Common Estate Planning Techniques

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<ul><li><p>8/14/2019 Common Estate Planning Techniques</p><p> 1/35</p><p>"PLANNING FOR THE FUTURE - ESTATE AND TAX PLANNING"By: Robert E. McKenzie</p><p>INTRODUCTION</p><p>1.05 Estate planning for many people connotes the way assets will be disposed of upon death. However, alarge part of estate planning consists of the disposition of assets during one's lifetime. There are numerousbenefits to making lifetime transfers rather than holding onto assets and transferring them upon death.Furthermore, there are several different methods and vehicles that may be used for making lifetime transfersdepending on the desired result. Some of these methods and vehicles include outright gifts of property,transfers of property into trusts, and transfers of property to and interests in family limited partnerships.</p><p>WHY YOU NEED A WILL OR LIVING TRUST1.10 A will or living trust is the foundation of any good estate plan. As a legal document, a will or livingtrust is the primary way to ensure that the property in your estate will be distributed according to your wishesafter your death. In addition, a will or living trust can help you accomplish the following:</p><p>provide financial security for your loved ones, allow for the special health or educational needs of a familymember, or make allowances for the varying income needs of your heirs;</p><p>appoint a guardian for children under age 18;</p><p>determine who will be in charge of carrying out your wishes by naming an executor or successor trustee;</p><p>minimize taxes and administrative costs; and</p></li><li><p>8/14/2019 Common Estate Planning Techniques</p><p> 2/35</p><p>support worthy charitable organizations.</p><p>What is Probate and How It May Be Avoided1.20 Probate is the process by which a person's estate is administered. The first step is for the court to</p><p>determine that the decedent's will is valid. This is often called "admitting the will to probate." Next, the courtappoints a personal representative to administer the estate. This is typically the person named as executor inthe will. Next, the court authorizes the personal representative to administer the estate. Estate administrationinvolves gathering the decedent's assets, discharging the debts and liabilities, and distributing the remainingassets according to the will or intestacy statutes. The court supervises the estate administration process anddischarges the personal representative from his or her responsibilities when the process is complete.</p><p>Living Trust Option1.30 For those who wish to avoid the time, expense, and public nature of probate, the living trust is often a</p><p>good supplement to a will. The living trust is a three-part document that handles the financial aspects of deathand possible incapacity without taking these matters through court. The first part of the living trust typicallyaddresses the distribution of your assets while you are of sound mind and body. Usually this involves namingyourself as trustee and granting yourself the right to distribute your assets as you see fit. The second part ofthe document often names a successor trustee to handle your financial affairs after your death, or if youbecome incapable of handling them yourself during your lifetime. The final part provides for the distributionof your assets. Like a will, the living trust is revocable, which means you can change it while you are livingand competent. To be effective, the trust must own all of your assets. Since some people don't remember totransfer all of their assets to the trust, it is advisable to also have a "pour-over" will, which transfers anyforgotten assets into the trust at your death.</p><p>If You Don't Have a Will or Living Trust1.40 If you die intestate (with no legal estate plan) your property will be distributed according to state law,without regard to your personal wishes or the specific needs of your family members. Although intestacy lawsvary from state to state, they frequently provide that your spouse and children receive equal amounts of yourestate. Without a will or living trust, these distributions will be made regardless of age, health, or financialneed and, of course, there can be no bequests to friends, more distant relatives, or charitable organizations.</p><p>Tax Planning Through Your Will or Living trust1.50 A carefully planned will or living trust can help you avoid or reduce taxes so that you can leave asmuch as possible to your heirs and/or charitable organizations. Should you want to take advantage of taxplanning opportunities, such as establishing a charitable remainder trust, you should consult your attorney orfinancial advisor to achieve the best results for yourself and your heirs.</p><p>OVERVIEW</p></li><li><p>8/14/2019 Common Estate Planning Techniques</p><p> 3/35</p><p>1.60 Why is estate planning necessary generally?</p><p>a. Unless you decide to whom you would like your assets to pass at your death, the State will make thedecision for you</p><p>i. State Probate Acts set forth a priority of distribution for individuals who die "intestate" (without a will ortrust);</p><p>ii. The statutory scheme may not be what you intend, or even what you would expect;</p><p>iii. It is not true, however, that if you die without a will your property automatically will pass to the State(unless you have absolutely no relatives living).</p><p>b. Unless you die with a will or trust in existence, the State will also decide who has the right to administeryour estate</p><p>i. The statute generally gives priority to relatives in the order of closeness (i.e., first your spouse, then yourchildren, etc.) -- The individual having priority, however, may not be the best person for the job (i.e., yourspouse or children might have absolutely no investment experience or may be "spendthrifts" who are unableto manage their own funds);</p><p>ii. If you establish a will or trust, you decide who should manage your estate -- you may decide to use anunrelated individual (such as your accountant or investment counselor) or even a bank, having moreexperience in these matters.</p><p>c. As a general rule, the costs associated with administering an intestate estate are greater than if you diewith a will or trust</p><p>i. The administrator of an intestate estate is required by law to post a bond with corporate surety in anamount equal to 1-1/2 times the value of your estate:</p></li><li><p>8/14/2019 Common Estate Planning Techniques</p><p> 4/35</p><p>(a) The surety bond premium charged is generally 1 to 2 percent of the amount of the bond (i.e., for a$500,000 estate, the required bond would be $750,000 (1-1/2 times), so the premium could be in excess of$10,000 annually);</p><p>(b) With a will or trust on the other hand, surety on the bond can be waived, thus decreasing the cost.</p><p>ii. Where a large number of statutory "heirs" are involved, the general administration of the estate and thetime expended by the estate's attorney tend to be greater, thus increasing cost.</p><p>d. Without a will or trust, there is absolutely no opportunity for planning for the minimization of Federal andstate estate tax (discussed below).</p><p>e. Moreover, in an intestate situation, there is no opportunity for planning for special circumstances, such asa minor or disabled child, or a "spendthrift" child who cannot properly manage funds.</p><p>i. With a will or trust, you can provide that a beneficiary's share is to be held in trust, with a trustee makingdecisions as to the beneficiary's need, and/or you can provide for the beneficiary's inheritance to be held intrust until a more mature age;</p><p>ii. In an intestate estate, all property would simply be distributed outright to your heirs, except in the case ofa minor, in which case a guardianship estate might need to be opened for the minor, or the minor's share mightneed to be held in a special bank account subject to further order of Court until the child reaches legal age.</p><p>f. Without a will, the Court will decide upon the appropriate guardian for any minor children.</p><p>1.65 ESTATE, GIFT AND GENERATION-SKIPPING TRANSFER TAX CHANGES</p><p>Phase-out and Repeal of Estate and Generation-Skipping Transfer Taxes; and Increase in Unified CreditEffective Exemption</p></li><li><p>8/14/2019 Common Estate Planning Techniques</p><p> 5/35</p><p>a. Beginning in 2002, the top marginal estate, gift and generation-skipping tax rate is reduced from 55% to50%. In addition, as of 2002, the unified credit effective exemption amount (for both estate and gift taxpurposes) is increased to $1,000,000. The "unified credit effective exemption amount" is the amount whichan individual may shelter from estate tax at his or her death (or from gift tax on lifetime gifts in excess of suchindividual's annual $10,000 gift tax exclusions). Presently, this exemption amount is $675,000. Beginning in2002, the 5% surtax (which phases out the benefit of both the graduated rates and the unified credit forestates in excess of $10,000,000) is repealed.</p><p>1. In 2003, the estate and gift tax marginal rates in excess of 49% are repealed. In 2004, the estate and gifttax rates in excess of 48% are repealed, and the unified credit effective exemption amount for estate tax andgeneration-skipping tax purposes increases to $1,500,000. The unified credit effective exemption amount forgift tax purposes remains at $1,000,000, as increased in 2002. In addition, in 2004 the family-owned businessdeduction under Section 2057 of the Code is repealed.</p><p>2. In 2005, the estate and gift tax marginal rates in excess of 47% are repealed. In 2006, the estate and gifttax marginal rates in excess of 46% are repealed, and the unified credit effective exemption amount for bothestate tax and generation-skipping tax purposes is increased to $2,000,000.3. In 2007, the estate and gift tax rates in excess of 45% are repealed. In 2009, the unified credit effectiveexemption amount for estate and generation-skipping tax purposes is increased to $3,500,000. In 2010, theestate and generation-skipping transfer taxes are repealed in their entirety.</p><p>4. It should be noted, however, that under the "sunset" provisions of the Act, unless further action is taken toextend the tax relief provided prior to 2011, the provisions of the Act will become ineffective as of December</p><p>31, 2010, reverting to a $1,000,000 exemption and a 55% top marginal estate tax rate for 2011.</p><p>b. Thus, from 2002 through 2010, the estate GST and gift tax rates and unified credit effective exemptionamount for estate tax and generation-skipping tax purposes are as shown below:</p><p>Calendar Estate and GST Highest estate, GST andYear transfer exemption gift tax rates</p><p>2002 $1 million 50%2003 $1 million 49%2004 $1.5 million 48%2005 $1.5 million 47%2006 $2 million 46%2007 $2 million 45%2008 $2 million 45%</p></li><li><p>8/14/2019 Common Estate Planning Techniques</p><p> 6/35</p><p>2009 $3.5 million 45%2010 N/A (taxes repealed) top individual rateapplies for gift tax only</p><p>c. Beginning in 2010, the top gift tax rate will be the top individual income tax rate, and, except as providedin Regulations, a transfer to a trust will be treated as a taxable gift, unless the trust is treated as wholly owned</p><p>by the donor or the donor's spouse under the grantor trust income tax rules. The gift tax exemption remains at$1,000,000, subject to adjustments for inflation.</p><p>d. Under the Act, from 2002 through 2004, the State death tax credit allowable under present law against theFederal estate tax is reduced as follows: in 2002, the State death tax credit is reduced by 25% (from presentlaw amounts); in 2003, the State death tax credit is reduced by 50% (from present law amounts); and in 2004,the State death tax credit is reduced by 75% (from present law amounts). In 2005, the State death tax credit isrepealed, after which there will be a deduction in arriving at the Federal taxable estate for death taxes (e.g.,any estate, inheritance, legacy or succession taxes) actually paid to any State or the District of Columbia, in</p><p>respect of property included in the gross estate of the decedent.</p><p>Basis of Property Acquired from a Decedent</p><p>e. After repeal of the estate and generation-skipping transfer taxes, the present-law rules providing for a fairmarket value (i.e., stepped-up) basis for property acquired from a decedent are repealed. After 2009, amodified carryover basis regime generally takes effect, which provides that recipients of property transferred</p><p>at a decedent's death will receive a basis equal to the lesser of the decedent's adjusted basis or the fair marketvalue of the property on the date of the decedent's death.</p><p>f. Several exceptions apply to the new carryover basis rules. First, a surviving spouse will be allowed astepped-up basis in up to $3,000,000 in assets received by the spouse. An additional $1,300,000 ofstepped-up basis will be allowed to other heirs (whether or not a surviving spouse) on assets passing to thoseindividuals. The basis of an asset cannot be adjusted above its fair market value. However, not all propertywill be eligible for an increase in basis. Property acquired by a decedent by gift from a non-spouse withinthree years of his or her death will be excluded (in order to prevent "gifts" of low basis assets in anticipationof stepped-up bequests). Property which constitutes "income in respect of a decedent" is excluded, as is stockin foreign investment companies and personal holding companies. Similarly, property subject to a power ofappointment is excluded.1. Surviving spouses and other heirs receiving stepped-up basis assets will be required to comply with fairlycomplex identification and reporting procedures to keep track of the stepped-up assets. Substantial penaltieswill be imposed for noncompliance.</p><p>2. The Act also extends the income tax exclusion for $250,000 of gain on the sale of a principal residence to a</p></li><li><p>8/14/2019 Common Estate Planning Techniques</p><p> 7/35</p><p>decedent's estate, revocable trust and heirs. If the decedent's estate, revocable trust or an heir sells thedecedent's principal residence, $250,000 of capital gain can be excluded on the sale of the residence;provided the decedent used the property as a principal residence for two or more years during the five-yearperiod prior to sale. In addition, if an heir occupies the property as a principal residence, the decedent's periodof ownership and occupancy of the property as a principal residence can be added to the heir's subsequentownership and occupancy in determining whether the property was owned and occupied for two years as aprincipal residence.</p><p>Modified Generation-Skipping Transfer Tax Rules</p><p>g. The Act increases the generation-skipping tax ("GST") exemption to parallel the estate tax exemptionincreases, and ultimately repeals the GST beginning in 2010. In addition to these changes, the Act makes thefollowing modifications to the GST provisions:</p><p>(1) Provides for a deemed allocation of the GST exemption to lifetime transfers to certain "generation-skipping transfer trusts" that are not direct skips;</p><p>(2) Allows for retroactive allocation of the GST exemption when there is an unnatural order of deaths;</p><p>(3) Authorizes a "qualified severance" at any time of trusts holding property having an inclusion ratio of</p><p>greater than zero. In order to be qualified, the severance must be on a f...</p></li></ul>