FAMILY ESTATE PLANNING
Written by Bradford B. Gornto, Esq.
Gornto Law, PLLC
310 Wilmette Ave., Suite 5
Ormond Beach, Florida 32174
Telephone (386) 257-2554
Fax (386) 944-9640
The family estate planning process is a time-consuming endeavor. However, if done correctly, significant benefits through tax savings, probate and guardianship avoidance, privacy of family wealth and affairs, and other benefits can be achieved resulting in an outstanding return on your investment of time and the legal costs incurred. To assist your family and you in this endeavor, I have provided below a brief explanation of some of the elements of family estate planning with which you need to be familiar.
Basic Structure of U.S. Estate Tax System
Currently, the marginal federal estate tax rates range from 18% to 45%.
When someone dies, the representative of the decedent's estate must determine the amount of the federal estate tax due, if any. Assuming the decedent had made no taxable gifts during his or her life, this estate tax determination is made by ascertaining the fair market value (FMV) of all property interests held by the decedent as of the date of death. From the total FMV of all such property interests held by the decedent, the estate is entitled to certain deductions in arriving at the value or amount of the "net taxable estate." These deductions include such items as mortgages, loans, debts, claims, expenses of administration, charitable bequests, and the so called "marital deduction." The "marital deduction" is equal to the value of the property transferred or bequeathed to a surviving spouse. Once the "net taxable estate" has been determined, the estate tax rate structure is then applied which produces the "tentative estate tax." Finally, for a person dying in 2009, his or her estate is entitled to a so called "unified tax credit" in the amount of $1,455,800 which is then deducted from the "tentative estate tax" to arrive at the final federal estate tax due. A full unified credit will effectively exempt or shelter $3,500,000 of wealth from estate taxes. This is a simplification of the actual computations involved, and there are other inclusions, credits and deductions that may apply under certain circumstances.
In 2001, the Economic Growth and Taxpayer Relief and Reconciliation Act of 2001 (the “2001 Tax Act”) was signed into law. While there were discussions of an outright repeal of the estate tax by both Congress and President Bush after the 2001 Tax Act was passed, in reality, the 2001 Tax Act only provided for a phase-out of the estate tax and generation skipping transfer (GST) tax through December 31, 2009, followed by a “temporary” one-year repeal of the estate tax and GST tax in the year 2010. While a full discussion of the 2001 Tax Act is beyond the scope of this memorandum, its key changes to the federal estate tax system involve the progressive increase of the “unified tax credit” (as mentioned above) and the gradual reduction of the maximum estate tax rate. Otherwise, the federal estate tax system, in general, remains unchanged under the 2001 Tax Act, at least until the “one-year” repeal becomes effective in 2010. Accordingly, the two important features of the federal estate tax system that you should continue to clearly understand for purposes of your family estate planning, even after the 2001 Tax Act, are the "marital deduction" and the "unified tax credit."
Unlimited Marital Deduction
The federal estate/gift tax system views a husband and wife as one economic unit and does not assess a gift or estate tax for most property interests transferred during life or at death from one spouse to the other or surviving spouse. However, upon the subsequent death of the surviving spouse, an estate tax will be assessed against all of the transferred property formerly owned by the other deceased spouse. Therefore, the "marital deduction" is merely a tax deferral mechanism. To accomplish this tax deferral policy, the federal gift and estate tax statutes allow a "marital deduction" equal to 100% of the FMV of the property transferred to the other or surviving spouse. The effect of this unlimited "marital deduction" is to reduce dollar for dollar the amount of property that would otherwise be subject to either a gift or estate tax. As you can see, it is possible to eliminate all estate taxes upon the death of the first spouse to die simply by transferring the decedent's entire estate to the surviving spouse. With smaller estates, this "all to the surviving spouse" strategy is generally an appropriate strategy. However, it is not the proper strategy to follow with larger estates (over $2,000,000 in 2009) since the "unified tax credit" of the first spouse to die will be wasted.
Unified Gift & Estate Tax Credit
As previously mentioned, every person is given one "unified tax credit" ("UTC"), currently in the amount of $1,455,800. This UTC may be used either: (i) during life to reduce or eliminate the gift tax on an otherwise taxable gift; or (ii) after death by the estate to reduce or eliminate an estate tax. It must be remembered that the UTC is a tax credit and not a tax deduction. Therefore, the UTC may be utilized only if there is an estate tax against which it may be applied.
Since both a husband and wife each have a UTC in the amount of $1,455,800, it is now possible for a married couple to transfer up to $4,000,000 in property "tax free" to their descendants or other beneficiaries. In other words, the UTC in the amount of $1,455,800 is equivalent to the tax on the first $2,000,000 of property taxable in an estate or gift transfer. Therefore, the two UTCs of the husband and wife are equivalent to the estate tax that would result from property valued at $4,000,000 passing at death. However, as discussed above, in order to fully utilize both spouses' UTC and achieve the "tax free" transfer of at least $4,000,000 in property to the surviving family beneficiaries, a taxable estate in the amount of $2,000,000 in the estate of the first spouse to die must be created. This $2,000,000 taxable estate value will generate an estate tax in the amount of $1455800 against which the decedent's UTC of $1,455,800 may be effectively utilized.
As previously mentioned, one of the major changes to the federal estate tax system under the 2001 Tax Act is the progressive increase of the UTC through the year 2009. Provided below is a schedule showing the remaining increase in the UTC and UTC applicable exclusion amounts from year 2009 through the year 2011 under the 2001 Tax Act. The amounts shown below can be substituted in the previous paragraph (and the following section regarding the Credit Shelter Trust) to illustrate the amount of wealth that is sheltered from estate tax in future years through the full use of one’s unified credit.
Credit Shelter or By Pass Trust
Typically, utilization of the first spouse's UTC is accomplished by funding a so-called "credit shelter" or "by pass" trust in the amount of decedent’s available UTC applicable exclusion amount. Remember at the first spouse's death, the estate tax objective is to intentionally generate an appropriate amount of estate tax against which the deceased spouse's UTC may be applied. Accordingly, since the funding of the credit shelter trust does not qualify for the marital deduction, the net taxable estate of the first spouse to die will be $2,000,000. However, no estate taxes will be due because of the utilization of the deceased spouse's UTC. It is important to note that the $2,000,000 credit shelter trust is available for the health, maintenance and support of the surviving spouse, if needed. However, upon the death of the surviving spouse, the property remaining in the credit shelter trust will pass to the surviving children or other designated beneficiaries without being subjected to estate taxation in the estate of the surviving spouse. If this intentional taxable estate scenario is not followed and all of the property is instead transferred to the surviving spouse as a "marital deduction" distribution, then upon the subsequent death of the surviving spouse, there will only be the one UTC of the surviving spouse available. Therefore, when husband and wife (i) own all of their property jointly with right of survivorship, or (ii) their wills simply provide for all the deceased spouse's property to be distributed to the surviving spouse, the UTC of the first spouse to die will be wasted. To make matters worse, the effect of wasting one UTC and subjecting the additional $2,000,000 of property to higher estate tax brackets in the surviving spouse’s estate is actually much higher than the amount of the UTC, $1455800. For example, if the combined estate of the husband and wife is exactly $4,000,000, the minimum cost of wasting one spouse's UTC is $900,000! Assuming the surviving spouse survives for several years, the additional estate taxes incurred by wasting a UTC may greatly exceed this amount because not only is the additional $2,000,000 of property subject to taxation upon the surviving spouse's death, but the appreciation on such property during the surviving spouse’s remaining lifetime is also subject to estate taxation.
Contrary to popular belief, the problem with probate in Florida is not with the people involved. It has been my experience that the judges, clerks and others involved are very concerned and generally do an outstanding job. Rather, the problem is with the probate process itself in that it imposes an inefficient and complex settlement system upon the estate that in most cases is simply not needed.
The term probate refers generally to the administration and settlement of a deceased person's estate under the supervision or oversight of the probate court. In Florida, this is the Circuit Court. If the decedent dies with a last will and testament, it is known as testamentary probate administration, and, without a will, it is known as intestate probate administration.
The administration of an estate in probate is actually the supervision or oversight by the Circuit Judge of the marshaling of the decedent's assets, the payment of debts, funeral expenses and taxes, and the distribution of the remaining assets in accordance with the decedent's will; or, if there is no will, in accordance with Florida law. Generally, all estates must undergo formal probate administration in Florida unless the gross value of the assets subject to administration is less than $75,000.
Customarily, in the absence of any litigation or delays through tax controversies, or the sale of properties, an estate's probate administration will take anywhere from 9 months to 2 years. In the interim, some distribution of the estate assets can be made if there are other assets which are retained in the estate sufficient to cover debts, taxes, etc. Usually, no distribution of estate assets is permitted until the three month creditor claim period has expired.
This is the period during which creditors of the estate must file their claims against the estate. However, if the decedent's family is in need of funds during this creditor claim period, the Circuit Judge will usually permit a distribution within specified limits.
In Florida, the person appointed by the Circuit Court to handle and represent the decedent's estate in probate administration is called the "personal representative." In other states, this person is often referred to as either the executor or executrix.
Funded Revocable Living Trust
A funded revocable living trust is an arrangement whereby you transfer legal title to certain of your assets to a trustee to be managed for the benefit of beneficiaries as directed by the trust agreement. During the lifetime of the person establishing the trust (grantor), the income of the revocable trust is taxable to the grantor whether or not the income is paid to the grantor. Typically during the grantor's life, the grantor is also the income beneficiary of the trust. Also, it is common for the grantor to serve as the initial trustee, or for a husband and wife to serve as co-trustees. When the income beneficiary dies, the trust property will be managed for or distributed to the remainder beneficiaries (typically the grantor's surviving spouse and/or surviving descendants) in accordance with the trust agreement outside the probate system. The primary distinction of a revocable living trust is that it can be modified or terminated at the grantor's request, or property can be withdrawn from the trust at any time. In other words, with a revocable living trust you can add or withdraw assets, alter the trustee's authority, change beneficiaries, or completely cancel the trust. In fact, flexibility and simple trust administration are key attributes of a living revocable trust.
Generally, a funded revocable living trust gives you the following primary advantages:
1. Avoidance of probate, reduce estate settlement costs and simplify the estate settlement process. Depending upon the facts, probate and settlement costs will generally range from 2% to 5% of the estate value. Remember that transfers of your property at your death into either a previously established trust or a trust established by your will must go through probate in order to be funded, therefore, only funding a trust during your life will avoid probate.
2. Certainty that your finances and family expenses will be taken care of in the event of disability or incompetence. This feature avoids the appointment of a guardian of your property by the court in the event of your disability or incompetence.
3. Professional investment management with freedom for you to participate in decision-making or not, as you wish (assuming a trustee other than grantor is appointed). However, as stated above, it is common for the grantor of the trust to also serve as the initial trustee during the grantor's life.
4. Assurance that your beneficiaries may receive immediate income/principal payments after your death. In other words, no delays in payments to your beneficiaries because there is no probate court involvement or oversight with such trusts.
5. Simplify or eliminate the problems of court-supervised guardianship when minors are beneficiaries of your property.
6. Minimize publicity, since the probate proceedings are generally a matter of public record while a trust is a private agreement.
7. Significant asset protection from potential lawsuits and judgment creditors of one spouse can be achieved for a husband and wife by appropriately funding the living revocable trust of the other spouse who is not exposed to potential claims (i.e., spouse of doctor). However, please note that if asset protection is a concern to you, there are more effective arrangements that may be used in conjunction with a funded living revocable trust (the discussion of which is beyond the scope of this memorandum).
8. Finally, if you own real estate in a state other than the state in which you are a resident, your estate will be subject to possible "ancillary probate administration" in that state for the real estate located therein. In other words, your estate could potentially be subject to a separate probate administration in every state in which you owned real estate. However, this ancillary probate problem could be avoided by simply holding title to such out-of-state real estate in the name of your living revocable trust.
Since the income of the revocable living trust is generally taxable to the grantor under Sections 673-677 of the Internal Revenue Code and the grantor serves as a trustee, the revocable living trust is not required to prepare and file a separate income tax return. Instead, pursuant to Treasury Regulation 1.671-4, all items of income, deduction, and credit from the trust are reported on the grantor's regular income tax return (Form 1040). In other words, for income tax reporting purposes the revocable living trust is ignored in such situations, and you merely continue to report such income items on your income tax return (Form 1040).
As mentioned above, reducing estate settlement expenses and eliminating delays in the distribution of property to beneficiaries are two benefits of a funded living revocable trust. Assets left by will or distributed by law in the absence of a will must go through the probate administration process. Court oversight, court accountings, and court review may be involved, and at each step there may be both delays and expenses. This is all necessary to assure that ownership of the various assets may be properly transferred from the deceased owner to the various beneficiaries. In contrast, when the grantor of a living revocable trust dies, the assets already in the trust are disposed of by the trustee "outside" the probate system in accordance with the directions specified in the trust agreement without the publicity, expense or involvement of the court. Also, since the trust has usually been in existence for several years before the grantor dies, the possibility of a will contest or dispute among the beneficiaries is reduced.
Joint Ownership of Property by Husband and Wife
It is often stated that "joint ownership" between a husband and wife is the solution to avoiding probate. While jointly held property will pass to the surviving spouse outside of probate, there are significant disadvantages to this form of ownership. First, joint ownership does not avoid the appointment by the court of a guardian of the property should either spouse become unable to manage their affairs due to disability or incompetence.
Second, in the event of a common disaster in which both spouses die, the property would be subject to probate. Third, after the first spouse dies, the surviving spouse will own the property individually and the property will be subject to probate upon the death of that spouse. Finally, as previously discussed, in cases involving extensive property interests there are significant tax planning opportunities and savings that are wasted by holding the property in joint ownership. For example, as discussed above, if all of the property of a husband and wife is owned jointly, the “unified tax credit” of the first spouse to die will not be used. Therefore, assuming the net estate value of a husband and wife was exactly $4,000,000, and assuming both spouses died in 2009, the fact that they held their property jointly would result in $900,000 in additional estate taxes that could have been totally avoided had the property not been jointly held. Furthermore, if the surviving spouse were to survive for ten years then the fact that they held all their property jointly would result in $1,462,000 in additional estate taxes (assuming an average after-tax growth rate of 5% per year) that could have been totally avoided had the property not been jointly held.
THE ABOVE DISCUSSION PERTAINING TO FAMILY ESTATE PLANNING, FUNDED REVOCABLE TRUSTS AND OTHER MATTERS IS INTENDED ONLY FOR GENERAL INFORMATIONAL PURPOSES OF THE READER AND NOT AS LEGAL ADVICE AND SHOULD NOT BE RELIED UPON AS SUCH. THE ESTABLISHMENT OF A FUNDED REVOCABLE TRUST SHOULD NOT BE UNDERTAKEN WITHOUT FIRST OBTAINING COMPETENT LEGAL COUNSEL.
Unpublished Work, All Rights Reserved: 2015, Gornto Law, PLLC
In the case of estates of
decedents dying during
the Unified Credit
<one-year estae tax repeal>
exclusion amount is