Check out this DailyFinance.com article about how animal lover Joan Rivers used a pet trust to take care of her dogs after her passing this month. In doing this, she made sure her four dogs (including rescues) will be cared for the way she would have wanted. Think a trust is too complicated for someone of modest means? Think again; almost all states now have straightforward laws about forming pet trusts, and you don’t have to be wealthy to benefit from one. A qualified attorney can advise you on these trusts and prepare one for you if appropriate. The Illinois State Bar Association provides some useful guidance for attorneys on pet trusts here.
Many blended families and families with adopted children face unfortunate (even shocking) consequences when a family member dies without an estate plan. This article discusses unique issues applicable to these families:
In the absence of a will or trust, a state’s intestacy laws control how someone’s property is divided upon his or her death. Different states have starkly different laws. In Illinois, for example, if one spouse dies without a will, the estate is divided 50/50 between a surviving spouse and the deceased’s descendants (755 ILCS 5/2-1). In Florida, in the same situation, if all descendants are descendants of both spouses, the spouse takes 100% of the estate, with nothing going to the children (Florida Statute Section 732.102). These are vastly different consequences for the same situation (50% to the descendants in Illinois; 0% in Florida), and every state’s law is different. Further, state law could change at any time, meaning you cannot count on these intestacy rules applying to you at the time of your death.
For these and other reasons, relying on state intestacy law is a bad plan for any family. Relying on state intestacy law is an especially bad plan for blended families or families with adopted children. During my estate planning time as an Air Force JAG, I assisted a lot of these families. With the young family population in the military and the frequency of moves, it was very common to see a family where a husband and wife were raising children from each other’s prior marriages. Often, the parents in the blended family would either formally adopt their stepchildren or treat them as their own. These blended family arrangements could create very difficult situations if state intestacy law comes into play.
The Illinois Supreme Court recently heard a case where a stepfather raised his stepson from a very early age. The stepfather treated the child as his son, called himself his “father”, provided for his son throughout his childhood, and told his son he had been legally adopted. Under Illinois law, an adopted child in this situation has the same intestate succession rights as a natural born child. However, after the father died, no records could be found to show a legal adoption had actually occurred. This left the child in an awful predicament, apparently unable to assert his rights as an heir under Illinois law. Ultimately, the Illinois Supreme Court decided to recognize the family’s arrangement as an “Equitable Adoption”, granting the child the rights of a legally adopted child. But not all states agree with this interpretation of the law. And if your family has to go to court and hire lawyers to argue for years over who in your family is really your child, does anyone win?
Much attention has been devoted to the Federal Estate Tax (a/k/a “Death Tax”) over the past 15 years. After much uncertainty, a December 2012 political compromise made permanent the current version of the tax. This brief post does not delve into the complexities of the estate tax, but deals with two common questions:
1) Am I likely to have to pay the federal estate tax?
2) If I don’t have to worry about the federal estate tax, are there still other death-related tax rules that might apply to me?
1) Am I likely to have to pay the federal estate tax?
In 2014, individuals with estates up to $5.34 million are not subject to the federal estate tax. This exemption amount is indexed to inflation, so it should go up over time. For married couples, if the first spouse to die does not use the $5.34 million exemption, the second spouse can combine it with his/her exemption for a total of a $10.68 million exemption for the couple. However, a couple must follow applicable formalities, such as filing an estate tax return after the first spouse’s death.
Additionally, transfers from one spouse to the other are also generally exempt from estate taxation, regardless of their amount. For example, a wife could give $600 million at death (or during her lifetime) to her husband without federal estate tax consequences. There are exceptions to these rules, perhaps the most prominent being property passed to a spouse who is not a United States citizen.
If your net worth is even close to the estate tax exemption amounts, or you have special circumstances (like a non-citizen spouse, prior gifts of large value, etc.), it is imperative that you discuss possible estate tax-avoidance strategies (such as lifetime gift-giving or QDOTs, respectively) with an estate planning attorney.
2) If I don’t have to worry about the federal estate tax, are there other death-related tax rules that might apply to me? Answer: Yes.
If you only remember one point from this blog post, remember this: Estate tax (the tax on transfer of your wealth at death) is only one form of taxation that impacts estate planning. Although the vast majority of Americans pay no federal estate tax, most Americans do pay federal income tax (which includes investment gains). In my last blog post, I discussed an enormous income tax loophole, known as the automatic step-up in basis at death. Taking advantage of that income tax benefit alone can easily save a family hundreds of thousands of dollars in income tax, even if they have nowhere near the net worth to worry about the estate tax.
Also, be aware that many states have estate tax exemption amounts that vary from the federal rates. For example, the 2014 Illinois estate tax exemption is $4 million for an individual, where the federal exemption is $5.34 million. So, for example, a Naperville resident who dies with $5 million in property would owe Illinois taxes (on $1 million that is above the $4 million exemption) but no federal taxes (because the value of the estate is below the $5.34 million federal exemption). Every state’s rules are different.
In conclusion, tax planning is a crucial component of a solid estate plan. An estate planning attorney can help tailor an estate plan to your family’s needs, incorporating the latest information about federal and state tax laws.
Even if you are not a close follower of estate planning issues, it is worth learning the basics of the most famous tax loophole in the Internal Revenue Code, known as the automatic step-up in basis at death.
After you learn the basics of the rule, remember this: Before deciding to sell any stocks, bonds, real estate, or other investment property, always consider the consequences the sale could have on your family’s ability to use this loophole. You don’t need to know all the ins and outs of the rule; simply seeking legal advice if you identify a potential “step-up” issue could save your family tens or hundreds of thousands of dollars.
Paula, a widow, has one adult daughter.
In 2011, Paula bought 2,000 shares of Apple stock for $100,000.
Today, Paula’s 2,000 shares of Apple stock are worth $200,000.
Paula has lived a long and happy life, but she has a serious medical condition and her doctors say she now has less than a year left to live. She wants to give $200,000 from the Apple stock to her daughter. Our goal is to get as much of that money to her daughter as possible.
Let’s look at the tax implications of two options:
1) Paula sells the stock now and gives the proceeds to her daughter, or
2) Paula holds on to the stock and passes it to her daughter at death.
Option 1 (Pay Lots of Taxes):
If Paula sells her stock today, the federal government will tax her on the gain (or appreciation) in her Apple stock. Calculating this gain is a simple subtraction problem. Take the value of the stock on the date of the sale ($200,000), and subtract the “basis”, which is the value of the stock on the day it was purchased ($100,000). $200,000 sale price minus $100,000 basis equals a $100,000 gain.
For simplicity, let’s say in Paula’s tax bracket, she owes 15% federal capital gains tax on that $100,000 gain. 15% of $100,000 is $15,000 in federal tax. If her state tax rate is 5%, she will owe an additional $5,000 in taxes on the sale, for a total of $20,000 in taxes.
Option 2 (Take Advantage of the “Step-Up” Loophole)
Let’s say instead of selling the Apple stock during her life, Paula keeps the stock until her death. She then passes it on to her daughter through a will, living trust, or by naming her as a death beneficiary on her investment account. For simplicity, let’s say the stock is worth $200,000 on the date of Paula’s death. Paula’s daughter takes possession of the stock, and then decides to sell it right away.
The stock is worth $200,000 today but was purchased for $100,000, so using the subtraction problem from above, Paula’s daughter will still owe taxes on $100,000 in gain…right? Wrong!
Under the Internal Revenue Code Section 1014(a), when someone receives property upon another’s death, the “basis” value of the property is calculated at the date of death, not the day the investment was purchased. So, the IRS forgets about the fact that the property was actually purchased by Paula for $100,000, and the new basis is “stepped up” to $200,000.
The subtraction problem becomes $200,000 sale price minus $200,000 “stepped-up basis”, which equals zero taxable gain. 15% federal tax on $0 is $0. 5% state tax on $0 is $0. Paula’s daughter takes the property and owes no income tax.
Option 2 saves Paula’s family $20,000 in tax, money that could have been lost had she not know about the “step up” loophole!
One of the fundamental principles of tax is that income (gain) is subject to taxation. The Section 1014 “step up” is a huge exception to these rules. But it is easy to miss out on the benefit if you aren’t paying attention. Remember, this is just a brief overview and is not individual legal advice, so make sure to consult an estate planning professional if you have property that might qualify for this loophole.
The Importance a Well-Drafted Estate Plan
The benefits of a complete estate plan (and the consequences of failing to make one) are immeasurable. For parents of minor children, a properly-drafted will ensures your children will be cared for by people you know and trust in the event of your death, not someone chosen by a judge you’ve never met. This reason alone makes life without an estate plan unacceptable for most families with small children, mine included.
Aside from wills, other useful estate planning tools can be tailored to your needs. If appropriate for you, a living trust can ensure your property is not tied up in probate after your death. Failure to plan ahead will often leave your loved ones unable to quickly distribute property, instead forcing them to spend a year and considerable sums of money muddling through the court system, unable to move on after a death in the family. A living trust and other documents can help avoid all of this. There are numerous other well-documented benefits to a solid estate plan.
Competent legal advice for your estate plan is of enormous value. The law governing wills draws back on centuries of English legal tradition before the existence of the United States. Many of the rules about witnessing, signatures, and other formalities are both archaic and draconian. However, failure to comply with these formalities often invalidates an entire will–an experienced estate planning attorney can help you avoid errors that could cost your family tens or hundreds of thousands of dollars in the future. The following are some practical considerations about hiring an attorney:
Barriers to Hiring at Attorney
I hear people of all ages and walks of life saying, “I have been meaning to get a will/trust. I just haven’t gotten around to it yet.” Inertia can certainly be a factor. And hiring an attorney to help with
your estate planning can be daunting, particularly if you have never worked with an attorney before, or don’t know anyone who could offer a reference.
I can understand the hesitation to seek out an attorney. In over six years as a JAG in the Air Force, I formed an attorney-client relationship with well over 500 clients in matters ranging from simply updating a power of attorney, to helping terminally ill retirees with their wills, and even to serious criminal cases during my time as an Area Defense Counsel. Most of my clients were seeing an attorney for the first time in their life. Some of them told me they felt embarrassed to seek help at first or didn’t know what to expect from an attorney. But after working together, I believe many of my clients felt much more at ease about their legal issues and confident in their knowledge of the process. I feel it is crucial to find someone that makes you feel comfortable, and who empowers you to take charge of your legal affairs.
Practical Tips for Finding an Attorney that Works for You
When looking for an estate planning attorney, make sure to research your options. If you know and feel comfortable with an attorney in your local area, call and ask for recommendations. Even if estate planning is not the attorney’s specialty, he or she may be happy to point you in the right direction. If you know people who have hired attorneys, ask about their experiences.
If you don’t know any attorneys or former clients, compare the websites of some of the estate planning attorneys in your area. Do they specialize in one or two areas of law, or are they general practitioners with many specialties? Have they practiced in other areas before?
Feel free to interview several attorneys before hiring one. Ask up front if they will do a free consultation. Pay close attention to the “bedside manner” of each attorney. Do you comfortable asking for clarification when you don’t understand something, or do you seem to be under pressure to get out of the office quickly? When you call the receptionist, are you treated respectfully? Are your calls returned?
When you interview attorneys, make sure to ask them about their philosophy. Why do they practice law? In my time as a JAG, I developed my own philosophy: It is better to spend most of my time carefully listening to my clients’ concerns, and only then offering advice, than to prescribe one-size-fits-all solutions. I find that doing this gives the client more confidence in the process, and ultimately yields a solution better suited to their needs. There are other successful philosophies out there, but the important thing is that you find an attorney whose philosophy fits your needs.
This blog is intended for a wide audience, from parents of young children researching the basics of wills and living trusts, to fellow attorneys and financial professionals wishing to discuss the latest developments in trust-related case law. As indicated in the title, my goal is to advocate for a more client-focused, personalized and less fill-in-the-blank estate planning experience. I feel the best way to achieve this is to invite a broad spectrum of people to read and to comment.
To facilitate navigation of the blog, I will tag each post either Basic, Intermediate, or Advanced Estate Planning. You can navigate to posts in the applicable category by clicking the tags on the right side of the screen.
Although I am licensed to practice in Illinois, and may sometimes reference my state’s law, I welcome comments from practitioners in other states. The intent is to keep the content broad enough that it is relevant to people across the country.