Manish C. Bhatia

It is a natural inclination to want to protect the assets that you have worked hard to obtain.  There are many levels of asset protection and the proper method must be determined depending not only on the type of asset, but also on the possible source, timing and likelihood of a threat.  However, the key to asset protection, much like estate planning in general, is that it must be put into place well before it is needed, because by the time it is needed, it is often too late.

Transfers of property that occur specifically for the purposes of hindering, delaying or defrauding creditors will be considered fraudulent.  There are many factors that a court will consider when determining whether a transfer was fraudulent, but the best way to avoid such a determination is to protect your assets before the claim arises.

For a discussion of some of the asset protection techniques that are available to individuals through estate planning to limit their liability against potential creditors, please see the February 2012 Newsletter.

Over the past decade, transfer tax exemptions, rates and planning opportunities have varied from year to year due to nearly annual changes in the laws.  As the calendar turns to the new year, it is important to take a look at what Federal and Illinois legislatures have told us about Estate, Gift and Generation-Skipping Transfer (“GST”) Taxes for 2012 and beyond as well as the uncertainty ahead.

Estate Tax 2012

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”), signed into law by President Obama on December 17, 2010, affects the estates of decedents dying between January 1, 2010, and December 31, 2012.  The Act includes a Federal Estate Tax exemption of $5 million per individual, as well as $5 million exemptions from Gift Tax and GST Tax for 2011.  Since the taxes were indexed for inflation, the exemption amounts will increase to $5.12 million for 2012.  All three transfer taxes have a maximum tax rate of 35% through 2012.

The Act also introduced us to the portability of the Estate Tax exemption, which allows the surviving spouse of a decedent to utilize the decedent’s unused Estate Tax exemption amount (see the January 2011 Newsletter).  The portability feature will remain available to the estates of decedents dying in 2012 but has not yet been made permanent.

Additionally, the annual Gift Tax exclusion remains at $13,000 per individual for 2012.  Meanwhile, the annual Gift Tax exclusion amount for gifts made to a spouse who is not a U.S. citizen has increased to $139,000 for 2012.

Regarding Illinois’ exemption, Governor Pat Quinn signed Senate Bill 0397 into law on December 16, which increases the Illinois Estate Tax exemption to $3.5 million for decedents dying in 2012.  This is a significant increase to the state’s exemption, which was only $2 million for decedents dying in 2011, and will allow greater flexibility in planning for the estates of Illinois residents.

Estate Tax Beyond 2012

After a rumor that the Congressional “Super-Committee” would roll back the $5 million Gift Tax exemption to $1 million effective November 2011 rather than after the provisions of the Act expire at the end of 2012, Congressman Jim McDermott (D-WA) introduced a bill (the Sensible Estate Tax Act of 2011) (the “Bill”) that would restore pre-2001 levels of the Estate, Gift and GST Taxes.

The Bill would bring the Estate Tax exemption back to $1 million per individual ($2 million for married couples) with a maximum tax rate of 55%.  The exemption amount would be indexed for inflation from the year 2000.  Additionally, the Bill would reunify and make permanent the portability of the Gift and Estate tax exemptions for spouses, require a minimum 10-year period for Grantor Retained Annuity Trusts and modify the rules for asset valuation and minority discounts.

There will certainly be other proposals regarding the Estate, Gift and GST Taxes beyond 2012, but the Bill gives us an idea of the levels and rates for which the Democrats will campaign.  An additional bargaining tool at the disposal of Congressman McDermott and other Democrats is the existing law that is in place; without Congressional action prior to 2013, the Estate Tax exemption will return to $1 million and a maximum tax rate of 55% on January 1, 2013.

The Illinois Estate Tax exemption will be $4 million for decedents dying in 2013.  However, if the Federal exemption were to decrease below $4 million, Illinois law would likely match it.

Planning Opportunities

With the increased exemption amount in Illinois for 2012 and Federal uncertainty ahead, this is an ideal time to discuss your estate with a specialist to ensure that all opportunities for reducing transfer taxes and protecting your assets are utilized.  If you have an existing estate plan, it should be reviewed at this time.  If you do not currently have an estate plan, this is the time to discuss your goals and financial situation and to have a proper estate plan in place.

Not having an estate plan or having an improperly drafted plan can result in a significant tax bill and probate costs that can be avoided through proper planning.

For additional information on Estate, Gift and GST Taxes and how to plan for your estate, please feel free to contact me at your convenience.

Some questions regarding Estate Planning are unique and based on specific family situations, but many are common questions that arise from misconceptions regarding Estate Planning.  Below, you will find the top five questions that I receive from clients, along with a brief explanation of the issues related to each answer.

1.  I know I need a Will—how much will it cost?

This is the most common question that I receive.  Since a Will is the most popular document associated with Estate Planning, people often incorrectly assume that this is all they need.

Instead of assuming that they need a Will, clients should focus on their goals.  A better question for an Estate Planning attorney would be “here are my goals, what do I need to do to accomplish them?”

The most common goals are to ensure that (a) Guardians are named for minor children and (b) the maximum amount of assets pass to their loved ones as efficiently as possible.  While a Will allows you to name Guardians for your children, it fails to maximize tax exemptions, avoid probate or protect assets from a beneficiary’s creditors or divorce, and is therefore rarely the ideal answer for clients.  Please see question 2 for a discussion of how to accomplish these important goals.

2.  My estate is small—do I really need a Trust?

The benefits of Trusts go well beyond tax savings.  While dual Revocable Living Trusts are the ideal instruments for maximizing a couple’s Estate Tax exemptions, use of a Trust also allows the creator (the “Grantor”) to provide the terms for distribution of the Trust’s assets and protect inheritances from the children’s creditors or divorce.  Additionally, assets held by the Trust at the Grantor’s death avoid probate, allowing the estate to minimize administration costs and transfer assets to the beneficiaries as quickly as possible.

Protecting a child’s inheritance is often a priority for parents who have worked hard to build their estate.  If a Will states that the individual’s assets shall be left to his children in equal shares, any adult children (older than age 18) will receive the assets outright at the time of death, after probate is completed.  Probate lasts a minimum of six months, which allows creditors to file their claims against the estate.  A minor child’s assets will be held by a Guardian on behalf of the child until he or she reaches age 18, at which time the assets will be distributed outright to the child.

Instead, by establishing a Trust, the Grantor can provide that (a) the assets shall be held in Trust for the benefit of the child, (b) the assets shall be managed and administered by the individual named as Trustee, (c) the assets may be withdrawn by the child at the stated ages in the stated amounts, (d) the Trustee may delay withdrawals if the child is involved in litigation at the time of withdrawal, and (e) if assets remain in the Trust at the time of the child’s death, they shall be distributed as provided in the document.

As you can see, a Trust provides much more protection and flexibility in planning than a Will.  When used properly, a Trust can greatly reduce the costs, time and headaches of estate administration for your loved ones.

3.  I had a Will prepared about 10 years ago, so it should be fine, right?

Over a 10-year period, it is likely that your goals and wishes have changed. Existing documents should be reviewed when there is a significant change in your family or financial situation.  Additionally, with the frequent changes in transfer tax laws in recent years, you should ideally have your documents reviewed every two to three years.

It is important to make sure that you understand your documents as written and that they meet your goals and expectations.  A review by an experienced Estate Planning attorney is the best way to ensure that both of these objectives are achieved.

4.  What is probate?

Probate is the process by which a court validates a decedent’s Will (if the decedent had one) and administers the decedent’s estate pursuant to the Will or, if the decedent did not leave a Will, then pursuant to the intestacy laws of the state.  Probate can be a complex, lengthy process which requires the court’s approval for distributions of assets and the opening and closing of the estate.

As stated above, a probate estate must remain open for a minimum of six months.  This window allows creditors to file claims against the estate.  Additionally, probate is a public process which makes court documents available to anyone who wishes to see them.

The cost of probate will almost always exceed the cost of having a proper Estate Plan prepared.  Proper planning can allow the estate and its beneficiaries to avoid probate and complete the estate administration process as efficiently as possible.

5.  What happens to my estate if I do not have an Estate Plan?

When an individual passes away without a Will (“intestate”), his or her assets will be required to pass through the probate process based on the laws of the decedent’s state of residence.  As discussed above, probate is a complex, lengthy process which can increase the likelihood of conflict amongst family members, open the doors to creditors and delay the distribution of assets.

Under Illinois’ intestacy laws, the estate’s assets would be distributed in the following manner:

1. If the decedent has a surviving spouse and one or more surviving descendants, then half of the assets pass to the spouse and half of the assets pass to the descendants, per stirpes (see Newsletter #1);
2. If the decedent has a surviving spouse, but no surviving descendants, then all assets pass to the spouse;
3. If the decedent has one or more surviving descendants, but no surviving spouse, then all assets pass to the descendants, per stirpes; and
4. If the decedent does not have a surviving spouse or descendant, then the assets pass to the parents and siblings of the decedent in equal parts.

Keep in mind that intestacy laws only apply to probate assets, not to assets with named beneficiaries or joint owners or those held in Trust.

Generally, individuals want to ensure that the surviving spouse has access to all of the estate’s assets before any assets pass to the children.  However, under Illinois’ intestacy laws, only half of the estate’s assets would pass to the spouse, while the other half would pass to the children in equal shares.

To most people, it is important that their estate passes based on their own wishes rather than the laws of the state.  The best way to accomplish this goal is to discuss your wishes with an experienced Estate Planning attorney and have documents prepared that will allow for your estate to be administered in the most efficient way possible for the benefit of your loved ones.

As the end of the calendar year approaches, it is important to take advantage of the annual Gift Tax exemption, which expires on December 31st and cannot be carried forward.  If you are making gifts directly to your beneficiaries, it is crucial that such gifts be made in a timely manner so the checks are deposited before the end of the year.  If you are making gifts by way of an Irrevocable Trust, it is important that any required documentation is prepared and waiting periods are complete before investing the assets.

Additionally, the end of the year is the ideal time to reflect on the changes in your family and financial situations over the past year and determine whether your existing documents require any changes or updates.  If you postponed your planning for another year or are uncertain whether changes are required, it is best to contact an experienced estate planning attorney who will take the time to review your situation and existing documents and address any questions or concerns that you may have.

It seems outrageous that the estate of one of the wealthiest men in the world, with an estimated net worth of $7 billion,¹ likely will not owe any estate tax, but your estate might receive a hefty tax bill from your State and Federal governments.  However, this is not a result of a tax loophole or a shortcut available only to the super-rich; it is simply the result of proper planning.  Through his estate plan, it is likely that the estate of Steve Jobs will remain private and any tax liability will be deferred until the death of his surviving spouse, Laurene Powell.

– Privacy -

We do not have access to any of Steve Jobs’ estate planning documents yet and it is likely that the only document that we will ever see will be a basic Pourover Will.  In accordance with his private nature, a Pourover Will, which is a public document, keeps the significant terms of the estate private by simply pouring all of the decedent’s assets into a Trust, which is a private document that lays out the terms of distribution of the estate.  The only people that will likely see the Trust document are the Trustee, heirs and beneficiaries, thus sheltering the family from a public dissection of Jobs’ desires for his estate and the increased possibility of conflict amongst family and friends.

- Tax Deferral -

Jobs died in a year when there is a $5 million Federal estate tax exemption.  Since the state exemption of California is tied to the Federal exemption,² his estate is free to use the full $5 million credit.³  Of course, this is only a drop in the bucket (0.07% of his total wealth) for Jobs’ estate.  The balance would be taxable at the top rate of 35% (a whopping $2.45 billion estate tax bill) unless it falls into one of several available exceptions.  The majority of Jobs’ estate is likely to be left to his wife or to charity, both of which are exempt from estate tax.  Assets passing to Jobs’ wife would be subject to estate tax at her death unless she uses the assets during her life, leaves the assets to charity or remarries and leaves the assets to her spouse at death.

- Failure to Plan -

Failing to plan would have meant that Jobs’ estate would pass intestate.  Since California is a Community Property state, Jobs’ wife would have received all Community Property but only one-third of Jobs’ separate property since Jobs’ is survived by more than one child.⁴

Additionally, Jobs’ first child was born out of wedlock.  Therefore, failing to plan would have likely resulted in a claim by the first child to a portion of Jobs’ estate.  As it stands, the child may or may not receive a portion of the estate, but it will be determined by Jobs’ desires rather than the courts of California.

1. Forbes Magazine, as of September 2011.
2. California Revenue and Taxation Code§§ 13302; 13411.
3. Illinois, on the other hand, has a $2 million state estate tax exemption.  35 ILCS 405/2(b-1).
4. California Probate Code§§ 6400-6414.

The United States Tax Court has issued a stunning decision regarding the notice requirement for present interest gifts.  As discussed in the December 2010 Newsletter, a present interest gift is one in which the beneficiary has an immediate, unrestricted right to the use, benefit, and enjoyment of the gifted property.  When making such gifts through a Trust, the best practice is for the giftor to make a gift to the Trust.  The Trustee should then notify the beneficiaries that a gift has been made and that they have a right to withdraw their portion of the gift within a stated time period (“Crummey” notice).  After the time period has passed, the trustee may invest the assets, often by paying the premium on a life insurance policy owned by the Trust.

In Estate of Clyde W. Turner, Sr. v. Commissioner (United States Tax Court, T.C. Memo. 2011-209), the decedent had established an Irrevocable Life Insurance Trust during his life for the benefit of his children and grandchildren.  The Trust gave each of the beneficiaries the absolute right and power to demand withdrawals from the trust after each direct or indirect transfer to the trust.  Rather than following the best practice as stated above, the decedent paid the life insurance premiums directly to the insurance provider and failed to give notice to the beneficiaries.

Surprisingly, the U.S. Tax Court disagreed with the Internal Revenue Service’s argument that the beneficiaries’ withdrawal rights were illusory because the decedent did not deposit money with the trustees first but instead paid the life insurance premiums directly and because the beneficiaries did not receive notice of the transfers.  Instead of determining that the gifts were future interest gifts as most practitioners would have expected, the Court held that (a) the fact that the giftor did not transfer money directly to the Trust is irrelevant and (b) the fact that some or even all of the beneficiaries may not have known they had the right to demand withdrawals from the trust does not affect their legal right to do so.

While this surprising decision provides some flexibility to giftors and trustees that fail to follow the established practices for making present interest gifts by way of a Trust, it is strongly recommended that when making such gifts, proper procedure be followed so that, when the time comes for the IRS to analyze the transfers, there is no question that the transfers constituted present interest gifts and are therefore excluded from the giftor’s taxable estate.

According to a recent survey by Harris Interactive, people despise addressing their estate planning needs so much that one-third of those participating in the survey would rather do their taxes, get a root canal, or give up sex for a month rather than create or update a Will.

However, creating a responsible estate plan does not have to be as painful or difficult as many people perceive.  As a matter of fact, the whole process can be completed within a few weeks.  More importantly, once it is complete, you will sleep better knowing that you are prepared for the inevitable and the unpredictable.

The initial step of deciding that you are ready to take control of your assets and your family’s future can be intimidating; death and the thought of leaving loved ones behind are not pleasant topics.  However, the right counsel should alleviate any concerns by addressing each issue clearly, explaining the transfer process after the death of an individual and answering any questions you may have.

The process of planning that I undertake with an individual or couple who has made this decision, discussed in detail in the September 2011 Newsletter, is designed to make achieving your goals as painless as possible.

The estate of a man who died in 1919 is finally being distributed to his heirs in 2011, and chances are that it is only being distributed now because it can no longer remain in Trust under a rarely invoked law.

The Rule Against Perpetuities is a complex common law provision that most clients never hear about and most lawyers learn and forget during law school.  The Rule provides that a Trust must terminate no later than 21 years after the death of the last identifiable beneficiary living at the time of the execution of the Trust.  Since most Trusts terminate much earlier, the Rule rarely applies.  However, once in a while, we see the Rule applied to a real life Trust.  The case of Wellington R. Burt, a lumber and iron tycoon who resided in Michigan until his death in 1919, will likely be used in law schools as an example of the Rule for decades to come.

Prior to his death, Burt executed a handwritten Will which essentially froze his estate until 21 years after the death of his last living grandchild, allowing for only small, unequal annual allowances for his children and similar allowances for some of his employees, including his secretary, cook, housekeeper, coachman and chauffeur.  The reason for the unusual provision requiring a final distribution at this time was clearly the Rule Against Perpetuities.

Burt’s last living grandchild died in 1989, which meant that under the Rule, his estate must be distributed by 2010.  The judge in the case advised Burt’s twelve living heirs to reach a settlement amongst themselves regarding how the estate, estimated over $100 million, will be divided—otherwise the court would have to determine the distribution.  The lawyers representing the heirs met in April and reached an agreement that would give larger sums to closer descendants and smaller sums to more distant descendants.  Burt’s living descendants who will now inherit his estate consist of three great-grandchildren, seven great-great grandchildren and two great-great-great grandchildren ranging in age from 19 to 94 and distributions ranging from $2.6 million to $16 million.

It is unclear whether Burt’s motive for the delayed distribution was to avoid property tax assessments or transfer taxes on his real estate or to circumvent his children due to a family dispute.  Regardless of the reason behind his decision, his estate will now be distributed to twelve of his descendants that he never met.

Had Burt been living today, he would have had the option of avoiding the Rule altogether and leaving his assets in Trust forever.¹  Many states, including Michigan, have either repealed the Rule or provided an opportunity to opt out of it.  Under current Illinois law, a Trust may opt out of the Rule Against Perpetuities by stating in the terms of the Trust that the Rule shall not apply, resulting in a “Qualified Perpetual Trust.”  This opt-out provision allows Illinois taxpayers to utilize a tool called a Dynasty Trust—a trust which is intended to last for generations, paying out only income or limited principal in certain circumstances.

While a Trust created today may avoid the limitation, it is possible that the Rule Against Perpetuities or another law limiting the life of a Trust may apply in the future.  Therefore, an opt-out provision must be drafted carefully to provide for unpredictable legislative changes that may arise.

The Gift Tax was first enacted in 1924 to prevent individuals from making deathbed gifts in order to avoid the Estate Tax.  Today, there is $13,000 annual exemption from the Gift Tax which allows any individual to give any other individual up to $13,000 per year without incurring any tax.  Such gifts can be made to an unlimited number of individuals.

In addition to the annual exemption, there are two categories of gifts which are exempt from Gift Tax.

First, gifts of tuition are excluded from Gift Tax.  However, in order to qualify, such gifts must be made directly to the educational institution.  In other words, reimbursements to the beneficiary or his or her parent for tuition that was already paid will not qualify for the exclusion.  Additionally, only tuition expenses qualify for the exclusion—expenses for books, supplies, room, board or other related expenses do not qualify.

Second, gifts of medical and dental expenses are excluded from Gift Tax.  Again, such gifts must be made directly to the institution or facility providing the medical services.

There is no limit on gifts of tuition or medical expenses.  Use of these exclusions can be a valuable tool in reducing an individual’s taxable estate.  However, it is important to understand these exclusions before they arise due to the strict requirements for making such gifts.

For additional information regarding available exemptions, please see The Importance of Planned Giving.

I will be hosting EP Café on Saturday, July 16, at Café Mozart in Evanston from 10:00 a.m. to 2:00 p.m. You are welcome to come by, have a cup of coffee and have your Estate Planning questions addressed in a friendly, casual environment.  There is no fee and no obligation for visiting EP Café.  Café Mozart is located at 600 Davis St. in Evanston (corner of Davis and Chicago).

Although our conversation will be casual and free of charge, I do ask that you contact me in advance and reserve a 30-minute window for a time that is convenient for you so that people are not waiting for others to finish.

Phone: (773) 991-8423
E-Mail: manish@mcb-law.com