Manish C. Bhatia

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

An issue that arises when gifting specific property by Will or Trust is whether the beneficiary is entitled to anything if the property is sold prior to the giftor’s death.  The doctrine of “ademption” provides that a bequest may only be satisfied with the specific property that is named.  This issue was recently addressed by the Supreme Court of Georgia.

Harvey, the decedent, who was a resident of Georgia, had left his Florida condominium to his mistress, Anne, by way of his Will.  However, prior to his death, Harvey entered into a contract to sell the condominium.  He then died prior to the closing date.

The court determined that a specific devisee (Anne) has the right to any remaining specifically devised property (the condominium) and any balance of the purchase price owing from a purchaser to the testator (Harvey) at death due to the sale of the property.  Since, in this case, a balance was owed to the decedent from the sale of his real property located in Florida, the proceeds from the sale were due to the specific devisee who would have otherwise inherited the real property under the decedent’s Will.  Therefore, Anne was entitled to the proceeds from the sale of the condominium.

For a discussion of how this case might have developed under Illinois law, please see the July 2011 Newsletter.

As discussed in the January 2011 Newsletter, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “Act”) applies to the estates of decedents through 2012.  As a first step towards progress beyond 2012, President Obama’s proposed budget includes several provisions relating to the Federal Estate, Gift and Generation Skipping Transfer (GST) Taxes.

Exemptions

The Act increased the Federal Estate Tax exemption to $5 million per individual and set a maximum Estate Tax rate of 35% for the estates of decedents dying in 2011 and 2012.  The proposed budget would decrease the exemption to $3.5 million and increase the maximum Estate Tax rate to 45%.  Of course, this could be considered an increase from the $1 million exemption which the Estate Tax would default to in 2013 without Congressional action.

Additionally, the Gift and GST exemptions were raised to $5 million as well for 2011 and 2012 by the Act, which made lifetime planning much simpler since an individual’s entire Estate Tax exemption could be used during his or her life.  However, the proposed budget would reduce these exemptions to $1 million and would also raise the maximum Gift and GST Tax rates to 45%.

Portability

The Act also introduced portability of the Estate Tax exemption between spouses, which would allow the surviving spouse to apply the remaining Estate Tax exemption of the deceased spouse to his or her own estate.  While portability could allow great flexibility in planning, the uncertainty of its future beyond 2012 makes the flexibility difficult to utilize.  The proposed budget includes a provision that would make portability permanent.  Most estate and financial planners would agree that any stability in this area would be considered progress.

Valuation Discounts

Through the use of Family Limited Partnerships and Limited Liability Companies, individuals and families have been able to pass interests in their assets to their descendants at a discounted rate by applying discounts for lack of marketability and minority interest.  Through litigation, the IRS has long battled such discounts, often successfully, by arguing that many of these entities do not operate a legitimate business and serve no purpose other than tax reduction. President Obama’s proposed budget would create a category of “disregarded restrictions” that would be ignored in valuing property for Estate and Gift Tax purposes, limiting the use of family entities as a conduit for transferring discounted ownership interests down the family tree.

Minimum GRAT Term

A minimum term for Grantor Retained Annuity Trusts (GRATs) has been a topic of discussion for several years.  In order to be successful, the grantor of a GRAT must outlive the term of the GRAT.  One technique for planning with GRATs is to use “rolling” GRATs—multiple, successive GRATs with short terms of two or three years—rather than a single GRAT with a longer term.  By doing so, the chances of the grantor surviving at least some of the GRATs are increased.  The proposed budget would impose a minimum term of ten years on all GRATs, thus limiting their use in Estate and Gift Planning.

Maximum GST Term

Most states have either repealed or allow for opting out of the rule against perpetuities—a rule that forbids perpetual trusts.  Thus, by opting out of Illinois’ rule against perpetuities, an individual could theoretically create a trust for his or her descendants that would last forever.  However, the proposed budget would limit GST trusts to a maximum of 90 years.

Of course, Republicans and Democrats will battle over these proposals in the months to come, but based on the provision of his proposed budget, it appears that President Obama is determined to tighten the screws on lifetime transfers.

One of the most important features of Estate Planning is to give individuals of your choosing the power to make decisions for the benefit of yourself and your loved ones if or when you are unable to do so.  The alternative to such planning is to allow the courts to decide who will make such decisions—a process which can be costly and time consuming.

The June 2011 Newsletter focuses on the positions that are filled by Estate Planning documents and issues to consider when choosing people to fill such positions.  These positions include Guardians, Executors, Trustees and Agents for Health Care and Property.

It is important to understand the responsibilities of each of these positions before determining who should be named to act.  If you have questions regarding these positions, please feel free to contact me at any time with general questions or those concerning your documents.

As of June 1, 2011, Illinois recognizes civil unions.  As discussed in the March 2011 Newsletter, the Illinois Religious Freedom Protection and Civil Union Act recognizes the members of a civil union in Illinois as having the same rights as the members of a “spousal relationship” under the law.

Beginning on July 1^st, Illinois’ new Powers of Attorney laws will go into effect.  Any Powers of Attorney executed in Illinois on or after July 1 must use forms updated to reflect the changes required by the new law.

An outright bequest made either through a Will, Revocable Living Trust or intestacy allows the beneficiary to directly inherit the assets—as long as he or she has reached the age of 18 in Illinois—and do with it as he or she may please.  However, there are many reasons why a parent or grandparent may want to control how and when a beneficiary receives an inheritance.  Whether your beneficiaries are minors and such planning is purely precautionary, your beneficiaries have given you a reason to limit their control over inheritances or you have a philosophical opposition against individuals receiving large financial windfalls too early in life, using a Revocable Living Trust to plan your estate gives you the flexibility to set the terms on which your children will inherit your estate.

First, a properly drafted Revocable Living Trust will allow the creator to establish the purposes for which the trustee may distribute assets to children—often the child’s health, support and education—and the ages at which children may withdraw the trust assets.  This allows a parent to ensure that a child will be taken care of if and when the need for financial support arises but will not be able to inherit a large sum of money without any restrictions at the age of 18.

Second, a properly drafted trust will permit the trustee to delay any such withdrawals in case the beneficiary is experiencing creditor issues or involved in a divorce proceeding at the time that such withdrawal rights go into effect.  Additionally, if the beneficiary has experienced drug or alcohol addiction issues in the past, the grantor may add additional restrictions on any withdrawals or distributions by the trustee while the beneficiary is undergoing treatment or suspected of continued abuse.

By utilizing a Revocable Living Trust when planning an estate, the creator can ensure that his or her wishes and concerns are made clear to the trustee and the beneficiaries and that a child’s inheritance is protected even when the child is unable to protect it him or herself.

Keeping trust assets out of probate is a benefit that not only reduces legal fees for the estate but also expedites the distribution of assets to beneficiaries.  An additional benefit that may apply to you is that placing out-of state property into your Revocable Living Trust may help your estate avoid ancillary probate—the probate of assets located in another state.

When a decedent passes away owning property located in a state other than the state of his or her residence, that out-of-state property must pass to beneficiaries either (a) by legal instrument or (b) through the probate process.  Legal instruments that allow the property to pass outside of the probate process include a deed providing for joint ownership with right of survivorship for real property, a beneficiary designation for certain accounts or a Revocable Living Trust.  If the proper planning is not completed prior to death, then the property must pass through the probate process of the state in which the property is located.  In other words, if an Illinois resident has a second home located in Michigan, the home is owned in his individual name only and no Estate Planning is completed prior to his death, then following his death, his estate will be required to probate his Illinois assets in Illinois and probate the Michigan property in Michigan.

Probate in even a single state can cause the estate to incur significant legal fees and delay the distribution of assets to the beneficiaries.  These issues are greatly exacerbated when dealing with probate in multiple states.  Through proper planning, the hurdles of estate administration can be minimized.