In this video blog, Associate Director of Education, Steve Hartnett, discusses same-sex marriage update and planning opportunities. This blog gives a brief update of the status of same-sex marriage as it expands to more states. It also examines two planning opportunities which still exist for same-sex couples, which would disappear if the Defense of Marriage Act (DOMA) is held to be unconstitutional by the Supreme Court. A decision in Windsor, which examined that issue, is expected in June.

If a client dies without leaving a Will or Trust or other instructions regarding their assets, the assets pass via intestacy. Intestacy, essentially, is the default Will for each person dying a resident of that particular state. Every state has such a default Will for its residents.

The default Will that is provided by intestacy varies slightly from state to state. However, they typically provide for the spouse and children in some percentages. If those people do not exist, then assets go to the decedent’s family of origin, typically. At the end of the line, the state has put in an heir of last resort. Therefore, if there are no living relatives of the specified degree, there is always somebody standing there to take. Guess who states have chosen for the role of heir of last resort? Themselves. That’s right, the state of residence is the heir of last resort. The assets “escheat” to the state.

You may think this never happens. Or that it last happened in 1865, right after the Civil War. But, that’s not the case. It even happens nowadays. Roman Blum recently died a resident of New York. Lucky New York! Blum left no Will. Blum also left no spouse, descendants, or relatives. Blum was a holocaust survivor who was childless and whose wife predeceased him by more than a decade. Thus, his entire estate of $40 million will go to the Empire State. Here is a recent article in Forbes about the situation and an article in the New York Times about Blum.

Of course, if you can prove you are related to Mr. Blum, then you would inherit and the estate would not escheat to New York. You better start looking back at that family tree!

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

It is difficult to overestimate the importance of communication. We all know it is essential for lawyers to communicate with their clients. It is only through such communication that the client knows what is going on with their case. The lack of such communication is a leading cause of bar complaints and malpractice suits. But, clients often do not know that it is also essential for them to communicate with their loved ones about their estate planning.

It is difficult to think about one’s own mortality. It is even more difficult to talk about it. That is why clients don’t like talking about the plans they’ve made to address what should happen in the event of their incapacity or death.

The problem is that client goals may be diminished or even thwarted without such communication. For example, clients almost uniformly want peace and harmony among family members after the client’s death or disability. The best way to achieve that goal is through… communication.

A surprise in the disposition of assets or the selection of those to serve in key roles, such as trustee, can disrupt family peace and harmony. Long-buried hostilities may resurface. Sibling rivalry, which had seemed long-vanquished, can rise again. Does the choice of one sibling rather than the other as trustee indicate that “mom loved you best”? If mom explains her reasoning in person, the matter may be settled relatively easily. However, if mom is dead or in a coma, she cannot explain her choice. Then, the emotions due to mom’s death or incapacity and the emotions of anger and fear can become mixed and amplified. Before you know it, the family’s peace and harmony is shattered, which is exactly what mom did not want to happen: family conflict.

Communicate with your clients. And, encourage your clients to communicate their wishes to their loved ones. It’s the best way for them to achieve their goals.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

A recent case caught my eye. First, the facts had an interesting twist. But, second, divorce is sometimes considered by couples who wish to protect assets from Medicaid or for other financial reasons.

In Burnett v. Burnett, the court looked at a divorce case. But, this was no ordinary divorce case. The traditional couple was married in 1984. However, in 2003, the party to the marriage who was born a man underwent gender reassignment surgery and became “Bobbie.” At that time, Devon, who was born and continued to be a woman, was not competent. Devon’s children, as her conservators, sued for divorce.

There were two primary issues in the case. First, since Michigan does not recognize same-sex marriage, did the gender reassignment surgery act as an automatic divorce? Devon’s conservator/children argued that the reassignment surgery acted as an automatic divorce. The court found that it did not. The parties were not the same gender when they were married back in 1984. The fact that one party underwent gender reassignment surgery did not invalidate the marriage.

Next, the court addressed whether a conservator can bring a divorce action for the conservatee, or, if divorce is a personal action and only exercisable by the individual himself or herself. The court found that a conservator may bring any action on behalf of the conservatee, including a divorce action.

Thus, in Burnett v. Burnett, Devon’s children/conservators were able to bring a divorce action on Devon’s behalf.

While few of your clients will have these circumstances arise, it is interesting to note that divorce is still a possibility, even after the incapacity of a client. Divorce is a drastic step that Medicaid rules now make less attractive. Medicaid now allows a substantial Community Spousal Resource Allowance that keeps the “well” spouse from being completely impoverished. But, if the circumstances require a divorce, it may be possible to achieve, even if one of the parties no longer has capacity.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

In this video blog, Associate Director of Education, Steve Hartnett, examines the Obama Administration’s “Green Book,” or revenue proposals. The blog discusses the 5 proposals of greatest interest to estate planning attorneys.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

President Obama recently released the Administration’s FY2014 budget proposal, including the Treasury’s “Green Book.” There were some interesting inclusions.

Many estate-planning attorneys breathed a sigh of relief in January, when ATRA was passed with a $5.25 million applicable exclusion. More importantly, they were relieved by the certainty of the removal of the “sunset” provision in the prior law. We finally had a “permanent” estate tax. We now learn just how “permanent” it may be. Only a few months after ATRA’s passage, the President has issued his proposal to modify the estate tax once again.

The budget would reduce the exclusion to $3.5 million, the 2009 level. Perhaps more importantly, it would remove the inflation-escalation provision and limit other strategies. This is basically the same as last year’s proposal, before ATRA was passed.

In addition, the proposal would limit tax-favored retirement accounts to a maximum of $3 million. This is concerning because it appears that these accounts are increasingly viewed as a potential source for increased revenue. Last year, the Senate Finance Committee had a bill that included a provision that essentially would have imposed the 5-year distribution rule on all accounts at death, other than ones going to the surviving spouse. While the Committee did not include it in the final mark up, it shows that increased revenue from retirement accounts is on the radar.

Does suggested planning change in light of this budget? It might accelerate it. If you have a client with over $3.5 million in assets, you may consider having them plan more aggressively to keep the value in their taxable estate down. As a reduction in the value of the taxable estate can take years with a methodical plan, it may be best to start sooner rather than late.

As for the proposed change to retirement money, one strategy would be to convert assets to Roth plans. That would make the value in the plans worth more, as they would be after-tax dollars.

Of course, the President’s proposal is just that, a proposal. Even though it comes from the President, passage is far from assured. We will have to wait to see what tax legislation comes out of the House and Senate.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

Often, there is confusion regarding the income taxation of trusts. There are two general types of trusts for income tax purposes: grantor trusts and non-grantor trusts.

A grantor trust gets its status because the grantor has one of the powers listed in sections 671-678 of the Code. Some of these powers also trigger estate tax inclusion, like the power to revoke. Thus, a RLT is a grantor trust because, as its first name suggests, it is revocable. Some of the powers do not trigger estate tax inclusion, such as the power to substitute assets. Thus, you can have a trust which is out of the grantor’s estate for estate tax purposes, but is income-taxed to the grantor. This has become known as an “intentionally defective grantor trust.”

A grantor trust is taxed directly to the grantor for income tax purposes. It can use either the grantor’s social security number or a tax ID number. Financial institutions may give some resistance on using the grantor’s social security number, but it’s right in the regulations. (See Treas. Reg. § 1.671-4).

One of the best ways to get value out of an estate is through the use of a grantor trust that is out of the estate for estate tax purposes (an intentionally defective grantor trust). With such a trust, the grantor pays the tax on the income, even though it will be held for or distributed to the beneficiaries of the trust. Let’s look at a quick example. Mary sets up a grantor trust, using $5 million of exclusion. The trust earns income of 2%, or $100,000. The $100,000 gets reported on Mary’s Form 1040 and she pays the tax, say $40,000. That $40,000 is not an additional gift to the beneficiaries or the trust. Thus, the trust gets to grow without the diminishment from payment of the income taxes.

A non-grantor trust is taxed to the trust itself. A non-grantor trust gets a distribution deduction when it makes distributions to the beneficiaries that carry out its income. This carries out the taxability to the beneficiary. Thus, a non-grantor trust which distributes the income has it taxed to the beneficiary.

Non-grantor trusts have a significantly compressed run-up in income tax rates. They hit the maximum income tax rate of 39.6% on less than $12,000. Thus, it often makes sense to distribute the income to the beneficiaries, especially if they are in lower income tax brackets.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

I’ve blogged in the past about how a Charitable Remainder Trust can help avoid the 3.8% Medicare surcharge and the 20% income tax bracket for capital gain / dividend income. It does so by spreading income out and paying it out when the taxpayer is in a lower income tax bracket.

So, too, life insurance can be used as a way of avoiding these taxes. Life insurance is a tax-free wrapper that can be used to avoid or defer taxes. Only when more than the taxpayer’s basis (i.e., the contributions) is withdrawn from the policy is it subject to taxation. In the interim, the assets are able to grow tax-free.

With a CRT, you get a charitable deduction upon contribution. Of course, with life insurance, there is no charitable deduction upon contribution. However, the earnings inside the policy can be sheltered from income taxes. Thus, like a CRT, life insurance is a way of contributing assets and getting future income sheltered.

Thus, a taxpayer can buy a single premium whole life policy and the income on / growth of the funds can be sheltered. Eventually, when the death benefit is paid out, it goes to beneficiaries free from income taxes. Of course, the death benefit will be included in the taxable estate for estate tax purposes if the insured owns the policy or has any incidents of ownership, like the ability to change the beneficiary. Today’s $5.25 million applicable exclusion means estate taxes are less of an issue for most people. However, if estate taxes are a concern, an irrevocable life insurance trust is still a great way to remove the policy from being subject to estate taxation.

Life insurance is not for everyone. Some people have health issues that make the insurance component too expensive. Depending on the company and policy, there may be other management fees that bring down the overall return. However, it is an option worth considering as a way to lower your clients’ taxes.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

Yesterday, the Supreme Court heard oral argument in Hollingsworth v. Perry, the case concerning the validity of California’s Proposition 8.

A link to the audio and transcript of the oral argument is here.

The California Supreme Court had held marriage was a fundamental right for all couples in California, without regard to gender. Thus, same-sex marriage ensued in May 2008. In November of the same year, Proposition 8, which defined marriage as only between a man and a woman, effectively overturned the California Supreme Court’s decision.

Today, the Court hears oral argument in U.S. v. Windsor, the case concerning the validity of the Defense of Marriage Act (“DOMA”). DOMA provides that only a marriage between a man and a woman will be recognized by the federal government, among other provisions which are not directly at issue. In Windsor, a decedent woman had been married to another woman. Their marriage was not recognized for purposes of the federal estate tax marital deduction, resulting in a greater tax burden for the estate.

These cases have far-reaching implications for your same-sex client couples (current and future) and for the estate planning which you might do for them on a go-forward basis. Nine states and the District of Columbia currently allow same-sex marriage. In addition, some states recognize same-sex marriages validly created elsewhere. In whatever state you are located, these cases could have great impact on LGBT planning in your state.

If your state allows or recognizes same-sex marriage, Windsor could result in federal recognition of those marriages. Federal recognition would mean that planning for same-sex couples might be much the same as planning for traditional married couples. This would impact not only estate planning, but also elder law planning, and financial planning. Federal recognition would mean that both spouses’ assets would be considered for Medicaid purposes. It would also mean eligibility for Social Security Survivor benefits and a broad range of other federal benefits including the ability to file a joint tax return.

If your state does not allow or recognize same-sex marriage, Hollingsworth v. Perry could hold that there is a constitutional right for same-sex couples to marry in all states.

These changes could mean significant changes in planning for LGBT couples. You will want to be prepared.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com

Grantor trusts are a thing of beauty (well, for a tax geek, anyway). All of the income of a grantor trust is taxed to the grantor of the trust, even if it is distributed to the beneficiaries. A non-grantor trust, by comparison, is taxed to the trust itself or to the beneficiaries (if there are distributions carrying out “distributable net income”). The result is that a trust could be set up for which the income tax liability is that of the grantor. Of course, this makes sense in the case of a revocable trust. But, even irrevocable trusts may be created as grantor trusts.

For now, at least, it is possible to draft a trust so that it is irrevocable and out of the taxable estate for estate tax purposes, yet taxed to the grantor for income tax purposes. (Sometimes such a trust is confusingly referred to as a “defective grantor trust.”) Such a trust provides extra bang for the transfer-tax buck. Let’s look at an example to see the reason.

John had a taxable estate and wanted to remove as much as possible from his estate. He set up two trusts, Trust A and Trust B. He contributed $1 million to each trust. Trust A is drafted as a grantor trust, Trust B is drafted as a non-grantor trust. Each trust has $50,000 of income each year. With Trust A, the income is taxed to the grantor, increasing his tax bill by $20,000. Trust B pays its own taxes from the trust corpus. The result is that Trust A can grow at 5% per year, while Trust B grows at only 3% per year, on an after-tax basis. After 20 years, Trust A would have $2.65 million, while Trust B would have only $1.81 million. (The payment of tax by the grantor is not considered an additional gift.)

The opportunity to have the best of both worlds with a grantor trust may be coming to an end. The administration would like legislation to align grantor trust rules and estate tax rules. In other words, if Treasury has its way, all grantor trusts would be included in the taxable estate of the grantor.

While such a change would not be welcome, estate planning attorneys and their clients would be well to make hay while the sun shines. While you can, use this tool that the administration recognizes is too good a deal for the taxpayer. If you draft a trust as a grantor trust, you may want to consider using a provision that allows an independent trust protector or special co-trustee to toggle off the grantor trust status, just in case Treasury gets its way.

Stephen C. Hartnett, J.D., LL.M.
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com