COURSE OUTLINE

I. The goals of estate planning

• There are two views of the estate planning process.

– It involves only the conservation and distribution of a client’s estate.
– It involves maximizing the distributable wealth of a client and transferring the wealth to the client’s beneficiaries in an appropriate fashion.

• The process involves answering three questions.

– Who will be the recipients of the property (or properties)?
– How will this property be transferred?
– When will this property be transferred?

II. Starting the process

• The estate planning process begins with gathering data from the client.
• This data will help determine whether the assets are in the appropriate form for distribution and whether their total value is adequate to provide the desired distributions.
• Ascertain the dispositive goals of the client (basically the "who" question).
• Ascertain how the property will be distributed.

III. Ownership of property

• Knowledge of the forms of property interest is essential to the estate planner to determine all of the possible property rights held by the client and the possible forms of dispositions the client can ultimately make to heirs.

A. Individual ownership of property

1. Fee simple ownership

• This is the outright ownership of property, that is, ownership of all rights associated with the property.

2. Life estates

• This gives the owner the absolute right to possess, enjoy, and receive current income from the property until the life interest terminates.

3. Term interests

4. Future interests

• This is a current right to future enjoyment of property.

– Remainder interest—taking effect immediately upon the expiration of another interest in the same property
– Reversionary interest —giving the transferor the right to the return of the property at the end of a term during which the transferee has possessed it

B. Joint concurrent ownership of property

1. Tenancy in common

• Two or more individuals may hold current possessory rights to property.
• Individuals may transfer interest in property.

2. Joint tenancy with right of survivorship

• Property is held jointly, with survivor ultimately receiving the entire interest.
• Transfer is automatic at death of one tenant.
• Interest may be transferred without consent of other joint tenant(s). (This may sever the joint tenancy.)

3. Tenancy by the entireties

• It is restricted to spouses.
• Property transfers automatically to surviving spouse at date of joint tenant.
• Transfer during lifetime requires consent.

4. Community property

• It varies somewhat among nine states having such laws.
• Generally property acquired during marriage is treated as community property and owned equally by the spouses.

C. Other property rights

1. Beneficial interest in property

• Not an "ownership" interest in the property but a "benefit" to be derived from the property, such as the right to current income or principal distributions
• Example: Interest that is owned by the beneficiary of a trust

2. Powers

• The power of appointment provides the holder of the power the ability to transfer property.

– General power allowing a holder a broad power to transfer property to virtually any recipient
– Special power providing limited class of potential recipients of the property

• The power of attorney gives the holder the ability to stand in the place of the grantor of the power.

IV. Estate planning documents

• Documents are necessary to facilitate the estate plan.
• Documents involve compliance with state law.

A. The client’s will

1. Requirements for a valid will

• written
• signed
• witnessed

2. What can a valid will accomplish?

• Direct the disposition of the probate assets
• Nominate or name an executor
• Nominate guardians
• Create testamentary trusts
• Name a trustee
• Provide directions regarding management of assets
• Provide directions for payment of taxes and expenses
• Establish compensation of executors or trustees

3. Living wills

• This deals with the health care measures that the individual wants imposed should disability occur.

B. Trusts

• The trust is a relationship that divides the ownership of property—legal title to the trustee and beneficial or equitable interest in the property to the beneficiaries.

1. Living (inter vivos) trust

• Created during the lifetime of a grantor
• Can be revocable or irrevocable
• Can be used as an estate plan (if revocable trust)

– Transfer appropriate assets to the trustee.
– Grantor can observe the management of the trust assets without relinquishing ultimate control of the assets.

• Since the irrevocable trust is a completed gift, it is effective for gift and estate tax purposes.
  – Property then is not part of a grantor’s gross estate.
  – Property becomes the property of the trustee and is exempt from the claims of the grantor’s creditors.

2. Testamentary trust

• No property is received until the grantor’s death.
• Since the creation of the trust is in the will, it is subject to probate.

C. Durable power of attorney

• A power of attorney is a written document that enables a principal to designate a holder of the power, known as the attorney-in-fact, to act on the principal’s behalf.
• A durable power of attorney is an estate planning document that is not terminated by the legal disability of the principal.
• A power of attorney should be drafted prudently for the specific circumstances of the principal.

V. Transfers at death—an overview

A. Probate property

1. Transfers through will provisions

• Court ensures that probate property is distributed according to the terms of the will.

2. Transfers by intestacy

• No valid will
• Distribution established by the state

B. Transfers by operation of law

• The nature of the ownership interest causes property to pass automatically at death of a decedent. (See "joint concurrent ownership" for examples.)
• One such transfer is the establishment of joint bank or securities accounts.
• Another vehicle is the Totten trust, where an individual opens a bank account in trust for a named beneficiary.

C. Transfers by operation of contract

• Example: The policy proceeds of a life insurance policy will be distributed to the designated beneficiary.

VI. Overview of taxes imposed on transfers of wealth

• The most significant costs of transferring wealth are the various transfer taxes imposed at the federal and state levels.

A. The federal transfer tax system

1. Federal gift taxes

• The federal gift tax applies only if two elements are present
  – There is a completed transfer and acceptance of property.   (Transfer of services by an individual is not a taxable gift.)
  – The transfer is for less than full and adequate consideration.

• Exempt transfers

– Transfer of property pursuant to a divorce or property settlement agreement
– Transfers directly to the provider of education or medical services on behalf of an individual
– Gifts that are disclaimed by the donee (in a qualified disclaimer)

• The annual exclusion
  – Qualifying gifts of $10,000 or less (annually)
  – Gifts that provide a present interest to the donee

• Deductions from the gift tax base
  – The marital deduction: Qualifying transfers to a spouse are fully deductible from the gift tax base.
  – The charitable deduction

• The unified credit

– The cumulative credit is $192,800.

2. The federal estate tax

• The gross estate includes property that is part of the probate estate and property that is transferable by the decedent at death by other means, such as
  – property individually owned by the decedent
  – property held jointly (some portion of)
  – life insurance
  – pension (or IRA) payments left to survivors
  – property subject to general powers of appointment
  – certain property transferred during lifetime

• Items deductible from the gross estate

– Debts of the decedent (if obligations of the gross estate)

– Reasonable funeral and other death costs

– Costs of estate settlement

• Marital deduction

– Unlimited (as with the gift tax)

• Charitable deduction

– Transfers at death will be fully deductible.

• Credits against the estate tax

– Unified credit (as with the gift tax)

– State death tax credit

B. Generation-skipping transfer tax (GSTT)

• Purpose
  – It differs from the unified estate and gift tax system.
  – Flat rate is applicable (in addition to any estate or gift tax).

• Three types of transfers
  – Direct skip (outright transfer)
  – Taxable distribution
  – Taxable termination

• Exemption of $1 million is available.

C. State death taxes

• Subject to state tax even when no federal death taxes (because of $600,000 unified credit equivalent)
• Definition of tax base varies

1. State inheritance taxes

• Tax may be imposed on right of beneficiary to receive the property.
• Tax rate may vary depending on relationship of beneficiary and decedent.
• Payment of tax is usually the responsibility of the estate.

2. State estate tax

• Similar to the federal system

3. Credit estate tax

• Brings total state death tax liability up to the maximum federal death tax credit
• Sometimes referred to as a "sponge" tax

4. Factors to consider in planning for state death taxes

• Property held jointly rather than individually
• Beneficiary named in life insurance

VII. Preserving the client’s wealth

A. The advantages of lifetime gifts

1. Nontax advantages of lifetime gifts

• Provides support, education, and welfare for donee
• Sees donee enjoy gift
• Avoids publicity and costs associated with probate transfer at death
• Protects property from claims of donor’s creditors

2. Tax advantages of lifetime gifts

• Annual exclusion avoids tax on substantial sums and allows reduction of ultimate transfer tax base.
• Value of gift is at completed transfer date (avoids future appreciation in value).
• Any gift tax payable on gifts made more than 3 years prior to the donor’s death is removed from the donor’s estate tax base.
• Income produced by gifted property is shifted to donee for income tax purposes.
• No gift tax is imposed on transfers between spouses.

3. The opportunities created by the $10,000 annual gift tax exclusion

• Systematic use can cause the transfer of substantial wealth free of transfer tax.

4. Gifts to minors

• Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA)
  – Model laws facilitate transfer of funds to a custodial account for the benefit of a minor.
  – Custodian of account manages the property.
  – Restrictions apply to the type of investments permitted.
  – Provisions for distributions are provided.
  – Generally funds can be accumulated during donee’s minority, but custodial assets must be distributed to the beneficiary upon majority.

• Sec. 2503(b) trust

– The trust is created by a donor during his or her lifetime to receive annual exclusion gifts.
– Income must be distributed at least annually.
– Distribution of principal varies.

• Sec. 2503(c) trust

– Irrevocable trust that can accumulate current income prior to its termination
– Income and principal distributed to the minor at age 21

• Irrevocable trust with current withdrawal powers

– Used to qualify annual gift tax exclusion

B. Federal estate tax planning

1. Planning for the marital deduction

• Through its maximum use, a married couple can eliminate all federal estate taxes due at the first death (defers tax until second spouse dies).
• Transfers qualifying for the marital deduction

– Outright transfers of probate assets qualify (or by operation of law or contract). Example: Life insurance proceeds payable to a surviving spouse can qualify.
– Property transferred will not qualify if the interest is terminable at the death of the surviving spouse. (In other words, deduction will not be allowed if property transferred would not be includible in surviving spouse’s gross estate.)

• Estate trust

– A transfer to a surviving spouse through an estate trust (the surviving spouse’s estate is the remainderperson) qualifies for a marital deduction.
– Income from the estate trust can either accumulate or be paid out, at trustee’s discretion.

• Power-of-appointment trust

– Since the surviving spouse has a general power of appointment over the trust principal, the principal is included in his or her gross estate for federal estate tax purposes.

• QTIP marital-deduction trust
  – A qualifying terminable interest property (QTIP) trust gives surviving spouse the right to all income annually.
  – QTIP election provides that the property will be included in the surviving spouse’s gross estate.
  – QTIP permits transferor to provide for surviving spouse and for ultimate interests of children.

2. Planning for the unified credit

• Credit is applicable to transfers that create estate or gift taxes.

3. Coordination of the marital deduction and unified credit

• The idea is to maximize both (or to avoid loss of unified credit available at the second spouse’s death).
• Transfer property to both a marital and unified credit trust.
• The marital-deduction trust (A trust) receives assets in a manner qualifying for the marital deduction.
• The unified credit trust (B trust) is designed not to qualify for the marital deduction.

– B trust is funded with approximately $600,000.
– B trust is part of taxable estate (subject to use of unified credit).

4. Planning charitable contributions

• Advantages of gifts to charity

– Donor can reduce current income taxes and the eventual size of an estate.
– Gifted property is removed from transfer tax base of the donor.
– Charitable gift tax deduction is unlimited.

• Gifts of remainder interests to charity

– A trust for this purpose is known as a charitable remainder trust.
– Donor gifts property to charity, but retains the current income for a period of time, with the charity then holding the future right to the enjoyment of the property.
– The current tax deduction is measured by the present value of the remainder interest.

• Donating income interests to charity

– Client may establish a charitable lead trust.
– Charity receives income for period of time, and remainder interest is retained by the grantor (or designates).
– Current income on the trust is taxable to the grantor, but grantor gets deduction equal to the present value of the income interest.

VIII. The role of life insurance in the estate plan

A. Life insurance for estate enhancement

• Used for younger clients, those with dependent families, and those with small to moderate-sized estates
• Used to replace future income

B. Life insurance for estate liquidity purposes

• For larger estates the marital deduction and unified credit may be inadequate to shelter the estate—life insurance can be secured to provide death proceeds equal to the size of the wealth lost because of state and federal death taxes.
• Much of the accumulated wealth is not liquid—life insurance proceeds provide cash.

C. Life insurance trusts

1. Revocable trusts

• Revocable trusts are not really appropriate for estate tax planning purposes, but are ordinarily used when a specific protection need exists, such as life insurance benefits for the protection of young children.

2. Irrevocable life insurance trusts

• A good tool for estate liquidity needs

– These trusts can be designed to provide life insurance benefits for heirs outside of the gross estate.
– Contributions to the trust can be designed to avoid gift or generation-skipping taxes.

IX. Conclusion