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May, 2019 | The Sheppard Law Firm

Who is a Descendant?

New reproductive capabilities pose interesting challenges to one’s estate plan. Typical language in a will or trust might read, for example, “upon the death of my wife, the remainder of my estate shall be distributed to my descendants, per stirpes.” The per stirpes designation means that the next generation steps into the shoes of a parent who predeceases the testator of the will or trust.

This therefore begs the question – who are your descendants? The answer may not be as clear-cut as you might imagine.

Modern medicine has turned reproductive capabilities – and therefore who might be considered a descendant of yours – upside down. In generations past, once a woman’s biological clock expired, she couldn’t have any more children – and the only way to expand a family beyond such event would be to adopt.

Today eggs can be harvested, frozen cryogenically and artificially inseminated at ages that used to be considered beyond one’s normal child-bearing years. Further, with surrogate mothers and donations of both eggs and sperm, the biological “parent” of the embryo isn’t as certain as it was yesterday.

Allow me to illustrate my point. Assume that Father and Mother have two sons, Greg and Peter. Father dies leaving everything to Mother. Mother’s will directs that the estate is to be left equally to Greg and Peter, and if either son predeceases her, then the share that would have been distributed to the predeceased son would instead be distributed per stirpes to that son’s descendants.

Assume further that Peter predeceases Mother, leaving behind his wife Sarah, and a daughter Rachel. Peter’s wife Sarah decides to have a reproductive specialist artificially inseminate her with Peter’s cryogenically frozen sperm. After several procedures it doesn’t work out as Sarah has reproductive deficiencies of her own. So Sarah finds a surrogate mother who is then artificially inseminated with Peter’s sperm and gives birth to a son, Jacob.  Mother then dies without ever changing her will.

Who inherits Peter’s share?  Remember that Mother’s will says everything to Greg and Peter, per stirpes. Since Peter died, the per stirpes designation would mandate that Peter’s child(ren) would step into Peter’s shoes to inherit. So we know that Greg still receives one-half (1/2) of Mother’s estate. But who are Peter’s children? We do know that Rachel is Peter’s daughter. That much is a fact. Does Rachel inherit Peter’s ½ or must she share it with Jacob?

The legal question therefore is whether Jacob is a descendant of Peter? Peter’s sperm produced Jacob after Peter’s death, but before the death of Mother – at the direction of Peter’s wife Sarah through a surrogate mother. I believe that under Florida law, Jacob would be entitled to split Peter’s share with Rachel.

Consider, however, that Peter may have even more children depending upon who had custody of his seed and how often it was used.  What if Sarah produced another child in the same way Jacob was produced? Assume that the next child was born after Mother’s death. Couldn’t you argue that the class of beneficiaries who would inherit Peter’s share could be unlimited? How could the personal representative for the estate know when to distribute Peter’s share if another child could be born long after Mother’s death? For this reason Florida law would likely treat any children born before Mother’s death as a descendant of Peter for purposes of Mother’s will.

What if Peter had instead donated to a sperm bank and a married couple, not related to the family at all, used it to produce a child? Here Florida law would not treat that child as Peter’s descendant. Donations to a sperm bank for third party use are generally not, for legal purposes, considered a descendant of the donor.

With modern reproductive medicine improving all of the time, and with the number of different choices that are available today, it isn’t hard to imagine any number of scenarios that could call into question who a proper descendant may be under any given will.

All of these issues can be addressed through the drafting of language that clarifies the intent of Mother and Father. If Mother and Father only wanted biological and adopted children of Peter during his lifetime to step into his shoes for purposes of inheritance, then this could be written into the legal documents: “For purposes of our will, a descendant of a child of ours shall only include those individuals born or adopted before the death of our child, or those born within nine months following the death of our child.”

On the other hand, Mother may want Jacob, and any other similar issue – to step into Peter’s shoes for purposes of the inheritance. She may look at Jacob as a gift from Peter – regardless how Jacob was conceived.

These are difficult concepts that many estate plans fail to consider. If you have strong feelings one way or the other, it might be time to dust off your documents to review how “descendant” is defined under the document, if it is defined at all.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.

IRAs and Second Marriages

Karen, and Bob, both age 78, are in a second marriage, and each has children from a prior marriage. A sizeable portion of their net worth is Karen’s Traditional IRA account worth approximately $3.5 million. Karen takes her Required Minimum Distributions (RMDs) each year. The divisor under the Uniform Life Table that governs Karen’s IRA this year is 20.3, resulting in a RMD of approximately $172,400.

Currently, Bob is the primary beneficiary of Karen’s IRA. Karen’s children are the contingent beneficiaries.

They arrive at my office with a dilemma. “What I’d like to do,” Karen says, “is if Bob survives me, I want my IRA to go into a trust for him, but whatever he doesn’t use would go back to my children.”

Because Bob is currently the primary beneficiary, Bob could, if he survives Karen, roll over her IRA. He would then take RMDs based upon the same Uniform Life Table that Karen now takes. When Bob rolls over the IRA, he could name whomever he wants as his primary beneficiary, which worries Karen.

It’s not that Karen doesn’t trust Bob, “It’s just that he could become vulnerable later in life due to dementia, or what if my children somehow upset him and he decides to change the beneficiaries,” she noted. Bob wasn’t offended and nodded in agreement.

“That’s not the only danger,” I pointed out. “If Bob were to remarry without a nuptial agreement, even if he left Karen’s children as the IRA primary beneficiaries, his new wife could take what’s known as a spousal elective share under the law. She might be entitled to as much as half of the IRA balance.”

“So that’s why I want to put the IRA in a trust for Bob if I go first,” Karen said.

“Well, there’s a problem with that strategy too,” I noted, pulling out the IRS RMD charts. “The only person who can roll over an IRA is a spouse. Provided the spouse does, in fact, roll over the IRA, then the Uniform Life Table applies. If the IRA isn’t rolled over, however, then the Single Life Table applies,” I continued, pulling out that chart.

The Single Life Table is used for non-spouse beneficiaries, or for spouses who don’t roll over the IRA. It is a much more aggressive RMD schedule.

“You’ll see that the Single Life Table the divisor for a 78 year old is 11.4 rather than the 20.3 that you find on the Uniform Life Table. So a $3.5 million IRA account would result in a RMD of approximately $307,000. Moreover, the Single Life Table’s annual divisor is not pursuant to the age of the beneficiary after the first RMD. Instead, you subtract one from the previous year’s divisor. In other words, the next year’s divisor would be 10.4, then 9.4 and so on. What this means is that the entire IRA account, all $3.5 million of it, will have been withdrawn within 10 years.”

Karen’s mouth gaped open. “You mean that if Bob lives ten years beyond me, the entire IRA is gone if we name a trust as his beneficiary?”

“Yes. But I’m not done with the bad news yet.” I said. “In order for the trust to qualify Bob as an ‘identifiable beneficiary’ under IRS rules, there are five requirements, one of which is that the trust act as a ‘conduit’. What that means is the income that is distributed from the IRA to the trust goes right through the trust to Bob. In other words, there’s nothing preserved for Karen’s children. Bob has control over all the distributions, even if he doesn’t need the entire amount for his living expenses. We could draft provisions that would toggle the trust to an accumulation trust, but when you do that the trust ends up paying the highest marginal tax rate once $12,750 is accumulated. That’s a bad result too.”

I added that when a trust is the beneficiary to an IRA, the identifiable beneficiary rules were important to satisfy, otherwise the entire income not yet taxed all becomes taxable in the year following the IRA account owner’s death. This is a terrible result because so much of the IRA is lost to income taxes right away, and all of the tax deferred growth is lost as well.

As an aside, in my thirty years of practicing law, I’ve seen many mistakes when clients name trusts as the beneficiaries to an IRA, often because their financial or legal advisor failed to understand the distribution rules that I explained to Karen and Bob.

There are answers to Bob and Karen’s dilemma, although not enough space in today’s column for me to review them all. For more information please visit http://estateprograms.com/explore/tax-efficient/#IRA.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.

The Current Estate Tax Exemption Might Not Last Long

Clients seem complacent about the federal estate tax since President Trump’s Tax Cuts and Jobs Act of 2017 increased the exemption to $11.4 million. A married couple, therefore, may shield as much as $22.8 million from the estate tax.

A lot of clients are quoting Mad Magazine’s Alfred E. Neuman, “What? Me worry?”

But don’t get too complacent.

That 2017 law sunsets in 2025, and may, in fact, be overturned sooner depending upon the results of the next general election.

If you read Bernie Sander’s proposed estate tax act bill, for example, the federal exemption would be lowered to $3 million. Further, his act would limit lifetime transfers to only $1 million before imposing gift tax. Under current law, you can consume your entire estate tax exemption during life as taxable gifts before having to pay gift or estate tax. Bernie’s law would make it that much more difficult to minimize the estate tax by making lifetime transfers.

While no one knows whether Bernie Sanders or any other similarly minded Democratic hopeful will win in 2020, and we also have no idea whether a new tax law would be forthcoming given the makeup of the House and Senate. It’s safe to say that there’s a voting block interested in wealth redistribution.

The current federal estate tax was enacted, in part, during the beginnings of our country’s industrial age to curb what was then viewed as economic inequality. Then-President Theodore Roosevelt (a Republican) was encouraged by wealthy families, the Carnegies among them, to enact the tax to curb the creation of an “elite, ruling class” made up of trust beneficiaries.

Sound familiar to today’s headlines?

The thought that the pendulum may quickly swing towards a harsher estate tax isn’t outside of the realm of possibilities. Is there anything that you can do about that now?

The answer is “Yes!”

While the federal exemptions remain high, you might want to consider advanced estate planning techniques that consume your exemptions now, prior to any changes in the law. One of the most common objections to making these gifts now is that the transfers must largely be irrevocable, meaning that they cannot be undone, and that in many circumstances the one who transfers loses the ability to use and enjoy the assets during his lifetime.

But there are exceptions to all these rules. There are certain kinds of trusts that you could create where you retain certain income rights for your lifetime. Further, if you are married, you can create marital trusts for your spouse that consume your current exemptions. They would pass on to your children upon your spouse’s passing estate and gift tax free.

Until recently, one concern about using your exemptions before the law changed centered on whether the IRS would “claw back” the gifts at your death if they were made during a time that the lifetime exemption was higher, but at your death would have been taxable. Recent proposed Treasury Regulations issued by the IRS appear to put that concern behind us. The IRS has indicated that it does not view current law as allowing “claw backs,” meaning that if you implement advanced estate planning techniques now, even if the exemptions should decrease, the IRS would not try to include those transfers in your estate upon your demise.

Lifetime transfers have a host of issues to consider, including whether you wish to retain the income or use of the assets transferred, who may serve as trustee, whether a technique would allow you to “leverage” your exemption, how your loved ones benefit and whether you could shield the trust assets for successive generations.

These are not issues that you should consider with someone who is not a wills, trusts or estates specialist. The Florida Bar deems board certified attorneys as specialists; no one else can use that title. In order to become board certified an attorney must demonstrate special skills in the area of law, pass a test, and take many hours of continuing, high level educational credits. A board certified attorney must become re-certified every five years.

Nevertheless, you have an opportunity now that may or may not be around much longer. If you have wealth above the $3-5 million range, it makes sense to visit your estate planning attorney sometime soon to consider your options.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Co-Signing Loans for Children and Grandchildren

“Ed” telephoned me the other day with a problem. “Craig” he said, “I have a bank coming after me for $200,000. Does my revocable trust offer me any protection?”

I was surprised to hear that Ed was in financial trouble. As it turns out, it wasn’t Ed who caused the bank problem. I learned that Ed’s son, “Bruce” purchased a home five years ago, when Bruce was employed. In order to help Bruce qualify for the mortgage, Ed cosigned and personally guaranteed the mortgage note.

You can guess what happened. Bruce lost his job. Bruce then fell behind with his mortgage payments. Ed decided not to help Bruce with the mortgage payments, which turned out to be a mistake since Ed co-signed the loan. The home was foreclosed. Since the value of the home hasn’t significantly increased, the foreclosure sale of the home brought an amount less than the outstanding balance of the mortgage. The bank therefore obtained a deficiency judgment against both Bruce and Ed.

Since Bruce doesn’t have any assets, the bank is seeking recourse from Ed. The first I learn of this mess was Ed’s call to me asking whether his revocable trust somehow protects him against the bank. I advised Ed that his revocable trust does not offer any asset protection because he can freely do with the trust assets as he pleases. A revocable trust is simply another form of ownership. Since Ed can freely spend and consume his trust assets, they are not protected against creditors.

Because of Bruce’s inability to pay the mortgage, Ed’s credit rating could also be adversely affected by these problems.

Ed’s dilemma highlights an issue that many parents of adult children should consider before co-signing notes, and that is to determine what the worst-case scenario looks like, and whether that scenario could be financially devastating.

In addition to the monetary losses Ed may have incurred, there could be gift tax repercussions to the guarantee Ed signed. While an old Tax Court case held that an agreement to guarantee the payments of another’s debts does not constitute a completed gift for purposes of the gift tax rules, the IRS position has in the past been that when a person guarantees the payment of another’s debts, the guarantor transfers a valuable property interest, and therefore a completed gift has occurred.

A controversial 1991 Private Letter Ruling, for example, held that a guarantee is a completed gift, although no guidance was provided suggesting what the value of such a guarantee might be. The IRS cited a Supreme Court decision Dickman v. Comr., a 1984 case that held a parent’s agreement to guarantee payment of loans conferred a valuable economic benefit to the child; as without the guarantee, the child may not have obtained the loan or would have had to pay a higher interest rate.

This controversial ruling has since been withdrawn without IRS comment. However, the IRS may maintain the position that if the child defaults on the loan and the parent repays amounts under the terms of the guarantee, additional gifts are made to the extent that the parent is not reimbursed by the child.

With today’s $11.4 million gift and estate tax exemptions, making a taxable gift might not result in any estate taxes. The current exemptions sunset in 2025 absent any further action by Congress, and it is entirely possible that following the 2020 general election the tax law changes anyway.

In Ed’s case this could constitute additional heartache. Not only may he be required to step in to cure the deficiency on the mortgage foreclosure, he may also lose some of his lifetime gift tax exemption.

The bottom line is that one should tread cautiously when cosigning or guaranteeing family obligations.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.