Estate Planning After the New Tax Law

By Robert F. Klueger

On December 20, 2010, Congress enacted the most sweeping changes in the estate tax law in 29 years. People who have already begun (or though they had completed) their estate planning now need to review their estate plans in order to determine if their plans still help them. For people who have not begun the estate planning process, there is no better time to start.

Estate Planning After The New Tax Law covers the basics and all of the complexities of estate planning. Using practical examples drawn from real life, the book examines the fundamentals of avoiding the probate of a decedents estate and reduction of estate taxes, starting with the basic tool, the living trust. The book avoids jargon and legalese, but does not skimp on the intricacies of estate planning law and practice.

• Language: English
• Publisher: Xlibris US
• Release date: Aug 29, 2011
• ISBN: 9781465361233

Robert F. Klueger

Robert F. Klueger is a partner in the law firm, Klueger & Stein, LLP, Encino, California. Mr. Klueger specializes in all aspects of estate planning, tax law, and asset protection law. He received his JD degree from Fordham Law School, New York, in 1973 and a Master of Laws in Taxation from the University of Denver Graduate Tax Program in 1980. He is a Certified Tax Law specialist from the California Board of Legal Specialization. A member of the New York, Colorado, and California Bars, he is admitted to practice before the U. S. Tax Court and the U. S. Supreme Court. He is one of the few private attorneys to have argued a tax case before the U. S. Supreme Court. This is Mr. Kluegers fifth published book on tax and asset protection-related topics. He is also the author of Asset Protection (Entrepreneur Press, 2008) and numerous scholarly articles on tax-related topics.

Book preview

Copyright © 2011 by Robert F. Klueger, Esq., LL.M.

Library of Congress Control Number:   2011915533

ISBN: Hardcover    978-1-4653-6122-6

ISBN: Softcover      978-1-4653-6121-9

ISBN: Ebook           978-1-4653-6123-3

All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, without permission in writing from the copyright owner.

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Contents

Introduction

PART I: THE BASICS

Chapter 1: Why Plan Your Estate?

Introduction

All About Probate

Which Assets are Subject to the Probate Process?

All About Joint Tenancy (and Tenancy in Common)

How Living Trusts Avoid Probate

Other Estate Planning Goals

Estate Planning and Asset Protection

Who Will Take Care of the Kids?

Chapter 2: All About Estate Taxes

Introduction

It’s an Excise Tax

It’s a World-Wide Tax

The Taxable Estate and the Probate Estate

Property is Defined by State Law

Retained Interests—All About IRC §2036

Revocable Transfers and Powers of Appointment

Computing the Estate Tax

When Is the Estate Tax Due?

Chapter 3: Estate Planning Fundamentals

Introduction

The Unlimited Marital Deduction

A Little History

The General Rule

All About Qualified Terminable Interest Property

All About QDOTs

The Exclusion Amount

Gift Taxes

Introduction

The Basics

The Lifetime Exclusion

The Annual Exclusion

The Unlimited Gift Tax Marital Deduction

Disclaimers

The Step-Up in Basis Rule

The Step-Up and Joint Tenancy

The Step-Down in Basis

Chapter 4: All About Trusts

Introduction

Who is Who in a Trust

Living Trusts and Testamentary Trusts

Revocable Trusts and Irrevocable Trusts

Spendthrift Trusts

Self-Settled Trusts

Support Trusts and Discretionary Trusts

No-Contest Clauses

Special Needs Trusts

Chapter 5: Marital Deduction Planning Using Living Trusts

Meet Mel and Martha

The Interplay of the Marital Deduction and the Exclusion Amount

All About A-B Trusts

A-B Trust Basics

Is this Legal?

Formula Clauses

Which Assets Go Where?

A-B Trusts in Separate Property States

The Downside to A-B Trusts

The A-B Trust After the Second Death

All About Portability

The Basics

Portability and A-B Trusts Compared

PART II: ADVANCED ESTATE PLANNING

Chapter 6: Estate Planning for Life Insurance

Introduction

A (Very) Brief Overview of Life Insurance

The Different Types of Life Insurance

Who is Who in a Life Insurance Policy

How Life Insurance is Taxed

How ILITs Work

The Three-Year Rule

Drafting the ILIT

All About Crummey Powers (or How Weird Can this Get?)

Funding the Trust

Chapter 7: Qualified Personal Residence Trusts

Introduction

How QPRTs Work

The Trap

The Trustees and Beneficiaries of a QPRT

How Do You Sell the Residence?

The IRS Speaks: The Q in QPRT

What Happens When the Term Ends

Income Taxation of QPRTs

The Downside: No Step-Up in Basis

Chapter 8: Planning for Business and Investment Assets

Introduction

The Basics of Discount Valuation

An Overview of FLPs and LLCs

All About Family Limited Partnerships

All About LLCs

The Discount Wars

The Saga of Albert Strangi

Estate of Kimbell

Estate of Samuel P. Black Jr.

Planning for Discount Valuation

Chapter 9: Planning for Generation-Skipping Transfers

Introduction to the GST Tax

How the GST Tax Works

Computing the GST Tax

The Orphan’s Exception

The Annual GST Tax Exclusion

Planning for Generation Skipping Transfers

Estate Planning Alert: Make Generation-Skipping Gifts in 2011 or 2012

Chapter 10: Installment Sales and Self-Canceling Installment Notes

Introduction

Installment Sales as an Estate Planning Tool

All About SCINs

Planning for SCINs

The Risk Premium

The Term of the SCIN

Why SCINs Are Not for Everyone

Chapter 11: Where Estate Planning and Asset Protection Meet

Introduction

Fraudulent Conveyances in a (Very Small) Nutshell

Planning for Exempt Assets

Are IRAs Exempt?

Other Exempt Assets

Asset Protection and QPRTs

Asset Protection and Life Insurance Trusts

Asset Protection and Business Entities

Asset Protection, Living Trusts, and the 2010 Tax Law

Acknowledgement

The author wishes to thank his legal assistant, Ms. Davida Hardesty, for her invaluable contributions in all aspects of the copy editing, proofreading and design of this book.

The author also wishes to thank Elizabeth Klueger for her valuable comments and suggestions.

Introduction

On December 20, 2010, President Obama signed the Middle Class Tax Act of 2010 into law. It contained major revisions to the Internal Revenue Code affecting income taxes for businesses and individuals. With respect to estate taxes, however, it represented the most substantial change in the estate tax in twenty-nine years, enacting changes that will require almost every person who has already implemented an estate plan to review, rethink, and perhaps modify the existing estate plan. All this despite the new law being advertised as a mere extension of the estate tax law that was set to expire on December 31, 2010.

Here, in a nutshell, are the major estate tax changes that went into effect on January 1, 2011. We’ll discuss each of these changes in far greater detail in later chapters.

o   The exclusion from estate tax is increased to $5 million per person. If a person dies with assets totaling $4.9 million, there are no estate taxes to worry about. A married couple can shield $10 million from estate taxes.

o   If a married person dies without using his or her $5 million exemption, he or she can shift the unused portion to the surviving spouse. This new portability feature will cause most married couples with existing estate plans to review their plans. More on this in Chapter 5.

o   To the extent that an estate is taxable, the rate is reduced to 35 percent. It was as high as 55 percent.

o   The lifetime exclusion from gift taxes is also raised to $5 million per person. The gift tax and the estate tax are once again fully integrated, as they were in prior years. That means, if you use a part of your $5 million gift tax exclusion during your lifetime, it reduces your estate tax exclusion by that amount.

All of these changes are supposed to be temporary, with the old rules set to come back to life on January 1, 2013. Most people are confident, however, that these rules are permanent, for the simple reason that the exclusion from estate taxes has never decreased; it has only increased. The exclusion was $200,000 in 1982. It gradually rose to $600,000 by the late 1980s. It rose to $1 million in 2001, and steadily rose to $3.5 million by 2009. There’s no way it’s going down. Count on it.

Unfortunately, many people are going to read that they can now shield $5 million from estate taxes ($10 million for a married couple), smile, roll over, and go back to sleep. For some people, what they don’t know won’t hurt them. For others, however, especially those married couples whose estate falls far below $10 million, they will one day learn that the estate plans they wrote prior to the new law actually now do more harm than good. Even if the new law doesn’t harm them, there are planning opportunities in the new law that they will miss.

The new law won’t harm you, and you won’t miss any of the opportunities, following your reading of this book. That’s true whether you’re single or married and whether you have an estate that tops out under $1 million or over $10 million.

Chapter 1

WHY PLAN YOUR ESTATE?

Introduction

You don’t have to plan your estate. No one can force you to. But if you don’t, you might wind up like Einar Borglund.[1]

I never actually met Mr. Borglund, but his children (my clients) told me all about him. He was, apparently, the most ornery old coot alive. Over the years, he amassed a large collection of apartment buildings in Los Angeles. He didn’t trust janitors or plumbers, so he did most of the repairs himself. He didn’t like property managers, so he collected the rents himself. He didn’t like accountants, he didn’t like his three children, and most of all, he didn’t like lawyers. What he did like—loved, actually—was his second wife Bertha, who was younger than his three children.

Because he loved Bertha, and because he disliked lawyers, at some point, probably when he was nearing eighty, he popped a sheet of paper into an ancient Underwood typewriter and typed out:

Last Will and Testiment

I, Einar Borglund, being of sound mind, leave everything to my wife Bertha when I die. I leave nothing to my children.

Signed

He actually typed in the word Signed, and under that, he signed his name. Trust me, when I tell you that, at the very moment you are reading this page, there are 10,000 law students in California (not to mention 175,000 lawyers) who will swear to you that Einar Borglund’s chances of having his typed, unwitnessed will hold up in court are absolute zero. That piece of paper might have served to record bridge or scrabble scores, or properly folded, served as a child’s paper airplane, but it could never serve to pass his estate to his intended beneficiary, Bertha. Einar Borglund died without a will, that is, he died intestate.

At first blush, you might think that dying intestate could not be so bad, because Bertha did, after all, survive Einar, and as Einar’s closest heir, surely she would inherit the property anyway. Unfortunately for Bertha, this is where things get complicated. California is a community property state. Had Einar’s property been community property, it would have passed to Bertha, even without a will. But Einar acquired most of the property before he married Bertha, which means that the property was not community property, it was separate property. And when you die intestate in California, and you have a wife and three children, your three children receive two-thirds of the separate property; the surviving spouse receives the other third.

Had Einar Borglund paid to have an attorney draft a proper will (or better yet, a living trust) he would have decided who was to receive his property upon his death, not the California Probate Code. Had he paid that attorney $2,300 for the estate plan, it would have represented 0.01 percent of $23,000,000, which was the value of the property that Bertha did not receive, but which went instead to his children (my clients, or did I mention that?).

Why plan your estate? Einar Borglund represents the first and most basic reason to plan your estate, to control the estate, that is, to assure that you decide who gets the money and the assets, when they get it, and under what circumstances and conditions, and that the government does not decide for you who gets the estate.

People sometimes are not sure what they can do with their estate. The answer is that, with few exceptions, you are completely free to do with your estate whatever you please. If you wish to exclude one of your children completely, you’re free to do so. If you’re not sure if you want to provide for a child, and wish to hold the money in trust until he or she matures, you certainly can do that too. If you don’t want to leave anything to your children or any of your relatives or friends, leaving everything to the Humane Society, you can do that too. When we plan an estate, we start with a blank sheet of paper; you fill it in.

There are a few things that you may not do. Many states (but not all) have enacted a law that provides for a spousal right of election. It works to prevent a person from completely omitting a surviving spouse. Many of the states that provide for a spousal right of election give the surviving spouse the right to elect against half—or approximately half—of the estate. For example, if Mr. Jones were to write a one sentence will leaving nothing to Mrs. Jones and everything to his girlfriend, Fifi, following Mr. Jones’s death, Mrs. Jones would have the right to tap Fifi on the shoulder and say, Nice try, but I’ll be having half of all those assets my husband left you. Thank you very much.

There are some things you may not do because they violate public policy. If you write a will that leaves your home to your son, provided that he never sells or leases it to a black person, you can rest assured that the son will receive the home without being subject to the offending condition. Similarly, a trust that leaves property to a son if and when he divorces his no-good wife Angelina will result in the son receiving the property whether he is married to Angelina or not. The courts will not assist in the breakup of families.

The control of the estate is the basic reason to plan the estate. Another reason, which we will cover at great length in succeeding chapters, is to reduce (or possibly eliminate) estate taxes. But there is another basic reason to plan your estate: to avoid probate.

All About Probate

Probate is not a mystery to anyone who has had a loved one who died and whose estate had to go through the probate process. But for most people, the probate process is something that they know they need to avoid, are not sure how to avoid, and don’t really know what it is. I have heard any number of people through the years tell me that they don’t need to worry about probate because they have wills. If you have a will (but not a trust) you avoid a mess, but you don’t avoid probate. If fact, the term probate means proving—the will! It is only with a living trust into which title to all of the assets have been placed that we are assured of completely avoiding probate. More on that shortly. All mysteries are dispelled right here. Guaranteed.

Let’s assume you write a will. It leaves your condo to your son, your golf clubs to your daughter, your half of your business to your partner, and your stock portfolio to your brother. The will is like a recipe, a directive. But there is one thing that your will cannot do: it cannot actually transfer the title of the condo to your son. It cannot endorse the stock certificates that comprise the stock portfolio to your brother. Were you alive, and you wished to transfer the condo to your son, you would draw up a deed, sign it, notarize it, have it recorded, and your son would own the condo. But once you have died, you cannot reach up out of the grave and sign a deed transferring the condo. You cannot endorse the stock certificates to your brother. Someone else needs to do those things. That someone is the probate court,[2] and the process of effecting the actual physical transfer of assets from a deceased person to the person’s chosen beneficiaries is what the probate process is about.

If probate is nothing more than transferring assets from a deceased person to the living people, what’s the problem? In some states, it isn’t much of a problem and can be accomplished at little expense within a period of weeks. In other states, such as California, the simple process of transferring assets from a deceased person to living people can be downright Dickensian, involving petitions, appraisals, motions, court appearances, inventories, more hearings, and more petitions, until a year and 5-8 percent of the value of the estate has been consumed, until finally the beneficiaries receive the assets they were intended to receive. Fortunately, probate is everywhere avoidable with a living trust to which title to the assets have been transferred before the decedent dies.

What makes probate so complicated—and expensive? For starters, the court has to be convinced that the person who was nominated by the person who wrote the will (the decedent) to handle the estate (the personal representative or the executor) is a fit and proper person. The court will also want to assure itself that the written will actually represents the decedent’s intent. Why wouldn’t it? Let’s assume that Mr. Brown had three children, but he left everything to only one of his children, Fred. The will looks OK, properly witnessed, and/or notarized in accordance with state law (unlike Einar Borglund’s). Why shouldn’t Fred receive everything? Perhaps, if Mr. Brown’s other children were to appear in court, they might shed some light on the matter. They might testify that Mr. Brown was in a wheelchair, and every morning when Fred took his father on their morning stroll, he threatened to release the wheelchair and