You Don’t Know What You Don’t Know

My parents are in the middle of winding down their farm operation in Northern Iowa. The idea was simple: sell the land; retire and walk off into the sunset. But as they began the process, so too came layers of complication. The deal involved land that had been in the family for decades, the estate of my grandmother, multiple siblings (nine total, to be exact), and complex tax treatment. It was to say the least – complicated.  

At some point in the process, they realized they needed help—not because they lacked capability, but because there’s no clear-cut blueprint for navigating situations like this. You can only go so far on your own before the complexity outpaces what you can manage without professional help.

To Work with Family, or to Not Work with Family?

Working with family members can be a double-edged sword. It may seem easier to start a business with family members because you already know and trust them, but if things go awry, the disputes can be even more personal and intense. Think about it–if things go bad, instead of losing a business partner, you may ruin a relationship with your sibling, cousin, or in-laws. I’ve even seen situations where siblings sue each other and children sue their parents when the business isn’t as successful as planned. Family members shouldn’t have to turn to litigation to resolve their business disputes. So, what can you do to prevent the worst from happening?

Below are a few suggestions from Andreas Scott (a financial advisor at Total Wealth Advisors, LLC) and me regarding common issues faced by family businesses. Andreas has extensive experience in advising family businesses and his goal is to help his clients create and control their total wealth picture.  

Ownership vs. Management

Ownership and management are two different functions that are often lumped together. When including family members in your business, consider if they would be more effective as an employee, a member of management, a board member, and/or an owner of the company. Each of these roles provides the family member with different responsibilities and rights to the business. For instance, if you give the family member an equity interest in the company, consider if it should be a non-voting equity interest. This would give the family member the benefit of having economic rights, but prevent the individual from having governance rights. Also, if a management transition is necessary, we recommend having open conversations with family members to discuss your future involvement in the company and how that would impact their economic and governance rights and roles within the company.

Going External

A significant decision that many successful family businesses will face is whether to bring in external management. When a family business reaches the second, third, or fourth generation, there will be differing views on whether it is appropriate to bring in professional external management or to continue to keep all management within the family. It may be beneficial to have an independent party weigh in on important decisions, but it’s important to understand the implications of bringing in external management from an estate, wealth, and ownership standpoint.

Differences in Generational Views

It may seem obvious, but the first generation and the third generation will have different views of the family business. If left unaddressed, opposing views can cause significant tension within the family. If Grandpa doesn’t believe his grandson has the same respect for the business that he does, it could cause challenges not only at the dinner table, but also when it comes time to run the business and do the estate planning. To resolve these issues, it’s important to work with professionals (e.g., an attorney, accountant, wealth manager, etc.) who are both subject-matter specialists and who understand the underlying family dynamics.

Although it may seem easier to work with family members, remember to tread carefully because conflicts in the work place will inevitably follow you home.

How to Answer the Top Five Legal Questions You Will Get from Family Members at Holiday Gatherings

1. Should Mom and Dad give us the house as a gift now so that they don’t have to “give it to the government” later?

This is a common question that involves technical medical assistance rules. Generally, the best way to answer this question is “no,” and, “You should talk to a lawyer who specializes in this area.” These rules are very complex and often misunderstood.

If you give a home to another person as a gift, that person will receive the home with a tax basis that is the same as your tax basis. In some cases, this can be a very low basis and the built-in capital gains very high. In addition, as the owners are no longer the primary residents, the recipient of the gift will no longer get any kind of exemption on paying some of that capital gain when the house sells. In contrast, if your parents die owning the house, the house will get a fresh tax basis. And if they sell the house while they still own it, they are exempt from paying much of the capital gains.

Further, transactions within a certain period of time are ignored. Your parents could end up without a house, and still be excluded from some government assistance.

Finally, if you and your siblings receive their house as a gift, YOU NOW OWN A HOME WITH YOUR SIBLINGS. And their spouses, really. Who gets along well enough with their siblings to start going into real estate investing? Overall, this is rarely a good idea. 

2. When our daughter, Susie, gets married next year, should we give the couple a down payment on a house?

Again, this is very generous; you have a great family. On the other hand, it can be difficult to navigate the marital property rules, and you could be sharing family assets in a way you don’t intend.

Sometimes a simple traceable gift like cash can be harmless, but if a gift is actually—for example—an interest in an operating business, or a job for a new son-in-law, such a gift should only be made with a prenuptial agreement attached. Especially if someone is going to own a growing business that he or she (or his or her new spouse) will be working at, consult a lawyer about the safest way to make that gift. Any family with operating family businesses or family wealth should discuss the possibility of an agreement or an estate plan that ensures you are protecting the family’s assets and preparing the young couple to be good stewards of that wealth.

3. When grandma died four years ago, she had a will, so we didn’t need to go through probate, right?

Probate is a court-supervised process that transfers property after someone’s death. Even if you have a will, probate is necessary to properly transfer property to the beneficiaries after someone dies. The beneficiaries are either determined by the terms of the will or by state law, but probate is a necessity either way. The only way to avoid probate is to transfer all of your property through beneficiary designations or through a living trust. If any asset is still in the decedent’s name and does not have a designated beneficiary, the only way to transfer it is through probate. Also, if it has been four years, you have to go through a slightly more complex court proceeding instead of the typically simple probate process.

Some people also ask why they need a will if they don’t have millions of dollars. A will does not avoid probate, but it does allow you to select the people who will be in charge of your estate and the people who will benefit from the assets you do have. Your will allows you to select specific assets or dollar amounts and give them to specific people. If you don’t have a will, state intestacy law will direct where your stuff will go. This is based on your living descendants and whether you have a spouse. If you have children, your children will have some interest in your assets, even if you are married. Intestacy tries to mirror what most people may want, but it is rarely applied in the same way that you would choose.

It does matter that you have a will.

4. Speaking of grandma, I can just use her power of attorney to close her bank account, right?  Is having a power of attorney the same as being her executor?

A power of attorney is a document that authorizes someone to make financial decisions and transactions on your behalf, while you are alive. This document is no longer valid once someone has died.

Often, people think they can continue to close accounts or write checks for bills after someone has passed away because they were the power of attorney when that person was living. The executor—or personal representative, as it is called in Minnesota—is the person in charge of collecting assets, paying debts, and distributing a person’s assets after their death. That person has to be appointed by the court through probate, and that can take some time. There is often a gap in time where there is no one legally able to conduct financial transactions on behalf of the person who has died.

5. If I get in an accident, I don’t want to be a vegetable, so you can just pull the plug—right?

Making medical decisions for someone is a very serious matter. Often medical staff will consult with family when important decisions are to be made, but they are starting with the presumption that they should save your life at all costs.

If you have situations where you would prefer that you not be kept alive, you have to put that direction in a legal document, or you have to be sure that you have immediate family that will convey that wish without wavering, and without disagreement among them. A health care directive, or power of attorney for medical purposes, is the best document to outline these wishes and to designate someone to carry them out.

This is also the case if you wish to donate organs or be cremated instead of buried, things like that.  Further, “pulling the plug” could mean that you want to be taken off life support after certain conditions are met or that you do not want to be kept alive by way of a feeding tube, or it may refer to an order not to resuscitate you if that is necessary. A health care directive can cover the first two examples, but does not cover an order not to resuscitate, and that must be done in a separate and specific document.

How Does Moving Impact Your Financial and Estate Plan Health?

I'm moving. So moving (and packing, hauling, and unpacking) is on my mind. It occurred to me that many clients have questions about what moving means for their financial and estate plans. 

In the context of your estate plan, there are a few things to consider if you are moving. If you are moving to another state within the United States, your will is likely valid in that new state as long as it was validly executed in the initial state. This means that if you executed a will in Illinois that complied with all Illinois requirements, it is most likely still valid in Minnesota.

That being said, it is still important to consider the meaning of that will in the context of the laws of your new state. Your new state may have different estate tax laws, and therefore your plan may not be the most efficient under the laws of your new state. Your new state may subject your property to community property laws, so your estate plan may no longer be appropriate. Your current health care directives and powers of attorney may require a legal opinion before they are respected in the new state. Because these documents apply when you are alive, but incapacitated, waiting for a legal opinion may waste valuable time. Updating these documents upon moving to a new state is a good first step.

If you are moving to another country, there are a number of things in your financial and estate plans that probably need review and changes. First, the requirements for executing a will and other documents may be dramatically different.  For example, in Germany, many legal documents have to be executed in the presence of a notary public—who receives a percentage of your transaction cost as a fee, and has to read the legal document in a very loud voice before you execute it. Additionally, some countries have required heirship rules, especially for real property, so it may or may not be possible to transfer certain property to certain beneficiaries. Finally, it is important to understand the taxing impact the new country makes and whether you would be subject to that country’s estate tax system instead of, or along with, the United States.

Any move should trigger a review of your financial and estate plan health. Make sure you investigate the impact of your move, and ensure that all of the careful planning you have in place still works the way you intended.

Estate Planning Tips from the Loss of a Hollywood Icon

A very notable woman in the entertainment industry (other than Joan Rivers) passed away recently—Lauren Bacall. Lauren, born Betty Joan Perske, left a true legacy in the entertainment world, as well as a couple of good reminders for those of us crafting our own estate plans. 

Lauren Bacall was the famous co-star and eventual wife of Humphrey Bogart, and she died this August at age 89. Lauren left an approximate estate of $26.6 million.  Of the $26.6 million, about $10 million represents the value of her apartment on the Upper West Side of New York City.  There is about $1 million of personal property and only $100,000 of cash. Lauren also possessed a general power of appointment over the trust that Humphrey Bogart left for her.

Lauren presumably died a New York resident, so there will be both federal and New York state estate taxes due on her estate value and the value of the trust. With only $100,000 of cash, her estate has a serious liquidity problem.

Her will directs that the real estate be sold, but depending on the market and other factors, that might not be practical. Her estate has nine months from the date of her death to pay any estate taxes.  The chances that there will be a closing on a $10 million property within nine months are pretty remote, and it will likely cost more than $100,000 to maintain a property of that size until it is sold.

What about the other assets? Lauren asked in her will  that her personal effects, letters, and memorabilia not be sold. This may be some very valuable property that (assuming the family is willing to part with some of it) the estate could use to pay taxes.

Anything else? Well, Lauren gave the rights to her “likeness” and other intellectual property to her children. If this property is valued anything like the similar property owned by the estates of Marilyn Monroe, Michael Jackson, or Elvis, its value is fairly significant.  And the IRS can argue they are owed taxes based on that significant value, even though the family hasn’t yet begun to profit from any of it. Even if valuation isn’t a problem, issues relating to whether and how the estate markets her likeness or how the estate divides royalties and other proceeds can leave families in litigation for years.

These two major issues—illiquidity and problems arising out of the management of valuable intellectual property—can be headed off by a carefully crafted estate plan.

Usually life insurance is the simplest way to assure there is a bucket of liquid assets available to pay taxes and other expenses, and it is also possible to borrow against illiquid assets (such as Lauren’s apartment) to pay expenses. These are relatively simple solutions that usually do not otherwise disrupt the plan.

As for the management of future profits from her likeness, a family entity or trust might be created to hold and manage the assets in order to avoid conflict and govern decisions regarding the use of the assets going forward. A family can agree to put this in place after the fact, but many individuals in similar circumstances choose to establish the entity, select the ownership interests and associated rights (think voting and non-voting shares, for example), and perhaps even a board of directors outside the family to make decisions.

Someone Finally Did Things Right! Lessons from Robin Williams’s Estate Plan

Last week we tragically lost an entertainer who played a major role in my life, and, I am sure, in the lives of many others as well. Most of the time when I write about celebrities and their estate plans it is to point out something they may have done wrong, but today I am pleased to report that I am able to discuss one celebrity who may have done things right.  Early reports, citing TMZ (seriously, where do they dig this stuff up and how ridiculous is it that I am citing it?), indicate that Robin Williams may have used a revocable trust as his primary vehicle to transfer his assets at death. 

There are a number of reasons a revocable trust may be the perfect estate planning tool, but primary among them is privacy: a revocable trust is a private document that normally will be unavailable to the public, an important consideration for a public figure. In contrast, consider the cases of Phillip Seymour Hoffman and James Gandolfini, among others, whose wills and dispositions from their large estates were on public display.  A will is a public document, filed with the court in a probate proceeding, and as such is available to the public; a trust is not automatically subject to probate or court jurisdiction.  If a client-say a celebrity, an athlete, or even a resident of a small town full of nosy neighbors—ever has a need for privacy, the revocable trust is the preferred instrument.

A revocable trust can also reduce (but not eliminate) the possibility of intra-family drama surrounding the estate plan.  A revocable trust avoids a probate proceeding, without which no notice to family members and heirs is necessary.  Only the named beneficiaries need to get notice of the distribution from a trust, unlike in probate where all defined heirs, along with named beneficiaries, are required to receive notice.  This means that a child or someone else who intentionally may have been excluded as a beneficiary will receive notice and will be an interested party in a court-supervised probate proceeding.  It is still possible to bring action to determine the validity of a trust, or to contest distributions from a trust, but a party who might wish to press such claims may never even receive notice that the trust exists.

Just because Robin Williams appeared to use a revocable trust instead of a will as his primary estate planning vehicle doesn’t mean his estate plan was perfect, but it does mean he was able to ensure that the division of his assets will remain private.

One caveat: revocable trusts are only helpful if you have actually transferred your assets to the trust.  In many jurisdictions if you have more than $50,000 or $100,000 in assets titled in your own name, and not in the name a trust or a designated beneficiary or in common ownership with another person, a probate proceeding will be necessary even if a revocable trust exists.

Cutting Your Kids Out of $300MM: That Stings a Little

Legendary rock artist Sting recently acknowledged that his fortune of approximately $300MM will not be passing to his six children.  In a recent interview with the U.K.’s Daily Mail, Sting said that he told his children not to expect much of this, because he would be spending it.  He also mentioned that he appreciates that his children work and don’t ask for much, and that he doesn’t want the inherited wealth to disrupt their lives.

Though this is a large and public example, Sting’s philosophy on estate planning is not that unusual.  I tell clients that their first estate planning option is to spend it all.  That is not necessarily a good financial plan, and often we need most of our estates in the very last few years of our lives, but my point is that they don’t have to feel like it is their absolute responsibility to stockpile wealth for the next generations at the expense of their own.  

I am assuming that much of Sting’s “spending” will be on charitable endeavors.  This is another philosophy shared by many.  Not only is giving to charity during your lifetime a decent tax planning option, but it is also a tremendous way to see your money work for the greater good.  Your children enjoy the advantages of growing up with wealth: good schools, no debt, etc.  They are already starting out ahead.

On the other hand, first generation wealth accumulation, like Sting’s, can make a family financially advantaged for many generations.  Leaving a legacy like that is powerful too.

It is a tough balance between empowering your children and grandchildren and enabling them to do nothing. A well prepared estate plan, and some family education, can perhaps do both.

The Battle Over Casey Kasem’s Medical Care: Lessons in Incapacity Planning

Last month I mentioned that every person should have a basic estate plan, including a medical directive.  This directive is not only necessary for the elderly, but also for anyone who could find themselves incapacitated temporarily or permanently.  

The experience of legendary American Top 40 host, Casey Kasem, can serve as a great example as to why this is so important. His use of such a medical directive and the fight over his care are putting health care directives in the spotlight.  Casey has the classic situation of second wife and children from his first marriage. Not to say this isn’t a very workable and loving situation, but often when money and health care decisions come into play, even a loving relationship can break down.

In 2007, Kasem was diagnosed with Parkinson’s Disease.  At that time he signed a medical directive giving his oldest daughter health care agent status.  In the next few years, as his health deteriorated, his second wife started to isolate him from his children.  She also took over his medical care and even moved him from California to Washington.  

Over the last several weeks they have been battling in court over who can make health care decisions for him, and whether the children have the right to visit their father. Further, Casey specified in his directive that he wished not to be kept alive artificially. Kasem’s wife and children have been directly at odds about this decision.  The courts have been forced to evaluate the medical directive granting the power, and, after a few twists and turns, have now confirmed his daughter’s power to make medical decisions, including the withholding of food and water.  Unfortunately, Casey lost his battle yesterday and passed away.  We hope that he found some peace in his final moments.

The lesson?  Your family is likely to be reluctant to impose anything other than lifesaving options when you are suffering and dying in front of them, and doctors and other medical professionals take an oath to save your life at all costs. If this is something that you feel strongly about, your choice to forego treatment HAS to be in a legally binding medical directive.  Making this decision for your family relieves the burden from them of making this decision on your behalf.

Many people, like Casey, suffer from debilitating illnesses, and they have no desire to prolong life and their suffering.  Everyone should have that choice.  However, you have to make that choice when you are lucid, thoughtful, and rational, and you should select someone with the courage to see that your wish is carried out.  

“Keep your feet on the ground, and keep reaching for the stars.” Casey Kasem, weekly signoff from American Top 40.

Singles and Couples Without Children Need Estate Plans More Than Ever

Clients often come to me for their first estate plan because they have recently had a child.  Many clients think that estate planning is unnecessary unless they have won the lottery or have had a child.   Not true.  If I think about many of the more complex or messy estate administrations with which I have assisted, probably half involve estates of single people or couples without children.  

One reason you need an estate plan is to plan for the possibility of temporary or permanent incapacity.  This is something that affects everyone, not just people who are married and have children.  Everyone should have a  health care directive (appointing someone to make personal and medical decisions for you if you are unable) and a  financial power of attorney (appointing someone to make financial decisions if you are unable).  Both are very simple documents to prepare and are especially important if you do not have a spouse.  If these documents are not in place, and you happen to be temporarily or permanently incapacitated, the only option for your friends and loved ones is often an expensive and public court proceeding to appoint someone to make those decisions.

Also, with the recent death of  L’Wren Scott, Mick Jagger’s longtime girlfriend, we are reminded that many unmarried couples are otherwise long-term committed partners sharing homes and the rest of their financial lives.  Without an estate plan, one partner would not benefit from the other’s estate, would not have rights to sentimental property, may have to move from the home, and would not be allowed to participate in the administration of that person’s estate.  The legal rights otherwise given to heirs do not apply to committed partners, so such a partner would be entirely excluded from all aspects of the process. 

Finally, everyone has assets (even modest assets) to pass on to beneficiaries.  It is important to be able to select the recipients of your property, and to nominate the person you would like to wrap up your affairs.  If you are a single person and have no estate plan in place, the law would allow your parents, maybe your siblings, or perhaps even your creditors to make all of those decisions.  Also, people without a spouse or children often have nieces and nephews or charities that they love and support and would like to provide for in the case of their death. Such arrangements really need legal assistance and can be tricky to draft correctly.

Phillip Seymour Hoffman’s Last Wishes—I Want My Son to be Raised as a New Yorker

Phillip Seymour Hoffman’s life tragically ended far too soon for movie fans, and I’m sure for his three children as well.  His will left his reported $35.0 million fortune to his long-time girlfriend, and if she did not survive him or disclaimed any amount, to his 10 year-old son, Cooper. The couple had another two children after Cooper, but they were not specifically mentioned in the will since it was prepared shortly after Cooper was born and never updated.  Even though his lack of planning—and likely large tax bill (over $15.0 million)—are both very interesting, it is Cooper’s trust and directions regarding is upbringing that warrant this blog post.

Hoffman’s will specifically leaves instructions for where Cooper should live.  Cooper’s trust will own Hoffman’s New York apartment, and provides for Cooper to live there. Later in the document, when discussing a guardian for Cooper, Hoffman states:

“it is my strong desire…that my son, COOPER HOFFMAN, be raised and reside in or near the borough of Manhattan in the State of New York, or Chicago, Illinois, or San Francisco, California, and if my guardian cannot reside in those cities, then it is my strong desire, and not direction, that my son, COOPER HOFFMAN, visit these cities at least twice per year throughout such guardianship. The purpose of this request is so that my son will be exposed to the culture, arts, and architecture that such cities offer.”

Such provisions of direction are not necessarily legally enforceable, but they can be persuasive to the recipient and, in some cases, a court.  

I have assisted clients in giving such informal direction (essentially, making known their “hopes and desires”) when it comes to the management of assets or the raising of children, but not necessarily in this way.    Often clients include provisions like this when they want the trustees to hold on to a specific asset (so as, for example, to enable the children to continue to use a family vacation home), and I have even had clients spell out appropriate school districts for their children in a separate letter to a guardian.

This provision is interesting mostly because Phillip Seymour Hoffman crafted it, but it is also a reminder about what belongs in and out of a will.  This will was written ten years ago, and he may feel dramatically different today.  Further, this direction is very specific, making compliance potentially difficult for both the guardian and Cooper.  Hoffman lived in New York and owned an apartment there, but seemed to have no connections or real estate in either Chicago or San Francisco.

If you have specific hopes for your children or the assets they will inherit, you can certainly prepare something that accompanies your estate plan and gives guidance to trustees and guardians.  These writings can be very helpful to those who manage your assets or raise your children.  However, be careful with where you include this language of direction, and revisit it often as your personal and financial life changes.

Holiday Estate Plan Makeovers

This time of year can be full of family, food, and good fortune; it can sometimes be full of good and bad change too. I am often busy this time of year because people are home for the Holidays and thinking about their financial and family health—but sometimes I am busy because of illness and tragedy. I thought this post might be a good “end of the year” checklist of things to think about and when to update your estate plans:

• Incapacity. Unfortunately this is a time of accidents (think Clark Griswold), or unexpected illness, and every single person should have documents in place to act in the event of incapacity. Of the emergency proceedings I have handled in court, 2/3 of them have been in the months of December and January. Business owners should especially have a plan in place should they become unexpectedly incapacitated. This is one that is not impacted by age or net worth; you should have a financial and health care agent in place in case you cannot make your own decisions temporarily or permanently.
• Guardians for minor children. Spending millions of hours with your children after eating pounds of sugary treats should make you consider whether the guardians you have chosen (or the ones you SHOULD choose) are the right choices. Can your brother really handle your kids? Does the geographic location of those guardians make sense still? Are your kids old enough that you can remove that section?
• Significant change in financial circumstances. Did you win the lottery this past year? Or did you spend your entire life savings on presents for the holidays? Many estate plans include specific dollar amount gifts to specific people; do you still have assets that cover those gifts? Are you in a financial position to add some specific gifts to family members?
• Charitable gifts. This time of year reminds us to be generous to the charitable organizations around us as well. Did you include organizations in a prior plan with which you are no longer active? Did you want to add some new charitable gifts to your plan?

This is not an exhaustive list, but the Holidays and end of the year are a good time to review our estate plans and think through the family and personal decisions that go with them. Happy Holidays!

L.C.—Laguna Beach Entrepreneur

Over the last week or so news broke that Lauren Conrad is engaged to budding lawyer, William Tell.  I am positive that almost no one reading this post knows who Lauren Conrad is, but to me she will always be the infamous L.C. on Laguna Beach and Lauren on The Hills, and she is now a notable fashion designer and author.  William is touted as a “normal guy” but he is another OC native, successful songwriter, and USC law student.  

Lauren is probably one of the only people to make money as a reality television star (during The Hills she was paid $2.5 million per year) and then successfully branch out into the real world as a successful business woman.  She currently has 8 published novels, a line of clothing, jewelry, and shoes with Kohls department stores, and a line of bedding.

I bring up Lauren for three reasons: (1) I shamelessly loved Laguna Beach and The Hills, and it is nice to see someone with a publicly tragic love life end up happy, (2) she is a young entrepreneurial woman who has turned her fame into a budding empire, and (3) she serves as another reminder of why successful entrepreneurs (or ones who expect to be someday) should consider some thoughtful premarital planning.

If you have business interests that are growing or will be inherited after your marriage, especially if you are active in the growth of that company (you are running the company, you are the face of the company, you supply the ideas of the company, anything like that), you should know that from the date you are married, one-half of that growth belongs to your spouse.  Even more so in a community property state (like California), where from the date you are married half of everything you acquire, including half of appreciation on any assets you brought to the marriage, will belong to your spouse.  Of course, this assumes the business will grow, but the same applies if businesses decline.  In the same way that appreciation belongs to your spouse, debt or other credit obligations can become responsibilities of your spouse and could subject their separate assets to your (or your company’s) debts.  Any personal guaranties or other obligations could become your spouse’s obligations without a marital agreement.  

A marital agreement (prenuptial and postnuptial) could address and opt out of this treatment of premarital business assets, and any other premarital assets, and are a critical tool in an entrepreneur’s toolbox.  If you want to partner in a business with your spouse (I wouldn’t recommend it), draft a good partnership agreement.  Don’t fight this out later in a divorce court; that is ugly for you, the business, and its employees. Remember them?

Lessons from Tony Soprano’s Estate Plan

James Gandolfini, a/k/a Tony Soprano, died unexpectedly at the age of 51.  Not that we should all take money management lessons from a TV mobster, nor should we take guidance on estate planning from him, but the death of a high profile actor at such a young age provides an opportunity to review the good and the bad decisions his estate plan made.

First, here is a copy of his will.  Mistake #1:  If you are a famous person, you should (or your lawyer should insist) that you keep your estate plan PRIVATE.  Any will that has to be probated is public.  Most of the time no one will care, but if you are Tony Soprano, someone will care.  In fact, I am nowhere near the first person to write about this.  If his estate plan had been private, no one could write about it.  His estate plan would have been private if he had used a revocable living trust to hold his assets.  Trusts are not public documents.  Even if they become an issue for dispute in court, often the document itself is a non-public filing.  Now we all know he is giving his assistant $200,000.  

The second reason James Gandolfini’s estate plan is notable is because it appears to be very tax inefficient.  Newspapers and magazines have been making a huge deal about this calling his estate plan a horrible mistake, a tax disaster.  His plan gives about 80% of his estate, including a property in Italy, to taxable beneficiaries (not a spouse or charity).  This triggers estate tax on all but $5,000,000 at a rate of 40% or more.  The New York Daily News estimates that this amounts to about $30,000,000 in tax on his approximately $70,000,000 estate.

Again, the media labels this a horrible mistake, a disaster.  Is it possible that James only provided 20% to his wife (thereby making that 20% not taxable) because they agreed to do that in a premarital agreement, he had another trust for her benefit, or he used the 2012 gifting craziness to give her a number of assets already?  Or, maybe, he WANTED to give the rest of it to his kids and relatives, and didn't care about the taxes.  Novel idea?  It is true, however, that most people care about the taxes.  A few relatively simple estate planning techniques may accomplish the same goals but save significant taxes.  I certainly hope he was informed of the consequences of the design of his plan.

The third lesson from this estate plan is how (not) to structure gifts to your children.  His will provides for his children significantly, and early.  Many children, even children of celebrities, are not ready to manage a pile of money at 21.  I can appreciate his desire to keep things simple, but providing more money to your young daughter than you do your wife—seems like a bad idea?

The final lesson is in the disposition of his Italian property.  James gave his children the property in Italy.  Italy and many foreign countries have limitations on who can own property there, and who may be taxed as a beneficiary of that property (inheritance tax).  It is also possible that a significant capital gains tax occurs when the property is transferred to certain individuals.  Our system is an estate tax borne by the deceased’s estate, not by the beneficiaries receiving the property (unless the document requires that).  As a result, it can be possible that the estate would pay estate taxes in the U.S. for the property, and the recipient could pay further taxes to the country the property is located in.  Many countries in Europe, like Italy, have a treaty with the U.S.to make sure there are less situations of double tax, but it is important to take careful consideration with properties abroad.

British Royal Baby Billionaire

As I write this post, most of the world is holding their collective breath waiting for the royal baby to arrive.  The Brits and much of the world are fixated on the fact that the next royal heir is about to enter the world.  I, on the other hand, keep thinking about how filthy rich this baby already is!  Do the royals pay inheritance tax?  What will the baby inherit?!

According to data from Wealth-X, an organization that tracks wealth information for ultra high net worth individuals, it is estimated that the royal baby will inherit approximately £1 billion (or about $1.5 billion U.S.) based on the estimated fortunes of other family members.  Queen Elizabeth II’s fortune is estimated at $660 million, with about $58 million in annual income.  And these figures don’t even include the crown jewels or other family heirlooms.  Even young William is estimated to be worth at least $20 million.

I was also surprised to learn that until 2011, if the Duke and Duchess of Cambridge gave birth to a girl, she may not have inherited the throne.  With Queen Elizabeth II having recently celebrated her diamond jubilee and 60 years on the throne, this very recent change to the law shocked me.  The leaders of the 16 Commonwealth countries actually had to agree to amend the succession laws to allow succession to the throne based only on birth order, and so now a daughter can inherit the throne, and not only when there are no sons (as was the previous rule). Now, whether a boy or a girl, the royal baby will be third in line to the throne.

Second surprise of the day: the monarchy is EXEMPT from inheritance tax (at a whopping 40% rate)! Apparently the Queen made an agreement in 1993 that leaves her exempt from this otherwise steep tax. Convenient.

Finally, just because I think it is entertaining (and I feel like I am writing part of Game of Thrones), the royal baby will inherit the following obscure items: 

• The Dutchy of Lancaster, 46,000 acres of land with various structures worth about $300 million and earning about $13 million per year in revenue;

• The use of numerous royal establishments, including Buckingham Palace, Clarence House, Hampton Court Mews and Paddocks, Kensington Palace, Marlborough House Mews, St. James’s Palace, and Windsor Castle;

• The use of the crown jewels (tiara party, anyone??); and

• Fishes Royal, or any sea life captured within 3 miles of shore.  Seriously.  This is based on a statute from the 1300s, and technically could still apply. What baby doesn’t want a dolphin for a pet?

This plan is slightly different from my parents’ estate plan, but then I guess I didn’t grow up in Buckingham Palace!

SkinnyGirl Gets Divorced

A few months ago I wrote about the real housewife turned mogul, Bethenny Frankel, and her massive deal to sell her SkinnyGirl drinks to Beam Global for $120 million.  In a matter of a few years, Bethenny went from near bankruptcy (despite her designer duds on the RHONY) to multi-millionaire.  She also went from single, to marriage, to motherhood in that same time frame.  And now, she is getting divorced.

I don’t pretend to be an expert in marital law, especially not in New York marital law, but I think this scenario lends itself to another discussion about owning closely held business assets and growing the company value, and the impact of premarital/postmarital agreements and divorce—as I discussed here and here.

Here are the basic facts: Bethenny built and advertised the SkinnyGirl brand prior to her marriage.  She grew the brand significantly as a member of the RHONY cast. About four years ago, Bethenny met her husband, Jason.  They were married a year or so after that and then welcomed a daughter a couple of months after the wedding.  The reason I point out the timing of the birth of their daughter is because Bethenny was pregnant when they negotiated and executed their premarital agreement.  A year or so after their daughter was born; Bethenny inked the $120 million SkinnyGirl deal. A year and a half or so from there, they are divorcing.

A dramatic change in circumstances from the time of the negotiation to the agreement to the time of enforcement of the agreement can be one of the biggest reasons agreements are thrown out or the courts alter the terms.  Having children, when no children had been contemplated in negotiating the agreement, can change the overall “fairness” of the terms.  This has nothing to do with child support—child support cannot be negotiated in a prenuptial agreement—but it does have to do with the expectations of the parties, lifestyle, and needs.  Selling a business or some other windfall can also impact the agreement.  

I don’t actually know the terms of their prenup, but it is possible that Bethenny was aware of the value of the company at that time or may have even been brokering its sale.  If the parties were both aware of the $120 million value and the possibility of the liquidity event, it is difficult to argue that this is a change in circumstances such that the agreement should be ignored.  However, adding $120 million to the balance sheet from relative bankruptcy is a significant change to the household lifestyle.  

Another factor here is likely the length of the marriage and the time between negotiation and enforcement.  Because this was a short union (yet longer than this marriage, this marriage, and this marriage combined), there isn’t much argument that Jason enjoyed the benefits of this lifestyle such that it would be a tremendous hardship to go back to his previous life.

The point of all of this is not to analyze Bethenny and Jason’s divorce, but to point out the impact of a liquidity event in a business completely built by the entrepreneur spouse, closely followed by a divorce.  If there are pieces of a prenuptial agreement that should be re-addressed or clarified, think about amending it or executing a postnuptial agreement.  If you have no prenuptial agreement, think about a postnuptial agreement that addresses this situation.  Issues regarding who can own the company or force liquidation of the company can (and should) be addressed in a buy-sell agreement, but that does not ensure that a divorce court will follow those provisions.  If you have a business, especially with other family members, think through what might happen if a divorce were to follow a significant increase in the business’s value.   

2012 Gifting—When is a gift actually complete?

Many clients are doing year-end gifting this year. We have an unusually large gift tax exemption and thus the additional ability to gift without tax implications, and we are facing unknown tax laws going forward.  You may or may not be gifting assets, or receiving assets by gift, but I thought this might be a good opportunity (albeit boring—unless you are receiving a large gift this year) to discuss what it means to actually complete the gift by the end of 2012.

• Cash and checks—a gift of cash or checks is complete when the transfer of funds is complete or when the check is cashed.

• Real estate—a deed (warranty deed or quitclaim deed) is necessary to transfer the property. The gift is complete when the deed is delivered to the recipient or recorded in the appropriate county.

• Stock in a company—a decision to make the gift, or even a letter, is not sufficient.  There must be an Assignment Separate from Certificate with the stock certificate, or an endorsed stock certificate, to complete the gift of stock. The gift is complete when the assignment or endorsed certificate is delivered to the recipient or an agent of the recipient, but not if it is merely delivered to the agent of the person making the gift.  The agent of the recipient could be a transfer agent, but often either (1) there is no such thing for a closely held company, or (2) that transfer agent is considered an agent of the person gifting and not the recipient.  The other way to determine if the gift is complete is if the transfer is recorded in the company records.  Be sure to check buy-sell agreements or other documents for transfer restrictions.  If a transfer is done in violation of any such restrictions, it could be considered void even if it is otherwise complete.

• LLC’s/Partnerships—as is the case with the transfer of corporate stock, an assignment with an acceptance from the recipient will complete the transfer of interests in an LLC or partnership.  The gift is complete when control is transferred to the recipient. Again, consult the transfer restrictions or requirements applicable to new members in the company’s documents to be sure you comply with those requirements as well.

In addition to completing the steps outlined above, it is important after the fact to treat the asset that has been given as a gift as having been transferred.  For real estate, it is important to treat property as if the new owners have complete control.  Change the insurance, execute a lease to use the property, change the property tax information.  With stock or interests in LLC’s and partnerships, the company records should reflect the change, distributions should go to the new owners, any guaranties should be negotiated, new members should be added to the buy-sell or other corporate documents, and K-1’s should be prepared for the new owners.  Also, report these gifts on a gift tax return.  If you are gifting in 2012, or really any year, be sure to meet the reporting requirements with the IRS and have your attorney or accountant prepare a gift tax return in April of 2013.

Pre-Transaction Estate Planning Part 3: Installment Sales to Intentionally Defective Grantor Trusts (IDGTs)

Continuing from the first two parts of this series (the simple gift of business units and grantor retained annuity trusts), this installment is about the second leveraged gifting option—installment sales to intentionally defective grantor trusts, or IDGTs. I know…another acronym.

This transaction mimics a sale of business interests to a third party, but it is really a sale of business interests to a trust for the benefit of others that is disregarded for income tax purposes. Because it is disregarded, we call it “defective” and there are no capital gains on the sale.

An IDGT involves another irrevocable trust that is established by the grantor. Because it is a grantor trust, the grantor pays all the income taxes associated with the assets held in the trust.  The grantor establishes a trust to benefit others (usually children or grandchildren), and that trust will be the buyer of certain business interests.

Along with the creation of that trust, the grantor usually gifts some assets to the trust to fund it. Typically we recommend the gift represent about 10% of the value of the assets that will be sold to the trust. After the gift, the grantor usually sells business interests, at a price determined by an appraisal, in exchange for a promissory note. The assets are immediately owned by the trust, and thus any appreciation that happens after the sale is owned by the trust and eventually passed tax free to the trust beneficiaries.  Even if the grantor dies before the note is paid off, he or she is the owner of only the remaining payments on the promissory note, not the business assets.

The grantor retains the right to payments on the promissory note equal to the sales price for a specified term plus a prescribed interest rate.  The mid-term rate for August, or up to a nine year promissory note period, is only 0.88%.  The note can be structured to pay only interest with a balloon principal payment at maturity, or interest and principal payments for the entire note period.

As is the case with the GRAT example, this technique is especially successful if the grantor is expecting an appreciation event to happen.  If the stock is sold at a lower price to the trust, and then appreciates to a higher value, the trust beneficiaries retain that benefit tax free.

• Example. Business owner gifts $5,000,000 to an irrevocable trust. Subsequently, grantor sells $50,000,000 worth of stock to the trust in exchange for a $5,000,000 down payment and 9 year promissory note with interest-only payments. The business owner will receive eight annual payments of $396,000 based on August’s mid-term interest rate of 0.88% (an all-time low), and one final balloon payment of principal and interest of $45,396,000.  If the assets grow at 10% per year, the trust will contain over $75,000,000 after the nine years. All transfer tax free.  If the assets grow at 20% per year, the trust will contain over $200,000,000.

There are no income tax implications to selling the stock to the trust and only the initial gift has gift tax implications. This is a great technique if you are expecting an appreciation event, or even have steadily appreciating business assets. The owner continues to have an income stream, but removes the appreciation from his or her taxable estate.  This also passes some ownership interest without control, and the grantor can manage how that interest is voted and managed through the use of a trust.  This technique is a great way to take advantage of an appreciation event and the low interest rate environment, and to begin the succession planning process without giving up control of the entity.

Pre-Transaction Estate Planning Part 2: Grantor Retained Annuity Trusts (GRATs)

Building on the first installment of this series (the simple gift of business units), this second post will discuss the first leveraged gifting option—grantor retained annuity trusts, more commonly known as GRATs. Estate planners love acronyms, so almost every specialized technique will have some kind of acronym associated with it.

A GRAT is an irrevocable trust that is established by the grantor, and the grantor pays all the income taxes associated with the assets held in the trust. The trust is established to last a certain period of years, usually 2-5 years. Right now there are no limitations on the term length, but that is something Congress is considering changing.

The grantor transfers assets to the trust, and then retains the right to get ALL the assets back in annual installments in the form of an annuity. In addition to getting all the assets back, the grantor receives a prescribed interest rate. Any growth the assets have over the initial value plus that interest rate, the trust retains tax free. Generally the lower the rate, the more successful the trust is. After the prescribed term of years, the trust usually continues for the lives of children. Just as in the example in Part 1, if you anticipate your business will grow in value, have a sale event, go public, or experience some other appreciation event, you can capture all of that appreciation tax free.

Example. Business owner transfers $10,000,000 of appraised business assets to a GRAT for a three-year term. The business owner will receive three annual payments of $3,400,200 based on August’s rate of 1.0% (an all-time low), and if the assets grow at 10%, the trust will contain over $2,000,000 after the three years. All tax free. If the assets grow 30%, say in a sale, the remainder left in the trust will grow to $8,400,000 tax free.

If the assets go down in value there is no risk to you as grantor; the assets are treated the same as if you held the assets in your own name. There are no income tax implications to transferring the stock to the trust and there are little to no gift tax implications. This is a great technique if you are expecting an appreciation event, or even have steadily appreciating business assets. The lower the interest rate, the better the technique works, so now is the time to take advantage.

Pre-Transaction Estate Planning Part 1: A Simple Gift Illustration

Especially in a time of very favorable interest rate environments, depressed asset values, a large estate/gift tax exemption, and capital gains rates that are probably as low as we will ever see them, pre-transaction planning is not an overly exciting blog topic, but it is an important thing for business owners to be aware of.  So here’s the first of a series of posts about some of the estate planning options you have as you prepare for a sale, liquidity event, retirement, or any kind of appreciation event this year.

By pre-transaction estate planning, I mean the estate planning opportunities that can capture the up-side of any appreciation or liquidity event and spread it among family at a low or zero transfer tax cost.  Transfer taxes are taxes levied on the transfer of assets to others, either during life or at death.  Currently we have a $5,120,000 exemption to use during life or at death before the person transferring the assets pays any tax.  Any gifts or transfers over that amount pay a 35% tax (substantially lower than the 45% or 55% tax in prior years). In Minnesota there is a $1,000,000 exemption at death, and no limit during life.  Combined with the low interest rates, low capital gains rates, lower business asset values, and exemption amounts that are set to expire at the end of 2012, this is a prime time to do any pre-transaction planning.

I will start with the most straightforward example: gifts to family members of business interests.  If you currently own 100% of a business entity, and are looking towards a sale in the next 2-5 years, you can use gifts of business interests to spread out the upside of that future sale.  For illustrative purposes, pretend you own 100 shares of the entity, currently appraised at $10,000 per share, or a total entity value of $1,000,000.  You consider this to be a very low valuation, and expect you could sell the entity for a higher price in a couple years.  You could transfer 1, 2, or even 5 shares to each of your grandchildren, in trust or outright.  If 4 grandchildren each own 5 shares, you still own 80% of the company, clearly retaining control.  The 5 shares are valued at $50,000, and because they are minority interests in the company and so are non-marketable business interests, could even be discounted further to $40,000 or $45,000 gifts.  The total gift is $160,000 to $180,000, barely using any of your allotted $5,120,000.  There is no tax due as a result of these gifts.  Fast forward 3 years, and you sell the company for $3,000,000 or $30,000 per share.  Now the grandchildren each have $150,000 and there is no additional gift implication.  The appreciation of $110,000 belongs completely to the grandchildren transfer tax-free. 

There are any number of variations to this example. You could create and gift non-voting shares, gift to dynasty trusts to last generations, or gift to a holding entity like a family limited partnership.  As this series progresses, I will discuss more leveraged gifts and how to use estate planning to make the sale of your business more appealing.

What if Your Heirs Become Hoarders?

Estate Planning Considerations for Heirs That May Have Addictive Behaviors or Mental Illnesses

Last week I was watching the intellectually stimulating program Hoarders, and it featured a gentleman named Kevin McCrary (Season 4, episode 53). Kevin is the son of famous parents and the beneficiary of a sizeable family trust. Kevin is also homeless because his Upper East Side apartment is completely full of trash.

Kevin McCrary is the perfect example of how trust beneficiaries can end up in a very different situation than the creators of the trusts intended, because of addictions or mental illness. Especially when trusts are created to benefit generations far removed from the creators of the trust, it is difficult to predict what provisions may be required. I’m pretty sure “hoarder” wasn’t even a term people used when his parents created their trust.

Two years ago, Casey Johnson, an heir to the Johnson & Johnson family fortune, died at the age of 30. Casey had a serious drug problem that was partially funded by access to her family’s wealth. Many of her trusts were able to turn off distributions and prevent her from paying for a lavish lifestyle of drug use, but not all of them could. She spent years estranged from her family, but living off the income of trusts to support her dangerous drug habit.

This is a problem that is appearing more and more in my practice. Parents or grandparents have executed complex estate plans that now benefit children or grandchildren, or they have even moved wealth during their lives through a variety of tax advantageous techniques that resulted in trusts for children or grandchildren. After those documents are in place, and are most likely irrevocable, the beneficiary develops a drug problem or a mental illness becomes more apparent. The trust terms often don’t anticipate these problems and may require a trustee to pay for any health or welfare related expense—including the twentieth time to rehab—or even to make mandatory income distributions to that beneficiary of significant amounts. Further, some trusts may lack the flexibility to assist a beneficiary in the appropriate treatment of a mental illness or to pay for psychotropic medications. 

It is very difficult to reform a trust after it is in place, especially if the reformation changes the interests of the beneficiaries. It is much simpler to add language from the beginning that provides flexibility if a drug addiction or mental illness should arise. I am finding that I recommend this language more and more to clients, especially if we are doing long-term legacy planning or funding irrevocable trusts with significant assets.