Estate Planning – Christopher C. Jones

The New Death Tax.

Here we are in a new tax structure for estates. All the old estate funding formulas are no longer relevant because Congress actually let the estate tax repeal take effect for this year. For the first time since 1915, the United States has no federal estate tax! But the change does not mean that there are no tax concerns under the present structure. We now have to be even more concerned with capital gains taxes. Next year we are scheduled to go back to the estate tax law as it existed in 2000, namely smaller exemptions and higher estate taxes.

While estate taxes are briefly off the table, we have other kinds of taxes to be concerned with in these changing rules. Perhaps the biggest change is with the repeal of unlimited adjustments in “basis” which directly affects the amount of capital gains taxes to be paid by estates. The income tax basis of assets acquired from a decedent will not be adjusted upward to equal their values as of the decedent’s date of death. Rather, the basis of these assets will “carry over” the same value as was held by the decedent. This means that either the estates, or the beneficiaries who receive appreciated estate assets, will have a tax liability upon the sale of those assets.

In other words, the estate and beneficiaries are faced with the same capital gains tax problems as the decedent. If property increased in value from when it was originally acquired until it was sold, the owner has to pay capital gains taxes on the difference in the increased value.

Formerly, the gain, or increased value, prior to the decedent’s death was added to the original cost basis so that capital gains taxes were eliminated. Only gains on value from after the date of death to the time of sale were subject to capital gains taxation. There was no cap on the amount of gain that could be added to the original cost basis from the date of original acquisition to the date of death. For 2010, that rule is repealed.

Now, the decedent’s executor may allocate up to $1,300,000 to increase the basis of property. For example, a decedent’s child inherits land worth $3 million in which the decedent’s basis at death was $1 million. The executor may elect to increase the basis of the and to $2,300,000. The child would only hav to pay capital gains taxes on the $700,000 gain, or the difference between what the land is worth and the adjusted basis.

In addition to the $1,300,000 increase in basis, if the decedent was married, the decedent’s executor can allocate up to $3,000,000 to increase the basis of assets that the surviving spouse receives, either outright or through certain trusts for the benefit of the spouse.

These rules are set to change again on January 1, 2011. Unless Congress enacts new legislation, the estate tax exemption will be only $1 million, and the estate tax will increase to 55%! Keep an eye on developments as the tax component of estate planning has become more important than ever. Now may be a good time to have your estate planning documents reviewed by your attorney.

By Christopher C. Jones © May 2010

Gifts to Care Custodians: Traps for the Unwary.

What does care custodian mean to you? A friend or acquaintance that visits, runs errands, pays bills, cooks, cleans, administers medications, and takes care of other pressing needs?

Probate Code Section 21350 provides that gifts to “care custodians” are invalid. This provision of the code was drafted and adopted in the early 1980′s as part of EDAPCA (Elder and Dependent Adult Civil Protection Act) when it became clear to lawmakers and lawyers alike that nurses, housekeepers and care givers were taking advantage of the impaired and the elderly. These laws were codified as Probate Code Section 21350 in 1997.

So, who is a care custodian?

A care custodian for purposes of Probate Code 21350 is the same as the definition in Welfare and Institutions Code Section 15610.17. Welfare and Institutions Code Section 15610.17 provides a list of twenty-five different individuals who qualify as care givers. Included in that list is a catch- all provision that includes ANY person providing health care or social services to elders or dependent adults.

There are many cases that deal with this subject. The first is Estate of Shinkle. Ms. Shinkle left a gift to the long term care ombudsman of the facility in which she resided. The long term care ombudsman changed jobs just prior to the execution of the trust and therefore, he argued that he (and by way of he, he meant the facility) was not a care giver to Ms. Shinkle because he was no longer in that position when the trust instrument was signed. The court disagreed and held that the ombudsman was a fiduciary when he came in contact with Ms. Shinkle, learned of the information, and gained access to the financial information. Therefore, the gift was held to be invalid.

The next case to address this was Conservatorship of Davidson. In Davidson, Mrs. Davidson and her friend started their relationship as just friends. They frequented each other’s birthday and other celebrations. However, as Mrs. Davidson became more and more feeble, her friend began to cook, shop, and drive for her. She executed a power of attorney in favor of the beneficiary who received Mrs. Davidson’s mail, paid her bills and took care of her banking. Here, the court held that when an individual becomes a care custodian as a result of a pre-existing genuinely personal relationship rather than any professional or occupational connection with the provision of health or social services, that individual should not be barred by Section 21350 unless there is evidence of undue influence, fraud, or duress.

Then there is the case of Mrs. McDowell. In this case, Mrs. McDowell broke her hip and was hospitalized. She was an elderly retiree and had become friends with her beneficiaries who would bring her coffee and sometimes food. When she was hospitalized, her beneficiaries did not visit her there, but they visited often and brought her meals after she was released from the hospital. They billed her for the meals they provided. They eventually started “taking care of Ms. McDowell’s personal needs, i.e. bathing, hygiene, etc.” resulting in the court deciding that they were care custodians under the Code. The court of appeal reversed the decision and sent the case back to the trial court to uphold the gift.

The last case that we have is Bernard. In Bernard v. Foley, the court, in a footnote, reasoned that the most important part of the statute was to protect the person being cared for, protect them from undue influence, and ensure that there is no wrong-doing. Therefore, the Court indicated that the built in safe guards and procedures in the Code allowed for a person to give a gift to anyone they wanted, by following certain steps. Because of the procedural safeguards within the Code, a strict reading thereof is now followed.

When considering, devising, and discussing an estate plan with your lawyer, client or advisor, it is essential that if you are making a gift to a non relative that you disclose all facts and circumstances regarding the gift. Thus, if you are giving a gift to anyone who is now or may become a care custodian in the future, the proper precautions can be taken. Additionally, it is essential to recognize the duties that result in the definition of a care giver so that inappropriate gifts can be spotted. While Probate Code Section 21350 may seem to be rigid, and at some times, unjust, the price to protect the elderly is never too great.

By Christopher C. Jones © September 2009

Qualified Personal Residence Trusts.

We are fortunate to live in an area where strong demands for real estate have pushed the prices to unimagined levels.  For many of us, home ownership has increased our net worth beyond the exemption amount from federal estate taxes.  Since one the goals of estate planning is to minimize the costs associated with transferring assets to your beneficiaries, it pays to make transfers in a way that minimize, if not eliminate, transfer taxes such as gift and estate taxes.  Personal residence trusts are a valuable tool in achieving that goal by leveraging the value of gifts.

How They Work: The owner of a personal residence creates an irrevocable trust and transfers the residence into the trust.  The terms of the trust allow the owner to retain the right to use and enjoy the residence for a fixed period of years.  At the conclusion of the term, the residence is transferred to others.

Because the residence is transferred into trust while the owner retains an interest in the transferred property, a transfer tax is not imposed on the full value of the gifted property.  The owner’s right to the use and possession of the residence for a specified term is a retained interest that is separately valued.  Using traditional valuation principles, along with published Internal Revenue Service rates, the value of the retained interest is subtracted from the fair market value of the residential property, resulting in a gift tax on only the value of the remainder interest.  This remainder interest is typically less than half the value of the transferred property.

For example, the value of the remainder after a ten year personal residence trust for a 60 year old when the IRS rate is 6.8% is approximately 42% of the property.  Although the residence may have a fair market value of $1,000,000.00, the gift tax is only applied to 42% of the fair market value of the property, or $420,000.00.  The rest of the fair market value is allocated to the retained interest for which there is no tax.

Advantages: A properly structured personal residence trust includes:

• The Grantor leverages his credit against estate taxes.  He transfers the full value of the residence, valued at the date of transfer, but only bears a gift tax cost equal to the present value of the remainder interest.
• The Grantor keeps control over the residence during the term of the retained interest, and has the use and enjoyment of the residence during such time.
• The trust may be written to permit the Grantor the right to lease the residence from the remainder beneficiaries after the expiration of the designated term.  If these beneficiaries are the Grantor’s children, the fair market rent payments are not considered gifts which further reduces the Grantor’s taxable estate.
• Once the residence is transferred to trust, all appreciation will not be taxed to the Grantor (as long as the Grantor outlives the terms of the trust).

A successful personal residence trust combines the advantages of a discounted gift for transfer tax purposes, with the removal of post-transfer appreciation from the Grantor’s estate.  The use of this type of trust allows a taxpayer to reduce the size of their taxable estate without spending investment assets or liquid assets that may be needed to support their retirement years.  Since our residence is a large portion of our taxable estate, this type of trust can be a useful way to transfer value without having to pay taxes for much of the value.

By Christopher C. Jones © Sep 2008

Intentionally Defective Grantor Trusts.

For most people, estate planning includes transferring assets to their children or grandchildren without paying any taxes.  The problem is that these transfers are typically subject to federal taxes.  The transfers are either treated as gifts for which gift taxes are owed, or sales for which capital gains taxes are owed.  But there is a solution to this dilemma.  Because of discrepancies in the Internal Revenue Code, it is possible to transfer the appreciation of assets to other generations without having to pay either tax.  This technique is through the use of what is known as Intentionally Defective Grantor Trusts.

How it Works: A person creates a trust for the benefit of their children or grandchildren but retains specific limited administrative powers, such as the power to substitute the trust assets with other property of equivalent value.  The Grantor “sells” assets at fair market value to the trust in exchange for a long-term installment note.

Because of provisions in the Internal Revenue Code, the Grantor is treated as the trust owner for income tax purposes, but not for estate tax purposes.  This allows the sale of the assets to the trust to avoid capital gains taxes and the note interest received by the Grantor to avoid being subjected to income taxes.  If the Grantor dies before the note is paid off, only the unpaid balance due on the note is included in the Grantor’s estate.

The only gift tax element is the requirement that the trust be capitalized with sufficient funds, usually ten percent of the value of the installment note, so that there is a debt equity ratio of not more than 10:1.  This prevents the trust assets from being included in the Grantor’s estate.

Income-Generating Trusts: As the Grantor pays income tax on the trust income, his or her own taxable estate is reduced by the amount of the tax paid.  The trust’s income accumulates and compounds over time.  Over a period of years, this is a dramatic benefit that will increase the value of the trust assets before they are distributed.

The taxpayer can allow funds to pass for the benefit of the trust beneficiaries free of gift tax by paying the income tax on the trust income.  All payments of taxes by the Grantor are, in essence, tax-free gifts to the beneficiaries.

Sale of Assets to Defective Grantor Trusts: Transactions between the trust and the Grantor are disregarded for income tax purposes.  When a person sells an asset to him or herself, the sale does not create any income tax consequences.  For example, the Grantor can sell appreciated real estate, or an operating business, to the trust.  The growth in value passes to the beneficiaries.  The sale of the assets to the trust by the Grantor in exchange for an installment note is a non-taxable event for the Grantor for income tax purposes.  Moreover, the payment of interest by the trust to the Grantor is a non-taxable event for income tax purposes.  It results in neither income to the Grantor nor any deduction by the trust.  The Grantor only pays income tax on the income generated by the trust property.  Since the Grantor, and not the trust, pays the income tax, the value of the trust assets is not reduced.  The trust is thus allowed to grow as a result of retaining the income as a result of the income tax savings and such growth is for the benefit of the trust beneficiaries, not the Grantor.

For Grantors with a taxable estate, this technique is very appealing in that it does not require the use of the Grantor’s estate and gift tax exemptions, nor does it require that the Grantor have to pay capital gains taxes.  With a goal of putting as many assets into the hands of beneficiaries as possible, this is a very useful tool in preserving the estate and even increasing the amount received by the beneficiaries.

By Christopher C. Jones © Sep 2008