Estate Planning

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The fall is upon us: is your new or soon-to-be adult (child) going off to college?  Besides taking with him or her the extra long sheets and a new credit card, should your child be leaving you with something too: the right to control his or her finances and medical decisions?

When a child reaches the long-awaited age of 18, everything changes and nothing changes at the same time.  Suddenly, your child is a legal adult, yet the child still depends on you for financial and emotional support.  Legally, the rules have changed.  The former legal minor is an adult, who is expected to make financial and medical decisions on his or her own behalf and you, as the parent for the last 18 years, can no longer make those decisions for him or her.

In fact, you are now not even legally required, or allowed, to be notified if your child is in the hospital emergency room, without the child’s consent.  You cannot generally make medical decisions for your child even if your child is not able to make those decisions for himself or herself, without the child’s consent.  And, what if the child suddenly becomes incapacitated and cannot give consent for you to assist in making those decisions?  You still cannot make decisions for your child without a legal document giving you this permission (even if you will ultimately pick up the bill).  Your child needs a health care directive, which authorizes parents to obtain medical information and make medical decisions for the child if the child is unable to make such decisions for himself or herself.

What about his or her finances?  The same is true.  Now the child has the right to sign a contract, such as for a credit card, but you have no right to file for disability benefits on his or her behalf in case of an accident, to file a legal complaint or complete more mundane tasks, such as renew a car registration on his or her behalf.

While in some states the closest living relatives—parents if the child is unmarried—will be allowed to make medical and financial decisions on behalf of a child over 18 without official papers, this is not guaranteed and instead the parents may have to seek guardianship in court.  A health care directive and/or a power of attorney grants and delineates the parent’s authority to act on behalf of the adult child, and obviates the need to resort to extreme measures, such as guardianship proceedings.

The health care designation should also include a living will.  A living will outlines an individual’s advance care directive about life-sustaining medical treatment, and can also cover organ donations.  Since parents and children may disagree on this topic, and parents understandably struggle to make the decision in such a dire situation, it should be discussed in advance and memorialized in a living will.  The health care directive will also include a Health Insurance Portability and Accountability Act (HIPAA) release allowing disclosure of sensitive medical information to parents in the event of a medical emergency.

Both the power of attorney and the health care directive can be tailored to each family’s particular situation.  For example, parents can be granted access to private medical records while the child is competent as well as in an emergency, or full financial power at all times (in a “durable” power of attorney) or only in the event of the child’s incapacity, or, while the child is competent, only over certain types and sizes of accounts and contracts.

This fall, as your children leave for college and become adults, power of attorney and health care directive/ living will documents should be on their college packing lists, ensuring their well-being and your peace of mind.

 

 

The IRS has at last issued long-anticipated proposed regulations under Code §2704.  We perceive the proposed regulations as an attempt by the IRS to curtail the use of discounts – such as minority interest and lack of marketability discounts – in valuing transfers of interests in family-controlled entities for gift and estate tax purposes.

“Family limited partnerships” – that is, family investment entities usually structured as LLCs or limited partnerships – have been a popular estate planning technique for years.  Generally speaking, a client can transfer non-voting, non-marketable interests in these types of entities to children or a trust, and claim a valuation discount due to the restrictions that apply to the interest transferred.

Code §2704 provides that certain “applicable restrictions” on ownership interests in family entities, ie, entities where the transferor and family members control the entity, should be disregarded for valuation purposes.  The statute also permits the IRS to issue regulations providing for other restrictions (as determined by the IRS) to be disregarded in determining the value of a transfer to a family member, if a restriction has the effect of reducing the value of the transferred interest but does not ultimately reduce the value of such interest to the transferee.

The proposed regulations make two overarching changes.  First, changes under Code §2704(a) create new rules relating to a lapse of a liquidating right.  These changes are less relevant, at least in our practice, as we generally do not structure entities to include liquidation or other rights that lapse.

Second, changes under Code §2704(b) create a new concept of “Disregarded Restrictions.”  Under the proposed regulations, a restriction that will lapse at any time after the transfer, or a restriction that may be removed or overridden by the transferor (or the transferor and family members acting together) will be disregarded for gift and estate tax valuation purposes.  This is the case even if the restriction on the interest is pursuant to state law rather than a governing business agreement.  There are certain exceptions – for example, an owner’s right to liquidate or “put” his or her interest to the entity and receive cash within six months is not considered a “disregarded restriction.”

The effect of this rule appears to be that it would eliminate minority interest discounts, because the holder of any interest would be deemed to be able to liquidate his or her interest in the entity without restrictions.  The effect of the proposed regulations on lack of marketability discounts is unclear, although it seems the IRS similarly could argue for a small or zero lack of marketability discount on the theory that the holder of the interest is deemed to be able to liquidate the interest.

Thus, if the proposed regulations are adopted in their current form, they likely will increase the value for gift and estate tax purposes of transfers of interests in family-controlled entities.

The proposed regulations are controversial.  Commentators already have questioned whether the Treasury has exceeded its statutory authority in issuing the proposed regulations.  The proposed regulations are (at least in this author’s opinion) complicated and ambiguous, and perhaps unfair.  For example, if a client creates an LLC to purchase and manage a commercial property, and the client transfers an interest in the LLC to his or her child, and the interest is subject to typical restrictions on sale of the interest or the ability of a member to liquidate (largely because the asset owned by the LLC is illiquid and perhaps leveraged), then it seems that the true value of the interest transferred to the child would be reduced due to these restrictions (think about what a willing buyer would really pay the child for the LLC interest); however, under the proposed regulations, the value of the LLC interest transferred would be artificially inflated for gift tax purposes.

The proposed regulations are not effective until they are finalized.  Treasury has requested written comments by November 2, 2016 and a public hearing on the regulations is scheduled for December 1, 2016.

Prince was not the first famous person to die without a Will.  Others who died intestate include:  Abraham Lincoln, Ulysses S. Grant, Howard Hughes, Martin Luther King, Jr., Sonny Bono and Pablo Picasso.  Dying intestate is usually a huge financial mistake.

In Prince’s case, as in similar cases of intestacy, dying without a Will causes several problems.  First, there is confusion among the family as no one knows what his true wishes were.  Confusion often leads to litigation.  Second, the costs are often greater because the steps to administer the estate are more involved.  For example, an administrator usually needs to pay for and post a bond (based on the value of the estate), whereas an executor named under a Will generally does not.  Third, Prince’s assets will pass under the rules of “intestacy” (in this case the law of Minnesota), which often is not the distribution (to family or charity) that the decedent would have wanted.  This can be especially problematic for single people or those in second marriage situations.  Fourth, if minor children are involved, a court proceeding will be necessary to name guardians for them.  And, without a Will, the decedent makes no provision for taxes and expenses, which can result in large tax liabilities or other unintended consequences.

All of these outcomes are easily avoidable.  In Prince’s case, the estate appears to consist largely of real estate and intellectual property rights (ie, his catalog of published and unpublished music).  From the tax planner’s perspective, this means it is largely illiquid, which is problematic.  The federal estate tax, imposed at a rate of 40%, is due nine months from the date of death.  Although it may take months to determine whether Prince actually had an estate plan, at the moment it appears the artist took few, if any, steps to plan for liquidity to pay taxes or to reduce his estate tax exposure.

Outdated Wills also present problems.  Fiduciary choices (executor, guardian, trustee) often change over time.  In addition, our choices as to who should inherit our property also may change over time.  We all know a story about someone who unexpectedly (or undeservedly) inherited under a Will, or someone who was unintentionally left out.

In a notable case in our office, we represented the estate of a deceased estate planning attorney who did not update his own Will for over 40 years.  The document led to significant litigation due to outdated tax planning and unanticipated tax allocations, among other problems.

Most of us, therefore, should have up-to-date Wills.  The Will governs the disposition of your assets and ensures that these assets pass to your family and loved ones in the manner you desire.  A Will usually includes tax planning, that is, setting up a structure that minimizes federal and state estate taxes.  You appoint an executor, the person who is responsible for carrying out your wishes.  You may also appoint guardians for minor children, and trustees for any trusts created under the Will.

Basic estate planning documents also include a power of attorney and health care directive – documents to plan for incapacity by naming an agent to make decisions on your behalf if you are unable.  Estate planning documents should be reviewed by an attorney every three to five years or following a significant life event.

Proper estate planning is a gift to your family.  It accomplishes your objectives, avoids confusion, saves money, minimizes taxes, and gives you the peace of mind of knowing that your affairs are in order.

It is difficult enough for families to come to grips with having to care for an elderly parent that may no longer be able to live on their own.  After coming to terms with this unfortunate reality, the next steps often involve moving that parent into their home, an assisted living facility or a nursing home nearby.  With all of this turmoil, it should be no surprise that most people would not consider whether such a move may create a significant estate tax liability should that parent die, even if it is shortly after such a move.  Your parent could live their entire post-retirement life in a state such as Florida where there is no estate tax and when they are no longer able to live on their own, you bring them to your home state.  If you pack your parent up, sell his or her home and get them established in new living quarters in New Jersey, should they die even a few months later, their entire estate could be subject to an expensive New Jersey estate tax.  How could this be?  Because New Jersey will take the position that your parent had either voluntarily changed his or her domicile, or if incompetent to do so, he or she has taken the domicile of their guardian.  What does this mean?

A change of domicile occurs when there is both a physical presence in the new locality (with an intention to permanently relocate) and an intention to abandon the old domicile.  In other words, once you permanently move to a new home and abandon your old home, you avail yourself to your new home’s tax laws. What about the adult who lacks (or who may soon lack) the capacity to change his / her domicile voluntarily and by his or her own act?   In New Jersey, domicile may be acquired in one of three ways: (1) through birth or place of origin; (2) through choice by a person capable of choosing a domicile; and (3) through operation of law in the case of a person who lacks capacity to acquire a new domicile by choice.  Importantly, even after an adjudication of mental incompetence, a person may nevertheless possess sufficient mental capacity to elect a new domicile, and it is generally recognized that his or her actual capacity to do so is a question of fact.  However, once incompetency has been shown, there is a presumption that the incompetent lacks the mental capacity to make such a choice and the burden of showing that he or she in fact possessed the necessary mentality shifts to the party claiming that his domicile had been changed.  How does the NJ Division of Taxation view it?

The 1969 Appellate Division case Estate of Gillmore is the authority for the above and very much remains good law today.  In Gillmore, the executors of the decedent’s estate appealed from an assessment of the New Jersey Inheritance Tax Bureau against the estate. Two years before Gillmore’s death, having become hopelessly senile, the decedent was moved from her New York apartment by her brother, who was named her guardian, into his New Jersey home for several weeks, and thereafter placed in a New Jersey nursing home. The executors claimed that the decedent had never been a New Jersey domiciliary, a prerequisite to assess tax.  The Court affirmed a judgment for the Tax Bureau on the grounds that the decedent, though incapable of acquiring a domicile other than New York by choice, acquired one in New Jersey by operation of law through the guardian.  This decision is reinforced by New Jersey law that provides that a guardian of the person has the authority to “establish the incapacitated person’s place of abode within or without this state.” N.J.S.A. 3B:12-57(a).  The New Jersey Division of Taxation continues to take the position that if your parent dies in New Jersey after having moved here, even if only for a short period of time, in most instances, they are expecting a check based on the value of their entire estate.

New York Courts have taken the opposite position in holding that an adjudication of incompetency and the appointment of a guardian for the incompetent is as a matter of law conclusive as to the incompetent’s legal incapacity to change domicile by his or her own act until he or she has been judicially recognized as competent or has been restored to sanity by a court of competent jurisdiction. This rule is apparently based on the following considerations: (1) that a person adjudged incompetent by a court is presumed to be incapable of choosing a new domicile; and (2) that only the court, which adjudged him or her incompetent retains control and only that court can determine a whether the incompetent’s domicile changed. This holding was originally set forth in the case In re Meyer’s Estate, 59 Misc. 2d 507, 299 N.Y.S.2d 731, 734 (Sur. Ct. 1969), which has also continues to be cited in current cases and remains good law today.

Believe it or not, New York is now a much more friendly estate tax home than New Jersey.  New York has no inheritance tax and its estate tax exemption is scheduled to be in line with the federal exemption in 2019.  New York’s currently exempts $4,187,500 where New Jersey exempts only $675,000.  Although there is pending legislation that may raise New Jersey’s estate tax exemption, it is unclear if that law will pass.

There is no suggestion by the authors to turn away an elderly parent in need of new living quarters in favor of potential New Jersey estate tax savings.  However, there are many steps that you can take as their advocate to avoid a New Jersey estate tax trap for your elderly parent who may be living in a no estate tax jurisdiction such as Florida.  If your parent lacks (or who may soon lack) capacity, but has lucid moments and is not completely incapacitated, you may be able to take effective steps to preserve their old domicile and avoid an unnecessary New Jersey estate tax upon their death.  These steps may include: (i) not establishing a new domicile in New Jersey; or (ii) not abandoning your parents’ former domicile in Florida.  There are several specific steps that you and your elderly parent can do to bolster the positon that they are not subject to New Jersey estate tax notwithstanding that they may have been living in New Jersey before he or she passed.  Managing your elderly parents’ affairs is never easy.  Adult children who care for their parents, however, must be mindful of this potential tax trap. Once you get your parent set up in their new living quarters, it is imperative that you consult with an experienced state and local tax professional for tax planning advice.

The loss of a loved one is a traumatic event and it can be among the most challenging of times to make important financial decisions.  Proactive planning with an attorney and financial planner can significantly lessen the burden.  Here are a few things to consider.

Be Prepared for the Immediate.  Even if you have prepared, following a death, there are several steps that generally require immediate attention.  These include (1) funeral arrangements, (2) guardianship of minors (3) liquidity needs for the surviving spouse or other family members, (4) ensuring that cash and tangible personal property like jewelry and valuables are safe and secure, (5) addressing the needs of an operating business, (6) locating and filing the original Will, and (7) obtaining death certificates.

Estate Administration is a Process.  The estate administration process generally takes one to three years to complete and is supervised by attorneys.  There are numerous steps in the estate administration process, including the following:  (1) get the executor appointed by the Surrogate’s Court, (2) open an estate checking account, (3) gather assets, consolidate and retitle them in the name of the estate, (4) address claims and expenses, (5) obtain date of death values for all assets, including appraisals for hard to value assets, (6) prepare estate tax returns (federal and state), (7) prepare income tax returns (including decedent’s final life income tax return and the estate’s income tax return, (8) obtain a closing letter and appropriate tax waivers from the IRS and state tax authorities, (9) distribution of the estate and funding of trusts, including allocation of assets among various beneficiaries, and (10) prepare accounting (formal or informal) and obtain receipt and releases from the estate beneficiaries.

Your financial planner plays an important role in many of these steps, such as providing account statements, retitling accounts, updating basis information, communicating with the entire team of advisors, and of course providing investment advice for the estate assets.

Tax planning.  There are various tax issues to consider during the estate administration process, including:  (1) selecting a taxable year for the estate, (2) considering alternate valuation date for asset values, (3) making a QTIP election for a surviving spouse’s trust (or a QDOT election for a non-citizen surviving spouse), (4) making an election to treat a revocable trust as part of the estate, (5) making a portability election for the decedent’s unused federal estate tax exemption, (6) making generation-skipping tax allocations on the federal estate tax return, (7) determining which deductions to take on the estate tax return or on the estate’s income tax return, and (8) deciding whether to make annual distributions from the estate or related trusts for income tax planning purposes (as the trust’s income tax rates are often higher than the income tax rates of the trust beneficiaries).

When Conflict Arises.  If there are conflicts in an estate, or any aspect of the estate will be contested, the financial advisor is often one of the first to learn of the situation, and importantly can consult with an attorney to objectively evaluate and resolve the issues.