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.

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.

Using a Charitable Trust to Offset Capital Gains

We are approaching the extended income tax deadline for 2012 and it reminded me (as if anyone could forget) that 2013 carries significantly higher income tax rates for a lot of folks. We have the Medicare surcharge, and most of rates increased as well at a state and federal level. Between now and the end of the year, many people, including cash strapped entrepreneurs, will begin to assess their income tax situation for 2013—WARNING, you won’t like it. One of the things that are (happily) back this year is capital gains.

I wanted to use this post to introduce an interesting way to offset capital gains—a trust for charities and other beneficiaries called a charitable lead annuity trust, “CLAT”—yes, we estate planners have an acronym for just about everything… A CLAT is an irrevocable trust that pays an annual amount to charity for a period, usually a term of years. At the end of this term, all assets remaining in the trust are given to one or more non-charitable beneficiaries. Any appreciation on the trust assets in excess of the specified amount given to charity each year will pass to the remainder beneficiaries free of tax.

There are two types of CLATs, a “Grantor CLAT” and (what else) a “Nongrantor CLAT.” With a Grantor CLAT, the grantor will receive an immediate income tax deduction for the present value of the charity’s interest when the trust is funded, but the trust’s income will be treated as the grantor’s income for income tax purposes. This is where the offset of capital gains comes in, a large charitable deduction.  In contrast, with a Nongrantor CLAT, the grantor will not receive an income tax deduction upon creation, but will also not pay any income tax on the trust’s income. 

When a CLAT is created, the present value of the remainder interest for the noncharitable beneficiaries (e.g., a sibling, child, niece or nephew) will be a taxable gift. This portion is calculated using the term of the trust and the current IRS §7520 rate.  The §7520 rate was at a historic low of 1.2% for June, but was up to 2.0% for August. We have the option to use any of the last three months’ rates.  A low rate means that the present value of the remainder interest will be extremely low—resulting in a low value taxable gift, even though the eventual benefit to your sibling or niece or nephew may be significantly higher. Essentially, any growth of the trust assets in excess of the projected rate of 1.2% will pass to your child, sibling, or niece or nephew tax free.   

Below you will find an illustration of how you could use that spare $1 million you’ve got lying around (from your last successful venture) to create a CLAT that would benefit of one or more charities for a term of years and then benefit your beneficiaries when the trust terminates. In preparing these calculations, I used the IRS rate for June (1.2%); I also assumed that the trust would pay out 5% each year and would be for a term of 15 years.  

Charitable Lead Annuity Trust: 

Initial Contribution:          $1,000,000
Term of the Trust:          15 Years
Initial Annual Payout to Charity (5%):            $50,000
Present Value of Interest for Family:          $317,355
Present Value of Charitable Interest:          $682,645
Immediate Charitable Deduction:  $682,645 (If a Grantor CLAT)
Taxable Gift to Sibling, Niece, or Nephew:  $318,871
Expected Value on Termination (7% Growth):$1,502,580
Benefit to each of Child: $751,290 (assumes 50/50 division between 2 children)

Although you would have an initial taxable gift of $318,871 (which reduces your lifetime exemption of $5,250,000), you would eventually transfer $1,502,580 without any tax.  If you share in this gift with a spouse, it will impact each of your lifetime exemptions by half as much. Using the above example, you would receive an immediate income tax deduction of $682,645!  Amazing option to benefit your favorite charities and beneficiaries while offsetting some gains this year. 

I often recommend this to clients with high earning years, or when selling a substantial block of stock or a business. It is just another tool in the estate planning toolbox that not many people know about.

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.

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.

Can Successful Entrepreneurs Use Incentive Trusts To Help Their Kids?

In his article, "Should You Leave It All to the Children?," Richard Kirkland quotes Warren Buffett for having said, “The perfect amount of money to leave children is enough money so that they would feel they could do anything, but not so much that they would do nothing.” In that same article, Minnesota native and famous entrepreneur, Curt Carlson, was quoted as saying, “There’s nothing people like me worry about more—how the hell do we keep our money from destroying our kids?”

Incentive trusts are a type of trust, often for the benefit of children, that make distributions or allow for withdrawals based on defined incentives. For example, if a child graduates from an Ivy League college, they can withdraw 10% of the trust principal, or if a child earns up to $100,000 per year, the trust will match that income.

Often, first generation wealth holders—or, in many cases, the entrepeneur that built the business—want to use incentive trusts to protect the money they intend to pass on to their children and impose some kind of control after their deaths. Incentives may seem like a good way to inspire your children to act and participate in society the way that you would want them to after your death, but often incentive trusts don’t work or may even backfire. Evidence suggests that money is helpful in controlling people, but not necessarily internally motivating people. Individuals subject to incentives will rarely go beyond the incentive benchmark.

For example, if you match income up to $100,000, very few people would ever strive to earn more than $100,000 or would ever start a business where the earnings may be more uncertain or less than $100,000 for a period of time. In addition, what might seem like a good incentive, like attending an Ivy League school, doesn’t actually ensure that the child will graduate or do anything with the degree. Some children may view the incentive as impossible, so they never try. In other cases, the trustees end up spending years in litigation with the child who demands distributions from the trusts that are outside of the incentives. This may be good for lawyers like my colleagues who handle these types of claims, but it is rarely good for the child or the family. Finally, drafting a trust agreement that perfectly insulates the trustee, yet makes the incentive clear and enforceable, is difficult if not impossible in most circumstances.

The bottom line is this: Trusts don’t develop values on their own. Incentives don’t usually work in the way we want, and may unintentionally cost the child ambition and potentially drain the trust in litigation fees. Try your best to impose good financial habits, charitable inclinations, and financial sense during your child’s life. If you can’t, and you are worried about how your children may spend their inheritance or manage a business in their trust, limit the amount they receive or ask your estate planner to give a professional trustee (a non-family member) unfettered discretion to make and withhold distributions.