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Modern Estate Planning
Scott G. Beattie, J.D., LLM

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I.    MODERN ESTATE PLANNING--WEALTH PRESERVATION AND TRANSFER
 

A. Traditional Definition of Estate Planning.

Traditionally, estate planning focused solely on death related issues. Estate planning was seen as the process of putting your affairs in order to transfer your assets at death. Its definition developed at a time when the principal assets owned by most people were real property, and personal belongings (e.g. a family farm or small family business, e.g. bakery, butcher shop), and some cash. The traditional vehicle for transferring property was the Last Will and Testament (the "Will") and the primary issues to be dealt with in the Will were who benefits from your estate, what do they receive, and when.

B. Tailoring Estate Planning for the Complexities of the Modern World.

In today's world, the average family owns a much more complex array of assets than in the past. It is not at all unusual for a person's principal assets to be much more than cash and real property. Today our assets also include mutual funds, stocks, bond, and other investment accounts, annuities, IRAs, Keoghs, 401K's, 4036's, Roth IRAs, partnership interests, family businesses, and life insurance. A Will or Trust may control the disposition of your house and other real property, bank accounts, and your family business if they are not held in joint tenancy. However, the typical Will or Trust does not control the disposition of your life insurance, annuities, and other deferred compensation arrangements such as Keoghs, 401K's, Roth IRAs, 403b annuities or 457 government plans. The disposition of these assets are controlled by a complicated set of state and federal laws. Therefore, a more coherent strategy must be developed which takes into account the disposition of all your assets. The more modern vehicle for controlling the disposition of your assets has become the living trust, but the focus of modern estate planning must go well beyond the creation of a trust in order to coherently plan for the lifetime management and disposition of all your assets.

In addition to dealing with the complexity of assets in the modern world, modern estate planning also has a different focus than traditional estate planning. Whereas traditional estate planning was purely death oriented, modern estate planning at its best will develop a coherent strategy for managing your assets both during lifetime and at death. In addition, the focus is not simply on who receives your assets, what do they receive and when. Rather the focus of modern estate planning should also include such things as wealth preservation (or asset protection) to preserve your assets from taxes and creditors during lifetime, wealth transfer to minimize estate and gifts taxes, and family business succession planning to minimize the risk of business failure upon transfer to the next generation of family members.

In addition to reducing estate taxes, particular care must be taken to control the income tax ramifications arising from the disposition of different types of assets. Often modern estate planning will involve the restructuring of your asset holdings in order to accomplish some or all of these goals, Thus, in addition to the basic living trust, other structures are often introduced such as family limited partnerships, life insurance trusts, generation-skipping trusts, grantor retained interest trusts, private annuities, and charitable remainder and charitable lead trusts.

C. Dealing With Tax Complexities in The Modern World.

With the average family holding a much more complex array of assets, the tax planning associated with the handling of these assets has taken on a new level of complexity. Each asset must be looked at separately to determine whether it is disposed of by your Will or Trust, by survivorship provisions in the asset title, or by beneficiary designations. For tax purposes, each asset must be reviewed for income tax characteristics (i.e., whether there is a carryover or stepped up basis for capital gains purposes at death, or whether it has deferred income that ultimately will be recognized upon disposition by the owner or beneficiary). Thus, to develop a coherent estate planning strategy, one must review and deal with each type of asset separately in order to insure that the estate plan not only deals with the disposition or control of those assets but also minimizes the tax ramifications during lifetime and on disposition at death.

If your pension (IRA, Qualified Plan or Annuity) is the most liquid asset, you can really have a disaster. If your family has to draw your pension down to pay estate taxes, what happens? When a pension is the source of funds to pay estate taxes, not only will you pay the estate tax, but you will also pay income tax on the distribution from the plan. The combination of income and estate taxes can rob you of 70% to 80% of the value of a pension.

D. The Peculiar Problems of Family Business Ownership.

One of the most difficult issues to deal with in modern estate planning is the lifetime structuring and death-time disposition of a family business. Given the extremely high failure rate of businesses passing between generations, estate succession planning (business succession planning) can be the key to insuring a successful succession of a business or farm from one generation to the next. Your decisions here could be very important to maximizing the value of the business during your lifetime and also keeping it viable for your heirs. The issues are frequently very thorny. For instance, what if only one child is involved in the business and you want to be fair to all of your children? How do you structure your estate so that the participating child controls the business and still be fair in providing equal distributions to the other children? Various solutions exist such as giving the participating child an option to purchase the share held by the other children or using life insurance to equalize the estate among your heirs.

E. Issues Relative to Interests in Professional Partnerships and Corporations.

California Corporations Code Sections 13405 and 13407 restrict the transfer of a professional partnership interest or a professional corporation stock to a living trust. A legal opinion from the California Department of Consumer Affairs indicates that an interest in a professional partnership or a professional corporation can be transferred to a revocable trust only when the trustee and the beneficiary of the trust are licensed, a non-licensed spouse does not have an interest in the trust greater than his or her community property interest in the stock, the trust instrument makes clear that on the non-licensed spouse's death, the spouse's children have beneficial interest, if at all, only in the proceeds that may be received from the shares and not equitable title to the shares, and the trustee-licensed spouse has exclusive control and powers relating to the shares of the professional corporation. Since in many instances a husband and wife act as Co-Trustees, it is extremely difficult to qualify an interest in a professional partnership or corporation as owned by a living trust. A trust must comply as much as possible with the requirements of the consumer affairs legal opinion. In many instances, cooperation with the other professionals in the corporation or partnership and their advisors results in the use of an assignment of the stock without any effective transfer on the books of the corporation, which is honored in the event of the professional's passing.

II:    CONTROL ISSUES IN ESTATE PLANNING

A. Vesting -- The Impact of How You Hold Title:

1. Joint Tenants With Right of Survivorship:
   1. Popular Misconceptions,
   2. Gifting consequences,
   3. Liability Exposure,
   4. Portion of value included in estate, and
   5. Portion of value receives cost basis step-up.
   
    
2. Community Property:
   1. Misconceptions,
   2. Portion of value included in estate, and
   3. Total value receives cost basis step-up.
   
    
3. Community Property with Right of Survivorship
   1. New Form of Title effective July 1, 2007
   2. Advantages - Best of Joint Tenancy and Community Property
   3. Disadvantages - May limit planning beyond first spouses death (e.g. still subject to Probate at second)

*With Joint Tenancy between Husband and Wife, at the first spouse's death only one-half (½) of the asset's value receives a new step-up in cost basis equal to fair market value for Federal Income tax purposes.

**With Community Property which only exists between Husband and Wife, at the first spouse's death the entire asset receives a new step-up in cost basis for Federal Income Tax purposes.

B. Intestate Succession:

1. Community Property:
   
    
   1. All to the surviving spouse.
       
   2. If no surviving spouse but surviving children, then equally to the children.
       
   3. If no surviving spouse or children, then in the following order:
      1. Surviving parents or parent, but if none, then to
      2. Brothers and sisters.
   
    
2. Separate Property:
   
    
   1. If no children, parents, or brothers and sisters, then all to the surviving spouse.
       
   2. If a surviving spouse and one child, then one-half to the spouse and one-half to the child.
       
   3. If a surviving spouse and two or more children, then one-third to the spouse and two-thirds to the children.
       
   4. If a surviving spouse and no children, then one-half to the spouse and other one-half to:
      1. Surviving parents or parent, but if none, then to
      2. Brothers and sisters, but if none, to
      3. Spouse.
      
       
   5. Single person, in following order to:
      1. Equally among children,
      2. Surviving parents or parent, or
      3. Brothers and sisters.

C. The Probate Process and Statutory Fees:

Effective August 17, 2003, as a result of the 2003 Budget Act, legislation was enacted to provide a new progressive filing fee for first papers in a probate matter. This graduated fee is based upon the fair market value of the decedent's estate with no reduction for encumbrances. The new fee schedule replaces the prior flat fee of $185 for filing an initial probate and provides a hefty increase in the total filing fee to initiate a probate action in California.

By way of example, the filing fee for initiating a probate matter for a decedent with a gross estate with an estimated fair market value of $1,000,000 would be $1,130.00 , calculated as follows:

Probate fees are determined by a statutory schedule and probate estate size:

D. Avoidance of Probate and Unnecessary Estate Taxation Through the Revocable Living Trust:

The Revocable Living Trust is an Agreement entered into between the creator of the trust (Settlor) and Trustee for the benefit of specified beneficiaries. The purpose of such a trust is generally to provide for the lifetime management of assets for the benefit of the Settlors and then disposition after the deaths of the Settlors. Such an arrangement offers the following advantages:

 
1. Right of Revocation: You (the Settlors) retain the right to amend or revoke the Trust.
    
2. Right to Income: You are the lifetime income and principal beneficiary.
    
3. Lifetime Control: You may act as your own Trustee, controlling all investment decisions until incapacity or death.
    
4. Avoidance of Conservatorship: If you become incapacitated, the Successor Trustee can provide for your financial needs.
    
5. Privacy. The Trust is a private document.
    
6. Avoidance of Probate: Probate cost can be avoided or mitigated for assets placed into the Trust during your lifetime.
    
7. Federal Estate Tax Savings: Because the Trust can continue after the death of a spouse and preserve the assets in two estates (one for the Deceased Spouse and one for the Surviving Spouse) additional personal and estate tax planning goals can be achieved for married couples.

E. Trustee Selection -- Who Should Be Trustee?

Trustee selection is often a difficult issue due to a number of circumstances that can arise in family dynamics. The basic choice is between using a family member or trusted friend or a corporate fiduciary. Often a mature family member or members (who can also be beneficiaries) are the best choice. However, lack of maturity, drug and alcohol problems among beneficiaries, ill will among beneficiaries or a lack of financial savvy or motivation are leading causes for use of a corporate fiduciary. Consider the following advantages of each:

 
1. Advantages of Corporate Fiduciary.
   
    
   1. They don't die or become disabled -- permanence (except merger, bankruptcy)
       
   2. They are financially accountable for their mistakes
       
   3. They are alleged to be impartial as to the beneficiaries/children. This may prevent the children from becoming bitter towards an individual trustee who happens to be a friend or relative, and who doesn't make distributions every time the children ask for something.
       
   4. They have investment expertise, tax and accounting abilities, and computer capabilities. Some studies suggest that they actually save money for the average estate when compared with estates that are not professionally managed.
       
   5. They refuse loans to "hard-up friends" of the trustee.
       
   6. They keep current with the constant changes in the law.
   
   
    
2. Advantages of an Individual Fiduciary.
   
    
   1. A relative or friend may not charge a fee.
       
   2. A relative or friend may have a more personal interest in the well being of the beneficiaries.
       
   3. An individual may have special expertise (i.e., running the family business).

Suggestion: Some people prefer the use of an individual and a corporate trustee, as co-trustees, to obtain the advantages of each.

F. Primary Married Person Estate Planning Techniques:

The following estate planning documents or combination thereof are for married clients with small to medium estates (approximately $500,000 to $3,000,000)

 
1. Revocable Living Trust - includes a Survivor's Trust for the survivor's spouse's share of community and separate property, a "Unified Credit" Bypass Trust to shelter the deceased spouse's share of community and his or her separate property up to the applicable exclusion amount (currently $1,500,000 and increasing to $3.5 million in the year 2009), and sometimes a Marital Deduction (QTIP) Trust for the balance of the decedent's share above the applicable exclusion amount (for purposes of avoiding and/or deferring federal estate taxation and probate fees on the first death), as well as Children's Trusts and Grandchildren's Trusts to provide asset management for young or irresponsible beneficiaries.
    
2. Pour-Over Wills for Husband and Wife - governs any probatable assets not transferred into The Revocable Living Trust. Revocable Living Trust - includes provisions to maintain privacy, avoid problems in asset management in event of incapacity, minimizes probate, may include Children's Trusts and Grandchildren's Trusts.
    
3. Durable Powers of Attorney for Husband and Wife - appoints an agent for financial matters and avoids the need of a court supervised Conservatorship in the event of incapacity.
    
4. Advance Health Care Directive for Husband and Wife - grants to another individual (the "agent") the authority to make health care decisions in the event you are unable to make these decisions due to incapacity, and requires physicians to follow your health care wishes (e.g., withdrawal of life support) in the event of terminal illness.
    
5. Property Status Agreement - defines the character of all property interests for purposes of state law and for federal estate, gift and income tax purposes.
    
6. General and Specific Assignments of Property - general documentation to reflect your transfer (e.g., vesting) of property to the Trust and states your objective that various assets (i.e., household furnishings, marketable securities, mutual funds, closely-held business interests) are considered to be Trust assets, and not subject to probate.
    
7. Grant or Quitclaim Deed to transfer title to Residence and other Real Property owned by Settlors into The Revocable Living Trust (includes preparation of Preliminary Change of Ownership Report for filing with County Assessor).
    
8. Beneficiary Resignations - used to coordinate the distribution of non-trust, non-probate assets such as life insurance, annuities, IRA's, Roth IRA's, SEP's, Qualified Person Plans (401K, 403b, Keogh, Profit Sharing Plans, etc) with your estate planning. Watch out for the very complicated Federal Rules under the Employee Retirement and Income Security Act (ERISA) which preempt state laws with regard to Qualified Plans.
    
9. Homestead Declaration (Optional) - provides limited protection of your residence from creditor claims.

G. Primary Single Person Estate Planning Techniques:

The following estate planning documents or a combination thereof are for single persons (including widows or widowers):

 
1. Revocable Living Trust - includes provisions to maintain privacy, avoid problems in asset management in the event of incapacity, avoid probate, as well as includes Children's Trusts and Grandchildren's Trusts.
    
2. Pour-Over Will - governs any probatable assets not transferred into The Revocable Living Trust. Persons with smaller estates may want to consider using a Will as their primary estate planning instrument to avoid the cost of creating and funding a living trust.
    
3. Durable Powers of Attorney for Husband and Wife - provides for handling of financial affairs and avoids the need of a court supervised Conservatorship in the event of incapacity.
    
4. Advance Health Care Directive (which includes the Power of Attorney for Health Care and the Declaration under Natural Death Act) - grants to another individual the authority to make health care decisions in the event you are unable to make the same, and requires physicians to follow your health care wishes (e.g., withdrawal of life support) in the event of terminal illness.
    
5. Property Status Agreement - defines the character of all property interests for federal income taxation purposes.
    
6. General and Specific Assignments of Property - general documentation to reflect your transfer (e.g., vesting) of property to the Trust and states your objective that various assets (i.e., household furnishings, marketable securities, mutual funds, closely-held business interests) are considered to be Trust assets, and not subject to probate.
    
7. Trust Transfer Quitclaim Deed to Residence and Other Real Property - transfers title to such interests into The Revocable Living Trust and includes preparation of a Preliminary Change of Ownership Report.
    
8. Beneficiary Resignations - used to coordinate the distribution of non-trust, non-probate assets such as life insurance, annuities, IRA's, Roth IRA's, SEP's, Qualified Person Plans (401K, 403b, Keogh, Profit Sharing Plans, etc) with your estate planning. Watch out for the very complicated Federal Rules under the Employee Retirement and Income Security Act (ERISA) which preempt state laws with regard to Qualified Plans.
    
9. Homestead Declaration (Optional) - provides limited protection of your residence from creditor claims.

III:    ESTATE TAX MITIGATION TECHNIQUES

A. Overview of Estate Tax Mitigation Techniques.

The Federal Estate and Gift Tax rules were substantially modified by the Economic Growth and Tax Relief Act of 2001. Attached is a chart entitled "Economic Growth and Tax Relief Act of 2001, Comparison of New Federal Estate Tax Rates" which depicts the Estate Tax Applicable Exclusion Amounts which are currently $1,500,000 and increasing periodically to $3.5 million in the year 2009. The estate tax is repealed in the year 2010, but the Senate lacked sufficient votes to make the repeal permanent. Instead, the new Tax Act ("Economic Growth and Tax Relief Act of 2001") sunsets (i.e., ends) on December 31, 2010, and on January 1, 2011, springs back to the former estate and gift tax laws including a maximum effective estate tax rate of 55% with a maximum applicable exclusion of $1,000,000. See my article entitled "Estate Tax Repeal-The Real Story" which details the repeal.

There are a number of techniques which can be used to mitigate the harsh impact of the estate taxes. Most of these techniques focus on how to leverage the benefit of the Estate Tax Exemption or the annual gift tax exclusion. Some of the more common techniques include the following:

1. Annual Giving to Children and Grandchildren
2. Leveraging Annual Giving with Irrevocable Gift Trusts
3. Discounts -- Leveraging the Gift and Estate Tax Exclusions with Discounts
   1. Fractional Ownership
   2. Family Limited Partnership and LLCs
   3. Other Business Entities
4. Grantor Retained Interest Trusts (GRATs, GRUTs, and GRITs)
5. Private Annuities
6. Installment Sales and Sales to Defective Grantor Trusts
7. Charitable Remainder Trusts, Charitable Lead Trusts and Private Foundations.

B. Avoiding Estate Taxation Using Irrevocable Gift Trusts and Irrevocable Life Insurance Trusts:

The Irrevocable Gift Trust is a special type of Irrevocable Trust established to maximize the use of the $11,000 per donee annual gift tax exclusion available to each donor. It is similar to an Irrevocable Life Insurance Trust except it is designed to hold other assets in addition to insurance.

The Irrevocable Life Insurance Trust is a special type of Irrevocable Trust established by the insured(s) during his, her, or their lifetime(s). The primary purpose of this Trust is to provide needed estate liquidity while separating the the life insurance so the proceeds are not included in either spouse's estate. This Trust can also easily be utilized for single clients.

 
1. Irrevocability: The most important consideration is to realize once a Life Insurance Trust is established, it is irrevocable and cannot be amended (although it can be modified by a court in some circumstances). The insured will no longer retain any "incidents of ownership" (e.g., the right to borrow against the insurance contract or designate the beneficiaries). However, the Trustee may purchase additional life insurance on the insured.
    
2. Establishment of the Trust: Ideally, the Trust should be established before any life insurance is applied for. If the insured is the original owner and applicant of the life insurance contract and later transfers the policy to the Trustee, then the death proceeds will be included in the insured's estate for federal estate tax purposes if he or she dies within three (3) years after transferring it to the Trustee.
    
3. The Trustee: As a precautionary measure, the Trustee should be an independent third party or an independent special co-trustee should be designated for certain purposes such as valuation of assets and approving the sale price of any trust asset. If a close family member (i.e., spouse, parent, child, sibling) is appointed as the sole Trustee during the insured's lifetime, the IRS may view such individual as being a "subordinate party." The result could be inclusion of the life insurance proceeds in the insured's estate.
    
4. Owner, Applicant and Beneficiary Designation: The Trustee should be designated as the original owner, applicant and beneficiary of any new life insurance contract that is to be a trust asset.
    
5. Premium Payments: All premium payments should be made by the Trustee from a Trust bank account. However, for the Trustee to pay premiums the insured (Settlor) must make gifts to the Trust. These gifts should qualify as a present interest to avoid being treated as "taxable gifts." (See Paragraph F below.)
    
6. Transfers to the Trustee: Each time a transfer is made to the Trustee, to qualify the same for the "Annual Exclusion" as a "gift of a present interest," all beneficiaries should be notified in writing of their rights to withdrawal a "pro-rata" share of the gift. This right is frequently referred to as the "Crummey Power." Failure to include this right will result in all transfers to the Trustee being treated as "taxable gifts."
    
7. Community Property v. Separate Property: If the insured's spouse is a Trust beneficiary, the life insurance contract and all future transfers (i.e., cash gifts) to the Trustee should be the insured's (Settlor's) separate property. To do otherwise will result in at least one-half (½) of the life insurance proceeds being included in the surviving spouse's estate.
    
8. Trust's Suitability: This type of Trust is well suited for various clients whose primary objective is to avoid life insurance proceeds being included in their estates. The Trust also is a better technique than multiple ownership of a life insurance contract by various beneficiaries. Such multiple ownership arrangements may cause the life insurance contract to become subject to the claims of creditors in any beneficiary's litigation (i.e., a divorce). Likewise, transfers to multiple beneficiaries may not qualify for the "Annual Exclusion," thus resulting in taxable gifts.

C. Avoidance of Capital Gains Taxation and Federal Estate Taxation Through Charitable Remainder Trusts:

Charitable Remainder Trusts refer to special types of Trusts generally established during your lifetime to benefit yourself and charity. These Trusts are often referred to as "Split-Interest Trusts" because you retain certain income rights (i.e., your lifetime interest) while giving the remainder interest to a charity.

 
1. Right to Income: You are the life income beneficiary.
    
2. Avoidance of Conservatorship: Assets in the Trust avoid the need for a Conservatorship.
    
3. Avoidance of Probate: Probate fees can be avoided for assets placed into the Trust during your lifetime.
    
4. Privacy. The Trust is a private document.
    
5. Irrevocable. Once established, the Trust is irrevocable; however, you may change the ultimate charity.
    
6. Federal Income Tax Savings. You receive an immediate income tax charitable deduction when the Trust is established based on certain government tables for the value of the remainder interest. No capital gain is incurred on transfer of appreciated securities to the Trust.
    
7. Federal Estate Tax Savings: Charitable deduction for total value of Trust at your date of death assuming you are only lifetime beneficiary.

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