Estate Planning


Well it finally happend — something that I never thought I would see.  No, my kids didn’t clean up their rooms without being asked – something even more remarkable. Congress has allowed our federal estate tax to expire. There have been an abundance of articles written on this issue in the last few weeks and I have been delaying this newsletter in hopes that I would be able to bring you some “hot off the press” discussion of new tax legislation. Congress is simply not cooperating with me.

So what is all the big talk on this estate tax repeal? Under the current law, anyone dying in 2010 is not subject to estate tax, no matter how large their estate. However, it is widely believed that Congress will enact legislation which will reintroduce the tax retroactive to January 1 of this year with an exemption yet to be determined but likely equal to the amount which was available in 2009 ($3,500,000). If Congress doesn’t act, then in 2011 the estate tax will return with a vengeance; the law will revert to what existed in 2001 with top rate of 55% and, more importantly, a reduction in the exemption to $1,000,000.What does this mean for you or your friends or clients? Today is a good day to die. However, I am not suggesting that as a prudent estate plan. My advice is that you all continue to pay attention to the headlines to see what action Congress may take. For most of you there should be no immediate need to modify your estate planning documents, but it is important to understand how the ground rules may change in this area of tax law. When we have some definitive action from Congress, I am sure I will have something more to say.

Any of you paying attention to this estate tax repeal saga will note that I haven’t mentioned “carryover basis” rules. When Congress gave us this 2010 estate tax repeal, it included a little surprise income tax increase by changing the way capital gains taxes are determined for heirs of a decedent’s estate. Imagine that. I will spare you all of the ugly details, but if you want to know more, a quick internet search will give you plenty of bedtime reading.

While I am on the subject of taxes, I do want to mention one other income tax change that might be of interest. As of January 1 all of you can convert your traditional IRA’s into a Roth IRA. Previously this conversion option was subject to annual income limitations, but those limitations have been eliminated. With a Roth IRA your assets grow tax-free and your distributions during retirement will be tax-free. A traditional IRA gets you the same tax-free growth but distributions are subject to tax. The trade off here is that the conversion to the Roth will generate an immediate income tax liability based on the value of the assets converted. So the choice is to pay tax now or pay later. If you believe that your tax rates will be higher in retirement then that weighs in favor of converting now. However there are many variables that impact this decision, including future changes in tax laws and whether you have other sources of liquidity to pay the current tax liability, so I encourage you to talk to your tax advisors about this planning option. Also keep in mind that Congress really wants you to convert in 2010 and the law includes special rules that will allow you to defer payment of your income tax over two years. This makes the conversion option a lot more attractive. Remember the show Let’s Make a Deal…I hope we all pick the correct door!

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Land and inherited by a group of misfits?  POA to the rescue!

Probably one of the worst things that can happen in a decedent’s estate is for a group of beneficiaries who don’t get along to inherit real estate.  Under North Carolina law, beneficiaries  under a Will are generally vested with title to the property as of the date of the decedent’s death, which means the beneficiaries, and not the executor, have the authority concerning sale of the property.   Although Wills often include a provision addressing the executor’s authority to sell real estate, the exact language of the Will is usually insufficient to allow the executor to handle the sale of real estate without involvement of the beneficiaries.  That is, if the real estate is not left to the executor with directions to sell the property as part of the estate administration, then the beneficiaries will inherit the property as tenants-in-common as of date of death.

This means that if the beneficiaries desire to sell the property they must all agree on the terms of the sale and they must all be involved in the execution of the documents.  Imagine the prospect of involving numerous owners in a sale negotiation and then getting them to agree.  Have you ever tried to pick a place to go out to eat based on input from a group of people?  Any interested buyer is going to lose patience pretty quickly unless the decision-making can be delegated.

A power of attorney (POA) is the solution.  The beneficiaries can appoint one individual (known as the attorney-in-fact) with full authority to negotiate the sale of the property and execute all documents including the deed.  This delegation eliminates any required involvement of the beneficiaries — the actual owners of the property.  The attorney-in-fact may be the Executor of the decedent’s estate or one of the beneficiaries or some other party; the key is to find someone who can make a good decision about a sale of the property and who is trusted by all the beneficiaries.

It is important to make sure that all of the beneficiaries as well as the beneficiaries’ spouses sign the POA; this is required under NC law to convey good title to the property.  Also the POA will need to be duly recorded in the county where the real estate is located.  The POA document should ensure that the attorney-in-fact is authorized not only to execute sale documents but also to receive proceeds of the sale on behalf of the beneficiaries.  This will ensure  that the attorney-in-fact can direct the closing attorney to dispose of the proceeds in the most efficient manner.

So what happens if the beneficiaries can’t agree on what to do and are unwilling to appoint an attorney-in-fact?  A mess…a big mess happens.  As tenants-in-common, each beneficiary will effectively have a veto right over any decision concerning the property.  More importantly, any one beneficiary can initiate legal proceedings to force a sale or a severance of the property, in which case the value of the property will likely be reduced for all concerned.  In this case, the POA may still be an option if cooler heads can prevail.

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How to carry out the decedent’s wish — 101.   I bet many of you have heard some variation of the following .

Aunt Lucy had no kids of her own but she had a bunch of nieces and nephews – seven of them in fact.  She loved them all but she was particularly close to her niece Mary who  helped out quite a bit during Aunt Lucy’s final years.  Aunt Lucy regularly talked about how she wanted Mary to inherit the old family farm.  When the time came, the family discovered that Aunt Lucy’s Will left all of her property and assets equally to her nieces and nephews and didn’t make any special provisions for Mary alone. Unfortunately Aunt Lucy’s statements didn’t change the Will.  This meant that after Aunt Lucy’s death the family farm was owned by all the nieces and nephews together.

So is there any way to fix this?  How can you carry out Aunt Lucy’s wishes when she failed to make the necessary provisions in her Will?  Some of you may wonder if a court proceeding would do the trick, but our courts are not in the business of changing provisions in a Will.  A court proceeding is appropriate if there is some ambiguity or conflict in the terms of the Will itself or if there is a question of the Will’s validity.  None of these applies for Aunt Lucy’s Will.

However there is a solution which is pretty simple, provided we have the agreement and cooperation of all the nieces and nephews.  As legal owners of the property, the nieces and nephews can execute a quitclaim deed in favor of Mary to transfer title to the property entirely to her.  This transaction does not require any court approval or any court procedure, other than recording the deed.   This is simply an independent action of the beneficiaries to fulfill the wishes of the Aunt Lucy notwithstanding the terms of the Will.

One caveat in this solution is that the valuation of the property is very important.  The transfer in this case is a gift from all the other nieces and nephews to Mary.  Under the tax law, each niece and each nephew can give Mary up to $13,000 worth of property in any given year; this is known as the annual gift tax exclusion.  As long as the value of the property divided among all of the nieces and nephews is below the $13,000 annual exclusion, there is no gift tax concern.  However, if the gift for each donor will exceed the annual exclusion, then you can always spread the gift out over several years with multiple deeds or you may also determine that a larger gift will not create tax issues for the donors.

OK that all works fine if everyone agrees, but what if you have that one nephew who doesn’t get along with Mary and won’t cooperate in the deed.  In this case you may be out of luck unless Mary and/or the other beneficiaries are willing to work out some type of “settlement” with the nephew.   Again the key is reaching some agreement between the beneficiaries.  As long as the beneficiaries can all agree and as long as the gift tax consequences can be addressed, then we really can fulfill Aunt Lucy’s wishes.  Of course all of this trouble can be avoided if we can just get people to update their Wills to reflect their wishes – get off the sofa Aunt Lucy!

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What’s the worst mistake you can make with beneficiary designations? Naming your estate?  Naming nobody?  Actually, the worst mistake you can make is naming minors as beneficiaries.  Believe me, people do this; I know from several bad experiences (fortunately not my clients).  Usually this mistake is just based on a lack of understanding how beneficiary designations work as compared to a Will.  People assume that a Will, with all its fancy legal words and formality, will control all of their assets.  Wrong.  The Will only controls property that is subject to probate, basically property that is in your individual name and does not have a beneficiary designation.  Life insurance, retirement assets, and pay-on-death accounts all have beneficiary designations and those designations that you filled out while you where sitting on the couch watching American Idol — that is what controls in the distribution of those assets.

Now you are wondering why is it a problem for these assets to go to my children if both my spouse and I are gone, that is what I want.  If you have named a minor as beneficiary directly, then the options for long term management of the assets are very limited.  North Carolina law typically requires that a guardianship be created to handle management of the funds until the child reaches age eighteen.  At age eighteen the child will receive complete access to the funds; eighteen with money to burn!  Also, the guardianship requires someone to qualify as guardian and regularly account to the court.  The guardian will have to be bonded which can be surprisingly expensive depending on the circumstances.  All of this creates extra trouble and expense which will only reduce the assets ultimately available for the child.  Although North Carolina law does also provide for a custodianship for minors, which is a less formal type of guardianship; I have found that the custodianship is only available in very limited cases.

One of the main benefits of having a Will when you have minor children is that you can avoid all of this trouble by allowing for a hold back trust.  In this case the crucial step in any estate plan is to ensure that you have beneficiary designations which are consistent with your Will.  Generally your initial beneficiary would be your spouse and, for minor children, your contingent beneficiary would be the holdback trust that is created under your Will or under a separate trust document.  If you want to add  a minor grandchild as beneficiary, the same rules apply; so if you don’t have a trust set up for the grandchild talk to your advisor about other options.  Obviously, there are other matters that play into beneficiary choices such as income tax planning or creditor protection, but I encourage you to check your current life insurance, retirement assets, and other pay-on-death accounts to confirm exactly what beneficiary designations you have.  Details are pretty important in this line of work.

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