two aspects of estate planning. Let’s assume the following:
a) Your beneficiary is likely to become divorced, and
b) You have an estate over 1 million (2 million)
 

Did you know that your beneficiary’s divorcing spouse may receive more than half of your beneficiary’s inheritance and that the current tax law may impose a 55% estate tax in 2011 on every dollar over 1 million.
 

E.g.,
In 2011, you die, with a will, and leave an estate worth 2 million (life insurance, home, retirement benefits, stocks) to your child Adam. The government assesses an estate tax of $550,000 (55% x 1 million). Adam’s wife, Eve, is awarded 50% of the property during a divorce proceeding. Thus, Adam ends up with $725,000 of the 2 million you left him. OUCH!!!!!
 

DID YOU KNOW: An estate planning attorney would likely have shielded the entire estate from the divorcing spouse and entirely avoided the assessed estate tax?
 

While we argue that everyone needs an estate planning attorney, not everyone is willing or able to pay the fees. The fees are high because there aren’t many estate planning attorneys and the issues are complex.
 

When you high a competent estate planning attorney, you are hiring a professional to secure your legacy during your life and after death. You’re hiring someone to create and implement a plan that protects your loved ones from plaintiffs, creditors, divorcing spouses, the government, and the imprudent actions of a spendthrift beneficiary.   
 

What happens if I die without a will? / Or my will is successfully contested, lost, stolen, or destroyed?

Answer: Intestate succession, and likely disasterous consequences

First and foremost, you don’t want to merely rely on the state statutes. The risks are too high (improper and unwanted beneficiaries, taxes, plaintiffs, creditors, divorcing spouses, government seizure, and spendthrift beneficiaries). Without planning, your legacy and your beneficiaries will be exposed. You should have a will, even when you have a living trust.
 

Virginia has statutes in place to distribute your probate estate if you die without a will. Who receives your estate depends on numerous factors, including who survives you and their blood relationship with one another.

There are many disaterous pitfalls. Consider just one example.

Generally, a surviving spouse is entitled to 100% of your estate. However, there are numerous exceptions and issues that may change that. For example, if you have a child who was born to a person other than your spouse, then your spouse will generally only inherit 1/3 of your estate.
 

E.g.,
You die with a surviving spouse and also one child born by another person. Your spouse will inherit 1/3 of your probate estate and the other 2/3 will go to your child.
 

Caution!
Consider that 2/3 of your estate may be under the control of the child’s surviving parent if the child is under 18 and that  your surviving spouse would only receive 1/3 of your estate.
 

What happens if I don’t fund my living trust?
 

Answer: Your plan will likely be totally disrupted and your estate and your beneficiaries will be exposed
 

Caution!!!
You have to fund a living trust. Having a trust, in itself, is generally insufficient and ineffective. You actually have to fund each asset you want the trust to govern.
 

An unfunded living trust is as useful as a DeLorean Time Machine without a Flux Compacitor. Or, for those of you who haven’t seen any movies within the Back To The Future Trilogy, as useful as a bank account with a balance of zero.
 

A living trust’s terms only govern assets that have been funded into the trust. Funding is the process of titling assets in the name of the trust. The type of funding method depends on the type of asset and other factors. Typical funding methods can include beneficiary designations (e.g., life insurance), assignments (e.g., tangible personal property), and deeds (e.g., real estate).
 

If you die with an unfunded trust, consider the following:
a. The living trust is likely utterly ineffective and useless
b. If you have a will, your will would likely control (but only to the extent its terms govern your entire probate estate)
c. If you don’t have a will, or it was lost, stolen, destroyed, or successfully contested, then intestacy controls
d. Your whole plan will be disrupted
e. You wasted your money on the trust
f. Your estate and your beneficiaries will be at risk and potentially subject to disastrous consequences (See Blog What Happens If I Die Without A Will (or Valid Will); Blog Categorie Do I need An Estate Planning Attorney?) 
 

Do I need an Estate Planning Attorney?/ Who Needs an Estate planning Attorney?
Answer: Yes/ Everyone
 

An estate planning attorney’s primary purpose is to create and implement a plan that protects you during your life and incapacity, and to protect your spouse and other beneficiaries when you aren’t around to do it anymore. The estate planning attorney shields your legacy from plaintiffs, creditors’ claims, divorcing spouses, imprudent beneficiaries, and the government. 
 

The law is too voluminous for you to do it yourself. The attorney must have a deep understanding of the current and prospective tax and non-tax law. That includes income, gift, generation, probate, and death taxes. Each year the firm spends many thousands of dollars just on tax-research-databases alone. 
 

The attorney should have litigation experience to better understand how plaintiffs choose their prey, trial/ litigation attorneys choose their clients, and how judges evaluate claims.  This insight goes beyond merely understanding the law, but actually understanding the business of being a litigation attorney and the practical realities of the judicial system.
 

Estate planning is not a transactional exercise. It is ultra complicated and the consequences can be disastrous. You wouldn’t have your general practitioner perform your brain surgery, and you certainly wouldn’t buy a hatchet and do it yourself.  That is why everyone needs to consult an estate planning attorney.  
 

As reported in the Wall Street Journal, the Federal Estate Tax will likely expire on January 1rst. n1 Consumed by Health Care Reform, and in an unsurprising expression of absolute inaptitude, Congress recently failed to pass an extension of the Estate Tax. Consequently people should speak with their tax advisors regarding how they will be affected by the complex rules and growing uncertainty.
 

Don't assume that the repeal will be a tax benefit to your beneficiaries. The income tax consequences can be dramatic. Many beneficiaries could potentially save hundreds of thousands of dollars if the Estate Tax (under its 2009 form) is in effect. In many instances, the Estate Tax rules have provided for very favorable basis rules that have been a tax benefit to beneficiaries. 
 

Don't assume that the repeal will be a tax benefit for you. First, with proper planning an estate planning attorney can shield many millions of dollars from the Estate Tax. The result may be little to no actual Estate Tax liability. Second, the repeal is merely temporary. If Congress continues to do nothing, the Estate Tax will be reinstated in 2011. The reinstated Estate Tax would be much more expansive in scope. Consequently many more people would be subject to the Estate Tax. Third, Congress may pass retroactive Estate Tax legislation to capture Estate Taxes for decedents dying in 2010. If you die in 2010, without planning for the Estate Tax, and Congress passes retroactive legislation, then you may have inadvertently been snared in a tax trap. The result could be finacially devastating.
 

Don’t be lulled to sleep by the seemingly inevitable Estate Tax repeal. The rules will most certainly change, and future legislation is likely.  Don’t delay talking to your tax advisor because you are overwhelmed by the complex rules and uncertainty. It's very important that you consult an estate planning attorney. Contact us today and let a knowledgeable estate planning professional go to work for you.
 

Note:
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was passed by the 107th Congress. Generally, the EGTRRA repeals the Estate and Generation Skipping Taxes (GST), for persons who, respectively, die or make GST transfers after December 31, 2009. However other particular rules apply (i.e. Qualified Domestic Trusts).
 
n1 The Wall Street Journal, Effort to Extend Estate Tax Fails: Levy Set To Expire Jan. 1, Setting Up A Political Standoff; Democrats Promise New Push, Authored by John D. McKinnon and Martin Vaughan, December 17 2009, http://online.wsj.com/article/SB126098351451293981.html

Authored by Luke Anthony Lenzi, Esquire