An often asked question regarding the administration of Trust or Estate after a death occurs is:
1. What happens if the beneficiary predeceased the decedent?
In this age of longevity, it is not uncommon for a beneficiary named under the terms of a Trust or a Last Will and Testament to predecease the inpidual creating the Trust (the “Trustor”) or the inpidual creating the Last Will and Testament (the “Testator”). When this occurs, what happens to the bequest? For example, a Trustor provides that a specific bequest of $50,000.00 be given to her son, Joseph. However, Joseph predeceases the Trustor. When the Trustor dies, what happens to the bequest? Does it lapse and become null and void? Or is it still legal effective? The answer is it depends on the terms of the Trust or Will and the facts of the situation. Nevada has an anti-lapse statute which provides that a bequest is saved and does not lapse if the predeceased named beneficiary is a child or other relation of the Trustor-Testator and the beneficiary left lineal descendants who survived the Trustor-Testator, unless the Trust or Will provides otherwise. NRS 133.200 provides as follows:
“When any estate is devised to any child or other relation of the testator, and the devisee dies before the testator, leaving lineal descendants, those descendants, in the absence of a provision in the will to the contrary, take the estate so given by the will in the same manner as the devisee would have done if the devisee had survived the testator.”
In our example above, the predeceased beneficiary, Joseph is a child of the Trustor-Testator. If Joseph left lineal descendants (child, grandchild, et cetera) and the Trust or Will does not provide otherwise, the $50,000.00 bequest will not lapse but will pass to Joseph’s lineal descendants. This may or may not be what the Trustor desires. When one creates a Trust or Will, one should always discuss and consider the possibility of a beneficiary predeceasing. If one does not want the bequest to pass to Joseph’s lineal descendants, the Trust or Will should specifically state that in the event Joseph predeceases, the bequest shall lapse or shall pass to some other beneficiary.
At the Jeffrey Burr law office, we have many years of experience in assisting clients in their estate plans through the drafting and execution of their Trusts/Wills. As part of this service, we go to great lengths to determine exactly what the client desires, including the client’s wishes in the event a named beneficiary predeceases the client.
During the two years before expiration of the “Bush Tax Cuts” (which, from enactment, were set to end on December 31, 2010) tax attorneys expected something to come out of Washington which would provide clarity going into 2010, the year in which the estate tax was fully phased out, and for 2011, the year in which the estate tax was set to come roaring back with the full 55% top rate and an estate tax exemption reduced to $1 million, from the $3.5 million exemption available to estates of decedents dying in 2009.
By the end of 2010, most estate planning professionals guessed that a deal was not going to happen and that the 55% rate and $1 million exemption would come back in 2011, but like the U. S. Cavalry in a John Wayne movie coming to the aid of the settlers, Congress acted just in time, December 17, 2010, to increase the estate exemption to a full $5 million per person with a top estate tax rate of “just” 35%. This law is set to expire on December 31, 2012, and if not extended, will put us back to the 55% rate and $1 million exemption, so we could go through this exercise again in less than two years. The fact that we could end up with a reduced exemption in 2013 has prompted some advisors to suggest caution about using the $5 million exemption for gifts and general planning considerations.
The writer of this blog has been involved with the estate tax for 35 years now and during that time, despite all the rhetoric and hand-wringing, the estate tax exemption has never been reduced, other than through the 2011 repeal of the repeal of the estate tax. Before November 1981’s Economic Recovery Tax Act (“ERTA,” we affectionately called it; funny how those acronyms usually work out) the maximum exemption was only $60,000 as I recall, and with ERTA, it immediately jumped to $200,000 and then grew each year to be $600,000 per person. Then in the late 90’s the exemption was increased from $600,000 to $675,000 and then to a full $1 million at the turn of the millennium. (I have been waiting for the right time to use that phrase, “Turn of the millennium.”) Then with the Bush Tax Cuts, the exemption grew steadily from $1 million, to $1.5 million, to $2 million and finally to $3.5 million in 2009, which brought us to full repeal for those heirs lucky enough to inherit from decedents dying in 2010. So ignoring the repeal year of 2010, the exemption amount has now grown from $3.5 million to $5 million per person. What’s more, “portability” now exists between spouses, meaning that a surviving spouse basically “inherits” the right to use the unused exemption of their last deceased spouse.
With a history of 35 years and no reduction in the estate tax exemption over that time, what are the chances Congress will cut back the existing exemption from $5 million to something less? This blogger sees that as doubtful. Some might argue that Congress will try to raise revenue on the backs of the “rich” and will reduce the $5 million exemption. While this is possible, such a move would be more cosmetic than anything else because, even when the rates were higher and the exemptions lower, the estate tax has normally provided only about 2% of federal revenues. Therefore, barring a demagogic move at raising the estate tax, it is likely the exemption will remain at $5 million, at least. It is, therefore, this blogger’s opinion that clients should make their plans based upon the expectation that the $5 million exemption is here to stay.
The following snippet was taken from Bill Bischoff's article as published in the Wall Street Journal's Market Watch web page on February 16, 2011.
"16 States and DC Have Estate Taxes
"The sixteen states and the District of Columbia, which impose their own estate taxes (as opposed to inheritance taxes, which I will explain later) base their taxes on the entire value of an estate in excess of the applicable exemption.
"The exemptions vary from a low of $338,333 to a high of $5 million. Specifically:
* Three states have exemptions of less than $1 million (Ohio at $338,333; New Jersey at $675,000; and Rhode Island at $850,000).
* Six states have $1 million exemptions (Maine, Maryland, Massachusetts, Minnesota, New York, and Oregon), and so does D.C.
* Three states have $2 million exemptions (Illinois, Vermont, and Washington).
* Two states have $3.5 million exemptions (Connecticut and Delaware).
* Two states have $5 million exemptions (Hawaii and North Carolina).
"The lowest tax rates are 7% (Ohio) and 12% (Connecticut). The highest is 19% (Washington). The other 13 states and D.C. all charge 16%.
"6 States Have Inheritance Taxes
"The inheritance tax exemptions are zero or negligible--except in Tennessee which has a $1 million exemption.
"The tax rates are 9.5% in Tennessee, 15% in Iowa and Pennsylvania, 16% in Kentucky, 18% in Nebraska, and 20% in Indiana.
"Worst Case: 2 States Have Both
"Maryland and New Jersey raise confiscation to a higher level by charging both an estate tax and an inheritance tax. In Maryland, the inheritance tax exemption is a whopping $150 and the tax rate is 10% (in addition to the 16% estate tax rate). In New Jersey, the inheritance tax exemption is zero and the tax rate is 16% (in addition to the 16% estate tax rate).
"The Other 28 States Have No Estate or Inheritance Taxes
"The 28 states NOT listed above[, including Nevada,] have no estate or inheritance taxes. They are better places to die."
For the past 10 years we have seen the estate tax exemption increase from $600,000 to $675,000, then to $1,000,000, then to $1.5 million, then $2 million, then $3.5 million in 2009 and finally in 2010, the one-year repeal of all estate taxes.
Over the last thirty years we have seen many changes in the estate and gift tax. In the 1990’s, with the upward climb in the stock market and real estate values, and with the estate tax exemption frozen at $600,000, we saw the growth of many estates far outstrip the exemption. For married couples, the A-B trust planning technique, which required at the first death between spouses that the joint estate be pided between the survivor’s trust and the exemption trust (the exemption trust also known as the “B” trust, or as the unified credit trust) would allow avoidance of estate taxes on a full $1.2 million at the second death. But if the estate exceeded the $1.2 million, there was the looming prospect of the heirs paying upwards of 55% tax on the estate in excess of the $1.2 million exemption.
In response to this concern about estate taxes, many people utilized family limited partnerships to put a cap on the growth in their estates. Taking advantage of the annual gift tax exclusion of $10,000 per donor, per donee (i.e. if there were two parents and three children, then the total number of exclusions was six, three for each parent, and even more if parents wanted to make gifts to children’s spouse or to their grandchildren) but not wishing to actually give money to these people, parents would create the family partnership, fund it with a parcel of real estate (or other types of assets) and then give children, grandchildren and even sons- and daughters-in-law shares of the family partnership. The result was that Mom and Dad’s estate was reduced by the value of the gifts of shares in the family partnership transferred to the heirs while allowing Mom and Dad to maintain control of the family wealth.
The IRS fought this planning technique but the IRS attacks were generally rebuffed by the courts as long as certain formalities in the formation and administration of the partnership were followed.
Due to the increase in the estate tax exemption in 2007 to $2 million per individual (hence $4 million for husband and wife using an A-B trust) and increasing to $3.5 million per person in 2009, the need for estate tax planning was curtailed except for those persons having what most of us would consider to be significant wealth (i.e. more than $7 million for a married couple).
But here we are now with the prospect that the estate tax exemption will drop back to $1 million per person in 2011. There is always talk of legislation which would increase the exemption beyond the $1 million, but for now, prospects do not seem especially good for any such increase. So with the drop in the exemption back to $1 million, many people who thought their heirs would be free from paying the estate tax are once again facing the likelihood of a significant portion of their estates being taken by this confiscatory tax.
If you, the reader, feel that paying taxes is your civic duty, and if you believe the government will make better use of your estate than will your heirs or charities, then there is no point in trying to plan around this tax. But if it bothers you that you have spent your entire life paying taxes and are concerned that what you have worked a lifetime to acquire and save is once again at risk of confiscation by a government which seems to have no limits on its ability to consume and redistribute, then maybe it is time to start thinking about estate tax planning the way it was done back in the 1990’s. If so, you might want to give us a call. If you are not concerned, then we thank you in advance for your contribution to the public weal.
In the wake of the real estate market meltdown, homeowners are often left singed with unexpected tax consequences from a foreclosure or short sale. Here are a few issues you may want to address if you, like many others, are left with a home that is “upside down” and are trying to determine your best course of action.
Tax treatment of foreclosures and deeds in lieu of foreclosure.
Foreclosure is the legal process whereby a lender obtains a court-ordered termination of a delinquent borrower’s interest in the borrower’s mortgaged property by forcing the sale of that property. The property is sold under the court’s supervision, with the proceeds going first to satisfy the mortgage, then other lien holders, then the borrower. In the current economic climate, of course, the fair market value of the property is likely to be lower than the amount borrowed to purchase that property. In that case, the proceeds are still applied first to the mortgage; however, an amount remains due on the loan. Depending on the type of promissory note signed by the borrower, the lender may have an action against the debtor personally for the balance.
If the debt is only secured by the real property, the debtor is not personally liable for the deficiency between the principal amount of the mortgage and the fair market value or sales price of the property, and the debt is referred to as a “non-recourse” debt. If the debt is "recourse," the debtor is personally liable for the debt above and beyond the value of the real property securing the debt. In Nevada, most mortgages in the residential context are recourse, and debtors are personally liable for any unpaid loan amounts on their mortgages after a foreclosure sale.
The tax treatment of a foreclosure also differs based on whether the debt is non-recourse or recourse. When a foreclosure (or deed in lieu of foreclosure) takes place in the recourse loan context, the debt is satisfied up to the fair market value of the property, and the transaction is treated as a sale. If the lender forgives the balance of the mortgage, the IRS treats the amount forgiven as ordinary income, which is reported to the borrower on “Form 1099-C Cancellation of Debt,” which must be reported as income on the borrower’s income tax return in the year of forgiveness. Hence the borrower is left homeless and may be taxed for the forgiveness of the debt above the fair market value of the house. There are certain exceptions that may apply, and you should consult with your tax advisor with the specifics of your situation.
When a nonrecourse mortgage is foreclosed, the property is treated as being sold for the balance of the mortgage regardless of whether the sale price equals or exceeds the amount borrowed. The balance of the loan above the fair market value of the home is not treated as income to the borrower; thus, the borrower is not taxed on any type of “forgiveness of debt income.”
Taxation of short sales.
A “short sale” is similar to a foreclosure in that the sale proceeds fall short of the balance owed on the property’s loan. It differs from a foreclosure because, in a short sale, both the lender and the borrower agree to sell the property at a loss in order to avoid foreclosure.
In a recourse debt scenario, even if the bank agrees to a short sale of your residence, the debt is not necessarily cancelled. Therefore, any debt not satisfied with the sale proceeds would be taxable as cancellation of debt income similar to the foreclosure situation above, with a few exceptions. For non-recourse debt, the seller and buyer can require the lender to cancel the debt as a condition of the short sale. In that case, the debt cancellation is included in the sale proceeds; therefore, it is not taxable as income to the seller.
A short sale can be a viable alternative to a foreclosure for debtors with nonrecourse debt and who qualify for certain exclusions. Be aware, however, that the lender has up to 6 years in the short sale context to try to recover a deficiency from the borrower compared to only 6 months in a foreclosure.
We are now nine months into 2010 and many of the same questions facing estate planners and their client earlier this year in January are still unanswered.
Will we see estate tax legislation prior to 2011 preventing a return to a pre-EGTRRA tax regime?
Will that legislation affect the current estate tax environment and provide for the retroactive installment of an estate tax?
How do I handle this carryover basis business?
What federal estate tax form should be filed for persons dying during 2010?
Thus, with these and other unanswered quizzical queries floating around the estate tax world, what’s an estate planner to say at the next neighborhood BBQ when his/her clients, tax preparing colleagues, and/or the throngs of interested parties and neighborhood children are almost certain to ask if a 706 needs to be filed during 2010? Unfortunately, as far as we can tell, these and many similar questions are no closer to being answered today than they were at the beginning of the year. And with a pivotal election season on the horizon, it’s unlikely we’ll see any resolution on the estate tax front before November. That being said, there are some hints of guidance and forthcoming information in the area of estate tax return compliance which we are wont to share with you, our readers, as expressed below:
First, Internal Revenue Code Section 6075 addresses the time for filing an estate tax return. Section 6075 states that those required to file estate tax returns are required to do so by the due date on which the final federal income tax return the decedent would have filed, i.e. April 15, 2011. At this point, you might be saying, “That’s great! But, on what form do I report the pertinent information, and how do I file it, seeing as how there is no IRS Form 706, United States Estate (and Generation- Skipping Transfer ) Tax Return for 2010 available?” To which I would reply, “See my second point below.”
Second, the word on the street is that the IRS will not be releasing a traditional Form 706 for 2010. Rather, the Service will be providing a new type of return meant to address the carryover basis provision of the 2010 estate tax law as well as the accompanying allocation of stepped-up basis allowances ($1.3 million to anyone and $3 million going to a spouse or QTIP-like trust) feature. Apparently the new return will require that within 30 days of its due date, each person receiving property as part of the administration of the trust/estate is to receive the basis information being reported on the return. Additional information from the IRS supports the rumor that the death of the 706 for 2010 is not exaggerated seeing as how an attorney for the IRS (Patrick Leahy) publicly stated that it is not necessary to file a Form 706 this year and that if one is filed, it will be returned to the party that filed the form. Consequently, in an estate tax world of many uncertainties, at least three things are quite certain: (1) The IRS will provide a mechanism to report the allocation of stepped-up basis on inherited assets for 2010; (2) the tracking of this basis will likely be the bane of many a CPA’s existence for years to come; and (3) whatever you do, don’t file a Form 706 for 2010.
Third, if new estate tax legislation is not put in place in the near future, the estate tax regime formerly known as a “55% rate and a $1 million exemption”s will be making an encore appearance come 2011. In the event of such an occurrence, rest assured, one more thing is relatively certain: enough federal estate tax returns will be filed for deaths taking place in 2011 to more than make up for the dearth of such filings this year.
Fourth, plan accordingly.
Most people in this day and age establish a revocable trust during their lifetime that becomes irrevocable upon their death. When the Trustor dies, beneficiaries of the Trust, of course, want to receive their share of the Trust as soon as possible after the death occurs. However, the Trustee obviously does not want to distribute the assets of the Trust to the beneficiaries per the terms of the Trust agreement only to then face subsequent litigation contesting the validity of the Trust agreement. What, if anything, can a Trustee do if the Trustee anticipates that someone may contest the validity of the trust?
Nevada law, namely NRS 164.044, furnishes one solution. Under this Nevada statute, the Trustee may provide written notice to any beneficiary of the Trust, to any heir of the Trustor, or to any other interested person within 90 days after the Trust becomes irrevocable (the date of death of the Trustor). The recipient of the notice must bring an action to contest the validity of the Trust within 120 days of the notice being served upon him or her. If the recipient fails to bring an action within such 120 day period, they are barred from doing so later on. Accordingly, once the 120 day period passes without the commencement of litigation, the Trustee can feel relatively safe in making the Trust distributions and not facing subsequent litigation.
A Trustee should also always require a beneficiary to sign a written Receipt and Release in which the beneficiary acknowledges receipt of all property that he, she or it is entitled to under the Trust and the beneficiary releases the Trustee from any and all liability as Trustee. This signed Receipt and Release should be obtained prior to, or contemporaneous with, the Trust distribution to the beneficiary. A Trustee does not want to make a Trust distribution to a beneficiary only to have the beneficiary use the distribution to hire an attorney and initiate litigation against the Trustee and the Trust.
At Jeffrey Burr, our attorneys have many years of experience assisting Trustees in the administration of a Trust after the death of a Trustor and protecting them from the potential pitfalls in serving as a Trustee.
Attorney John Mugan
Nevada Revised Statutes 164 was amended last year to allow for a trustee of an income trust to convert such a trust into a unitrust. A unitrust is a type of trust that allows for a trustee to distribute a percentage of total trust assets as opposed to all of the income. The advantage of a unitrust is that occasionally current income beneficiaries and remainder principal beneficiaries will be different individuals or entities. As such, the dichotomy of beneficiary classes can result in competing interests over how the assets should be invested: current income versus long-term growth. For instance, it is not far fetched to assume that each class would prefer that the assets be invested in a manner that will maximize their return, which isn’t always possible.
For example, income beneficiaries likely want the trustee to invest in more aggressive assets that may maximize income but put underlying principal at risk. On the other hand, the remainder principal beneficiaries will typically prefer a more conservative asset mix invested for growth to maximize their return; but, this form of investment typically results in a lower income yield. By allowing the trustee to distribute a share of the total assets regardless of income earned or principal growth, the trustee can invest the assets in a way that benefits both classes. Moreover, a unitrust arrangement provides for a reduced degree of scrutiny from the previously competing interest beneficiaries, thus, making it easier for a trustee to make investment decisions.
Special attention should be paid to NRS 164.797-799 to ensure that the proper legal formalities are adhered to in converting an income trust to a unitrust. For instance, if trust agreement strictly prohibits such a conversion, it is not allowed. On the other hand, if the trust instrument is silent on the matter, conversion is allowed. Both beneficiaries and trustees are able to initiate the process of conversion. Thus, given the new language codified in NRS 164, it may be appropriate to review your or your clients’ trust documents to determine whether conversion to a unitrust is appropriate. However, keep in mind that if a conversion is done that doesn’t resolve beneficiary discord, NRS 164 also allows for a unitrust to be reconverted back into a non-unitrust trust (NRS 164.799).
If you anticipate the probability of someone challenging the validity of your Trust and/or Will, what can you do? For example, you desire to disinherit or greatly reduce the inheritance of a child, but you believe if you do so, the child will almost certainly challenge the validity of the Trust and Will in a Court of law. There are a number of preventive things you can do, but one of the most common estate planning tools in this situation is a “no contest clause”. A no contest clause is a provision in a Trust and Will that essentially provides that anyone challenging the validity of the terms of the Trust and Will shall be disinherited and shall receive nothing. Nevada Courts recognize the validity of a no contest clause; however, Nevada Courts, as Courts in most states, will not enforce a no contest clause if the Court finds that the challenge was made in good faith based on probable cause. The Court realizes that there will be cases where in fact there are legitimate challenges questioning whether the person making the Trust and Will had the ability (testamentary capacity) to do so, whether the person was under the undue influence of someone at the time, et cetera.
You should always state in the Trust or Will that you are intentionally omitting a person as a beneficiary if that person is someone who would be considered a natural object of your bounty such as a child. However, it is usually not a good idea to explain why you are disinheriting or reducing the share of the person in the provisions of the Trust or Will. An example would be to state that the person uses or is addicted to illicit drugs or is addicted to gambling. This opens the door to the argument that the person was not using or addicted to illicit drugs or addicted to gambling and that you made the Trust or Will based on this incorrect belief (often referred to as an “insane delusion”), or the argument that the person is no longer using or addicted to illicit drugs or gambling at the time of your death, or similar arguments.
One thing to keep in mind is the old axiom that “greed can be a wonderful thing” in certain situations. Needless to say, someone who is completely disinherited has nothing to lose in challenging the validity of a Trust or Will. On the other hand, a person who is left something, even if minimal, under the terms of the Trust or Will potentially can lose it all in bringing a Court challenge. This, at a minimum, tends to give one pause in bringing such an action.
The attorneys at Jeffrey Burr Law Office have many years of experience in not only planning your estate in this situation, but also in upholding your wishes as expressed in your Trust and Will once you are gone.
With the current uncertainty on the estate tax front, some people feel frozen in place in their estate planning. But regardless of the outcome of estate taxes, there are many other issues that we want our clients to be aware of and which have very little to do with how the estate tax law finally settles out. Following is a list of important factors in your estate planning which may require changes in your existing plan. We recommend you keep this list handy so as life changes, you will know your estate plan must be modified to best deal with changing circumstances.
1. Estate taxes are important, but minimization of taxes should not be the driving factor in any plan.
2. Has your net worth changed significantly since your last meeting with your advisor?
3. Are your documents up to date for changes in your current health status? As clients age, they may want to consider adding a capable family member or friend as a co-trustee. Is everything in place to deal with coming incapacity or known illness?
4. Have your ideas changed with regard to leaving some of your estate for charitable purposes? Have your favored charities changed?
5. Do you have any heirs or potential heirs who have disabilities or handicaps? Are you sure your plan will not negatively impact any benefits they may be receiving? Even a small inheritance can upset a person’s benefits.
6. For our clients who have moved out of Nevada, although your trust and will are valid in any state, we recommend that you have health and asset powers of attorney which comply with the law in your primary state of residence. We have health power of attorney forms for some states; for other states we recommend you contact a local attorney to get the most up to date forms.
7. Have there been marriages or divorces among any beneficiaries or yourself? Many of our divorced clients have not yet removed ex-spouses from their power of attorney designations. Although a divorce automatically voids any bequest under a will or trust in most cases, it is still good to make sure this is done properly. Also, divorce does not void beneficiary designations of retirement accounts, life insurance and so forth.
8. Does your plan do the best it can to eliminate potential conflicts among heirs? Too often important things, like who inherits family heirlooms, are left to chance, setting up the possibility of expensive and divisive family lawsuits.
9. Has a change in the value of your estate negatively affected the prospects for the surviving spouse? Some plans call for the survivor to make distributions of the estate upon the first death. These distribution requirements may have been reasonable when the plan was first drawn up, but we sometimes see cases where the amounts designated to pass upon the death of the first spouse to die may cause hardship for the surviving spouse.
10. We have many clients these days who wish they had taken advantage years ago of our recommendations to set up an asset protection Nevada onshore trust. These trusts may not protect you from a lawsuit which is threatened or already in progress, but it’s still a good idea to plan for future problems. At least 12 states now have asset protection trust laws, so the concept is gaining more of a following all the time.
11. Have you chosen the correct trustee? Is the son or daughter you have appointed really capable and will they be fair, or does their appointment set up a strong potential for conflict? Perhaps an independent trustee, such as a bank or trust company, would be a safer choice. With all the services provided by banks and trust companies in trust administration, we think they are one of the best bargains around.
12. Have you designated your beneficiaries of retirement accounts properly, e.g. for IRA’s, qualified plans, deferred compensation, etc? These assets form a large part of many estates and it is vital that beneficiary designations be done properly.
13. Are your assets properly assigned to your trust?
Estate planning is not static; it is a dynamic process. Pay attention to changes in family circumstances and be sure to contact your advisor to be sure your plan is set up properly to deal with the changes in life which inevitably come to us all.
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