Monthly Archives: June 2009

Common ways to reduce Estate Taxes

Question: My parents have considerable assets. What can they do now to reduce the potential estate taxes?

Investing towards the future. Elder Law Estate planning in Massachusetts.Many clients may be near or over the estate tax exemption and owe federal estate taxes upon their death (see my post on ways to avoid state taxes to see federal estate tax rates).  Furthermore, individuals must also face a much lower threshold and may also be subject to Massachusetts estate taxes (currently assets over $1,000,000 are subject to the MA estate tax).

Here are some common, somewhat complex examples on how to reduce your estate in order to minimize the ultimate tax owed:

  1. The Credit Shelter Trust (By-Pass Trust) – In 2009, a married couple will be able to transfer $7,000,000 without federal estate tax.  To do so, each spouse must make maximum use of their $3,500,000 applicable exclusion amount.  A credit shelter trust can allow us to take full advantage of the applicable exclusion amounts and still provides for the surviving spouse and children.  Both a credit shelter trust and a marital deduction trust can be included in a Will or a Living Trust.
  2. Family Limited Partnerships (FLP) – One can use a family limited partnership or an LLC to consolidate ownership and management of family assets and potentially shift income or appreciation to the children.  In essence, these entities allow parents to make discounted gifts of limited partnership interests to children and grandchildren without surrendering control of the business or property.  Such gifts make qualify for gift tax discounts on their valuation as they can be discounted as much as 35% due to lack of control and marketability.
  3. Benefits of Lifetime Gifting – If one still expects estate tax liability even after applying the above mentioned options, one may consider gifting strategies.  For example, in 2009 anyone can make a $13,000 gift, income tax free and gift tax free. Lifetime gifts can remove assets and their future appreciation from the estate.  When deciding what to gift, it is best to gift assets that are likely to appreciate after the gift.  Consider a husband and wife with two children, each spouse can give each child $13,000 annually.  This amounts to $52,000 of tax free gifts annually. Also, any medical or education related expenses you pay directly on behalf of a child or grandchild are immediately removed from your estate without any gift tax.

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Good News for Estate Planning

Declining interest rates may not be good for potential buyers of bank Certificates of Deposit, but they are good news for various estate planning strategies.

Estate planning for Massachusetts elder couples.I will address a few areas and techniques where low interest rates can have a very positive impact on the estate planning process:

  1. Qualified Personal Residence Trust (QPRT) – A QPRT is an irrevocable trust to which the donor transfers their personal residence and retains the right to reside in the residence for a specific term of years, 10 years is common.  After the term of years, the residence passes to the children or other beneficiaries.  In periods of low interest rates, the value of the retained interest is high, and the amount of the gift remains low.
  2. Grantor Retained Annuity Trust (GRAT) – A grantor transfers property to an irrevocable trust and retains an annuity interest for a specific term.  At the expiration of the term interest, the property typically passes to a child.  Gift tax is payable on the present value of the remainder interest.  As interest rates drop, the value of the retained interest increases—thereby decreasing the value of the gift of the remainder interest.  A drop in interest rates is good for GRAT planning.
  3. Private Annuities – In a typical private annuity transaction, a parent transfers property to a child in return for that child’s unsecured promise to pay the parent a fixed income for life.  If the fair market value of the property equals the present value of the annuity under I.R.C. Section 7520 tables (currently at 2.8%), there is no gift tax on the transfer.  A further decrease in the interest rate lowers the annual payment amount that the child has to make to the parent.  Furthermore, if the parent dies during the annuity payments, all payments cease and the child has met their obligations and owns the property outright.

Low interest rates, including the IRS’ Section 7520 rate, can have a significant impact on an individual’s estate planning outcome.  The effectiveness of many estate planning techniques vary with interest rate changes.

If you have any questions about any of these areas and techniques of the estate planning process, feel free to contact me or your estate planning attorney.

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How a Living Trust protects the Grantor in the event of incapacity

Advice on Elder Law trust in Massachusetts.Revocable Living Trusts have become popular for probate avoidance and maintaining private information about assets and loved ones.  In addition to these two very important features, many people may not fully understand the living trusts protective power in the event the grantor, the one who establishes the trust, becomes unwilling or unable to manage the trust, often due to incapacity.

The grantor of a living trust is most commonly named the trustee of the trust.  During his or her lifetime the grantor, acting as trustee, continues to make his or her own decisions regarding the management of the trusts’ assets.  The trustee manages the trust property in accordance with his or her own wishes and also for the benefit of the beneficiaries of the trust, usually a spouse or children.  A very common question arises when I meet with clients to discuss utilizing a living trust:

What happens to my Living Trust if I become incapacitated?

A benefit of a properly drafted Living Trust is that the grantor can name co-trustees, or successor trustees to simply step into the shoes of the grantor in the event the grantor is unable to serve as trustee.  This helps to insure the grantor’s continuity of asset management.  Assets held in a Living Trust can continue to be held and invested as the grantor desires even after the original trustee (often the grantor) has been replaced by a successor trustee. Moreover, a change of trustee due to the original trustee’s death, incapacity or resignation does not cause a delay in the successor trustee’s authority to manage the trust assets.

In summary, a Living Trust allows the grantor to plan for the possibility of his or her own disability or incapacity and to chose their own successor trustee.  Otherwise, in some cases, a person who becomes unable to manage his or her own assets and make financial decisions on their own behalf may need to have a court appoint a conservator or guardian of his property to act for him. Not only is this a clumsy and comparatively expensive process, but it may even result in the court’s appointment of a stranger as the conservator or legal guardian if the court is not satisfied that any of the incapacitated person’s relatives would make a suitable fiduciary.  The result is that the property owner’s assets will be managed by someone who does not know the owner, their investment preferences, their values, or what their relationship with various family members may be.

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Who should be named as a trustee of a Living Trust and what are their duties?

The naming of a co-trustee or successor trustee is a very important decision that should not be made without careful thinking.  Once the grantor either voluntarily appoints a trustee, or a trustee begins to serve as a result of incapacity, this individual will be making important financial decisions as they relate to all assets held in the name of the trust.

The question then arises: Who should I name as trustee?

There is no single answer that is best for all clients.  Some individuals wish to manage their assets as long as possible; others are eager to transfer that responsibility.  Some will prefer an institution or unrelated individual such as a trusted advisor.  Others will look to children or other family members to act as trustee.  In selecting a trustee, the most important factor to consider is whether a person will act in accordance with the grantor’s wishes and in the best interest of the trust and those it benefits.  Some of the most important decisions when drafting a Living Trust arise in connection with the selection of a trustee or successor trustee, and these issues should always be discussed carefully with the attorney who prepares the trust instrument.

Because the powers of a trustee are variable, the grantor of the trust can determine the extent of the trustee’s powers in the trust agreement.  The trustee must thoroughly understand what his or her duties are that accompany the title of legal owner of the trust assets.

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Why your Will may accomplish very little with unintended results and how to easily resolve this problem

Many people have a Last Will and Testament, (“Will”) which serves as a written disposition of your assets. In the case of a widow, her Will may state that all property she owns at her death is to be distributed equally to her three children. It sounds easy enough, but can you answer the questions below with certainty?

  1. When you think of passing your estate to your children, will each child ultimately have an equal share?
  2. Who will pay your funeral expenses?
  3. Who will pay any income or estate taxes you may owe?

While you may think you know these answers, the end result may surprise you.

Think of our hypothetical widow who does not have any estate tax liability, but is concerned that her three children share equally in her moderate estate. She has a Will drafted with instructions that all children are to share equally. But looking at the actual ownership of the assets, she owns her primary residence in joint ownership with one child, her three certificates of deposit have different balances and different children as owners, and one of the children is the beneficiary of her life insurance policy. The Will states all assets are to be distributed equally to the three children.

The problem: They won’t be. The only assets that pass through the instructions of your Will are probate assets. All the assets listed above are non-probate assets as they will pass outside the Will under operation of law and go directly to the named beneficiaries.

The result: One child owns the house, each child owns a certificate of deposit with a different balance, and one child receives the proceeds of her life insurance. Needless to say this was not what she intended.

So what did this typical Will accomplish? In this very real situation it accomplished very little. Your intentions were to equalize your estate between all your children, but the way you held title to your assets created an unequal distribution of your estate. Furthermore, if one child pays your funeral expenses and income taxes owed, there is no way to force the other children to contribute, potentially creating a rift among siblings.

The Solution:
Have your assets owned and all beneficiaries listed as your Living Trust. This way, your primary residence, certificates of deposit, and life insurance would all be held by your living trust upon your death. The living trust will avoid probate, just like joint ownership and naming a beneficiary, but more importantly your wishes of estate equalization will be met.  You would also appoint a trustee, (analogous to an executor in your Will), in the Living Trust to pay your final expenses and any income tax owed before any distributions are made to your three children equally. Keep in mind, a living trust should be set up and funded prior to your death.

If you have questions on the effectiveness of your will, or to see how a living trust may benefit you situation, please contact me to discuss your situation.

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