Tying Step-Relations Together

I’m going to turn a popular estate planning technique upside down.

The technique I’m referring to is leaving trusts to provide for your surviving spouse, and then upon his or her death leaving the remainder to your children.

These are commonly referred to as “Marital” or “Family” trusts. There is a difference between the two. A Marital Trust generally refers to a trust that qualifies for the federal estate tax marital deduction, which leaves amounts exclusively for the surviving spouse until her death. A Family trust usually does not qualify for the marital deduction, and can be left exclusively for the surviving spouse or may be sprinkled among the surviving spouse and other beneficiaries.

In situations where your spouse is not the parent of your children, these trusts can become problematic, as I’ll describe below. Keep in mind that a trust that continues for the lifetime of a spouse and then distributes to children at his or her death ties all of the parties together economically.

I can best illustrate the issues with an illustration. 

“Alan” was a physician who had been in a second marriage with “Sally” for over twenty years. He had two adult daughters from a prior marriage, “Betty,” age 32 and “Carla” age 30. Alan instructed his attorney to create a Marital Trust for the benefit of Sally for her lifetime. The trust was to pay Sally income, with principal invasions authorized for her health, maintenance and support if the income was insufficient for those purposes.

Every dollar that Sally received from the trust was one less dollar that would ultimately be distributed to Betty and Carla. Betty and Carla wanted the trust to invest in more growth-oriented holdings, since they were interested in receiving as much as possible when Sally died. Sally, on the other hand, who relied on the income from the trust to pay her monthly bills, naturally desired that the trustee invest in high income producing assets.

The trustee, whoever is named as such, has a fiduciary duty to balance the needs of Sally against the needs of Betty and Carla. In other words, the trustee shouldn’t invest all of the trust in either growth or income producing assets, but rather a healthy percentage of each, unless the language of the trust itself directs otherwise.

Many such trusts don’t instruct the trustee at all as to which of the beneficiary’s needs takes priority. Consequently, the trustee must assume that Alan, here, would have wanted the needs balanced. Imagine if either Sally, Betty or Carla are also serving as trustee. In this case, they have a conflict of interest that could present some problems, although it is common to have family members serve in this role. So long as the family gets along, then problems normally don’t arise. But when Alan died, the glue that held the familial relationship may have died with him, thus straining the family with the economic relationship.

There are alternatives. One alternative is the Family Trust, that can sprinkle its benefits between Sally, Betty and Carla during Sally’s lifetime rather than the daughters having to wait until the step-mother’s death to enjoy the fruit of the trust. This presents additional problems, particularly if the trust language doesn’t speak to the relative priority of the beneficiaries.

Another, less common alternative is to invest in an insurance policy. Imagine if Alan had instructed his attorney to draft the language of his trust to first address Sally’s needs as opposed to Betty’s and Carla’s. Understanding that Sally might consume the entire trust, or, at a minimum live a long life which would delay the daughters’ inheritance, Alan might look into purchasing an insurance policy. He could name Betty and Carla as the outright beneficiary to the policy, thereby ensuring that they receive at least some inheritance immediately after his passing.

Insurance could therefore be used to mitigate the economic tension that might otherwise exist between the surviving spouse and Alan’s daughters.

That’s just one alternative. In any event, if you have a situation similar to Alan’s, you should carefully review the trust language to ensure that your intent is clearly stated, and direction is provided to your trustee.

© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.

I Am Truly Thankful

Happy Thanksgiving to you and yours, and thank you so very much for following my column over the years. In the spirit of the Thanksgiving holiday, allow me to list some of the things that I am thankful for:

I’m thankful for my family. I have a loving, devoted, smart, and very patient wife who has put up with me for over close to 30 years. We started out with nothing to our names save our student loan debt. It seemed as if our adventure had just begun.

We have three daughters of whom we couldn’t be more proud. While I lost my mother to leukemia a few short years ago, I am thankful for the eleven plus years we had with her since her initial diagnosis. She danced at all of her grandchildren’s bar/bat mitzvahs, which is wonderful to reflect upon fondly.

I’m thankful that I’m alive and well. This may sound trite, but some may recall from previous columns that I almost died in a terrible bicycling accident almost fifteen years ago. I am an avid road cyclist, but on a July afternoon in 2004 a car cut me off while I was enjoying my ride. My helmet saved my life, but I had four skull fractures and problems with my neck and spine. The accident required hospital stays and surgery, but. today I’m still on the bike and doing well. I am thankful for those motorists who are considerate of us cyclists and beg the rest of you to please watch out for bicyclists both on the bike paths and on the road.

I’m thankful for my career and the people with whom I work. I truly enjoy what I do for a living. My firm’s is established in this community, dating back to 1924. My law partners and I get along very well because it’s more like a family than a firm. We have a loyal and hard-working team – one of whom has been with us for over forty years! My clients are second to none as they are a bunch of friendly, warm and sincere people who have interesting backgrounds and life experiences. I’ve learned so very much from many of my clients.

I’m thankful to live in Southwest Florida. I grew up in Indianapolis but have lived in Florida for most of my life. The people here are kind and empathetic. While our summers are hot, our temperate winters and ability to enjoy outdoor activity year-round more than makes up for it. One of my good friends from Chicago visited a few years ago, and I took him out to dinner. We traveled to a waterfront restaurant via boat instead of the car. He saw dolphins jumping and a wonderful sunset that evening. He couldn’t believe that we can do this anytime we want. It made me proud and happy to live here.

Finally, I’m thankful for this column and the people of Sanibel. I appreciate Lorin Arundel and all of the good folks at the Island Sun Newspaper as well as my faithful readers for allowing me to bring you this estate planning column. I will say that it is sometimes a challenge to come up with interesting topics on a weekly basis for years on end.  Estate planning isn’t the most entertaining of subjects by itself, but I’ve received a lot of positive feedback along with appreciation from many who’ve told me they understand the concepts that I’ve tried to highlight over the years. I thank all of you for your continued support;

Once again, Happy Thanksgiving to you and your family & loved ones! Be sure to reflect on what treasures exist in your life, especially as we approach the holiday season.

© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Joint Accounts Don’t Count Towards Bequests

Salvadore created a trust that first distributed $2 million to his wife, Sophia before making $500,000 bequests to each of his two daughters, Gloria and Dorothy. When Salvadore created his trust, he considered the bequest to his wife to be enough for her to live off of the rest of her life, also considering that she had other assets of her own in her own trust. He didn’t want Gloria and Dorothy to wait until both his and Sophia’s deaths before enjoying any of their inheritance, and that is why he included those bequests.

When Salvadore died, his trust had less than $2 million of assets in it. Salvadore had more than $1 million of other assets, both those were all held jointly with rights of survivorship with Sophia. They were not ever funded into Salvadore’s trust.

So Sophia took the joint assets as her own. When Salvadore’s trust was administered, the entire balance also went to Sophia. Gloria and Dorothy received nothing from Salvadore’s estate.

And this is the important point that I wish to make today. Salvadore may have considered the joint account to count towards what he wanted to leave Sophia from his estate. But Salvadore didn’t direct his attorney to draft language into his trust indicating that was his intent. Maybe Salvadore assumed that the joint account gift would serve to satisfy part of what he intended to leave Sophia through his will and trust.

But that isn’t the case.

Maybe Salvadore intended to fund the joint account into his trust account in order to satisfy his intent. Transferring a joint account into a single trust generally requires both joint account owners’ signatures. Perhaps upon discovering this, Salvadore decided not to do it and didn’t believe it necessary to alter the terms of his trust.

Upon discovering what was to occur in Salvadore’s estate administration, Gloria and Dorothy wondered if anything could be done to rectify the situation. The answer is not unless Sophia wants to cooperate.  Sophia could, for example, file a legal disclaimer for some portion or all the $1 million in bequests that Gloria and Dorothy didn’t receive. A legal disclaimer must be signed in accordance with Florida law and with the Internal Revenue Code. There are several requirements that must be satisfied to file a disclaimer.

Sophia could also cooperate if she simply gifted some of her inheritance to Gloria and Dorothy. The gift would be taxable, as it would be above the $15,000 annual exclusion limitation, which only means that the gift would reduce Sophia’s current $11.2 million federal estate tax exemption. Provided Sophia’s taxable estate at the time of her passing is below the then available federal exemption, the gift would not affect her. If, on the other hand, Sophia’s estate could be in danger of exceeding the limitation, she has the option of filing a Federal Estate Tax Return Form 706 on Salvadore’s estate to transfer any of his unused exemption to her own estate negating the gift transfer.

Depending upon the assets that Sophia transfers, and whether they came from the joint account or from assets she inherited from Salvadore, there could be unrealized capital gain that may one day be realized by Gloria and Dorothy that would require the payment of capital gains taxes. This is because joint account assets do not receive a full step up in tax cost basis upon one of the account holder’s deaths.

Sophia may also choose not to cooperate, leaving Gloria and Dorothy with no inheritance. Much of this depends upon the relationship between the parties as well as Sophia’s comfort as to whether she has sufficient funds to live off of the remainder of her lifetime.

As you can see, an assumption on Salvadore’s part could lead to some very real problems between his loved ones. If you have questions as to whether certain accounts will serve to satisfy bequests you have in your will or trust, be sure and discuss your questions with your estate planning attorney.

© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Yesterday’s Planning Upside Down

Now that the federal gift and estate tax exemption is over $11 million per person, I’ve had some clients inquire whether they still need their revocable trusts, or if any adjustments should be made to their trusts.

The short answers are “yes” and “yes”.

Revocable trusts do more than plan for estate taxes. They keep our affairs private both in the event of our incapacity as well as our death. In today’s world of identify theft, that’s more important than ever. Revocable trusts also avoid tedious, time consuming and expensive court processes, such as a guardianship in the case of your incapacity or a probate in the event of your death.

But let’s talk taxes.

For those clients whose estates are larger than the current $11.2 million federal exemption, estate tax planning may still play a role. These clients may have a foundational plan consisting of a revocable trust and related pour over will, durable power of attorney, health care surrogate and living will, among others. Moreover, when one has estate tax issues, advanced planning strategies are often considered.

But what about those of us below the federal exemption? There’s still tax planning involved, but it is income tax planning. There are a variety of issues at play, including maximizing the step-up in tax cost basis that occurs upon someone’s death, the income tax consequences to the beneficiaries of IRAs, 401(k)s, and annuities, as well as the collapsed income tax rate structure for testamentary trusts that continue for our spouse, children, grandchildren or other loved ones.

When the federal estate tax exemption was lower, it was common for married couples to segregate assets into a “husband’s trust” and a “wife’s trust”. Upon the first spouse’s passing, those assets were held in a “Credit Shelter”, “Family” or “Bypass” trust, all of which have the common characteristic of being excluded from the surviving spouse’s estate for federal estate tax purposes.

But for those with estates below the threshold, this planning may no longer be appropriate. Generally speaking, the beneficiaries would like to have a “step up” in tax cost basis not only at the first spouse’s death but also at the second.

Allow me to provide an example. Suppose that Tom and Barbara each have separate revocable trusts, but their combined net worth is lower than the federal estate tax exemption of $11.2 million, and that net worth is unlikely to rise to that level. When Tom dies, the assets in his trust achieve a “step up”. In other words, the assets are re-valued at the fair market value as of Tom’s date of death. Any unrealized capital gains that existed the day before Tom’s death, vanished upon his death. If his trust were to sell all of the assets the day following the death at the then fair market value, the capital gain or loss consequence would only be the difference between the selling price and the date of death value.

If Tom’s trust creates a “Credit Shelter, Bypass or Family” trust for Barbara’s benefit for the rest of her life, he’s used his exemption and the assets will not be taxed in Barbara’s estate when she dies.

But we don’t care if those assets are included in Barbara’s estate because she won’t have an estate tax. In fact, we generally WANT the assets included in her estate so that the ultimate beneficiaries upon Barbara’s death get ANOTHER step up in tax cost basis when Barbara dies, eliminating the unrealized capital gains that have accumulated between Tom’s death and Barbara’s death.

This requires a major transformation to Tom and Barbara’s estate plan. I would venture to say that almost all of the recent estate plans that have come into my office in the last year are set up under the “old” planning technique, and that the beneficiaries to many families could minimize taxes if the Toms and Barbaras of the world would revisit their estate plans with someone who understands these issues.

Space constraints don’t allow me to explore other significant income tax opportunities available under the new law. I’ll review those further in future columns.

Hopefully your takeaway from today’s column is that if you haven’t revisited your estate plan in the last couple of years, it’s probably time to do so.

© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Behind the Scenes

Meeting with an attorney can sometimes be intimidating. I’d like to think that I’m not the least bit intimidating, as I don’t usually even wear a tie to my office. Nevertheless, it occurred to me that many clients are anxious before our first meeting. Psychologists tell me that if a client knows what to expect, then that helps alleviate the anxiety.

Consequently, I thought I’d take all of you behind the scenes to what the attorneys in my firm do prior to an initial meeting with an estate planning client. There’s actually a significant amount of preparation involved, and I hope that once you understand that process, the insight will help you gain an advantage in exactly what might be accomplished during an estate planning meeting.

In our firm, we have three requirements prior to the initial meeting. The first requirement is to either attend one of our workshops, watch a 25-minute instructional video about the first meeting, or read my book, “The Florida Residency & Estate Planning Guide.” The second requirement is to complete our client organizer, and the third requirement is to drop off or email us a copy of any existing estate planning documents that you’ve already put into place.

The reason for these requirements is that we want our first meeting to be as productive as possible. Our workshops, video and book are designed to raise issues that we want you to consider before sitting down with us. There’s more to an estate plan than who gets what when we die. Our workshop, video and book delve into the other important elements to a successful plan.

Believe it or not, at our first meeting we will likely dive deeper into what you hope that your estate plan accomplishes.

Our client organizer is designed to provide us insight into who you are, who your beneficiaries are, and what’s transpired in the past that might affect your planning. Our organizer contains a balance sheet for you to complete. That balance sheet is extremely important, not because it reveals your net worth, rather, it tells us whether your assets have unrealized capital gains, ordinary income tax consequences, estate or gift tax issues, family business or real estate considerations and a host of other matters that we should discuss to put together a plan that will meet your goals, both during your life and after.

Finally, it’s important for us to review your current plan documents, including your will, trust, durable power of attorney, health care surrogate and living will. Before our meeting, our attorneys review your client organizer, and compare it to your legal documents. We sometimes find that your assets aren’t properly aligned with your estate plan. If, for example, you have a revocable trust, but all of your assets are titled in your name individually, we note that your assets may not be aligned with your plan. Similarly, we like to review your IRA and 401(k) beneficiary designations to ensure that you’ve taken the necessary precautions to protect your loved ones and minimize income taxes.

If we notice an out-of-date estate tax formula clause, that will be something that we’ll raise during our initial meeting. Some clients own family businesses, so if that’s disclosed on your organizer but we don’t find corresponding closely held business interest or Qualified Subchapter S Corporation provisions in your documents, we know there’s something else that’s important to review with you.

We gain so much when we take the time to review your situation before we even sit down together with you in our conference room.  That’s why we ask that you complete the three requirements at least three business days prior to our meeting. That way, our attorneys will have the opportunity to review what you have provided to us prior to the conference. When we sit down, we’re ready to help you in the best way possible.

Do all other firms operate in a similar manner? I can’t speak for the others, but I’m sure that some do, while others don’t.

We’ve had this process in place for almost two decades. When I was a younger lawyer I used to spend more than an hour during the initial conference gathering the information we now ask you to provide before the meeting. I discovered that was a colossal waste of time both on our part and on the client’s part. It’s so much better to review the information before the conference so that everyone can hit the ground running, spending our valuable time together on what really matters.

After all, who wants to spend more time than they have to in an attorney’s office!?

© 2018 Craig R. Hersch. Originally published in the Sanibel Island Sun.