Thank Congress if You Made Big Gifts in 2012

Am Tax Rel Act

Hank Wittenberg has a great article on on why those of you who did year end planning in 2012 made the right choice, even though Congress extended the generous gift and estate tax exclusions with the American Taxpayer Relief Act.

The tax act signed into law by President Obama last week provided some very good estate planning provisions. Surprisingly, I have already read and heard complaints from other estate planning attorneys that this new tax act renders the 2012 year end gifting a “waste of time.” This is absurd; quit your whining! These are the same folks who complain that their clients would not make any significant gifts in spite the significant benefits that go with it, tax and otherwise. The one good thing about the “fiscal cliff threat” is that it convinced some to implement plans that should have been implemented already.

He also adds his top 10 estate tax and gift tax benefits of the new law:

1. Predictability: Taxpayers now have some reasonable estate tax expectations for the foreseeable future so they won’t be paralyzed by “what Congress might do in the future.”

2. Unified Gift and Estate Tax: Since the exemption amount for an estate is now permanent there was no need to split the gift tax exemption and the estate tax exemption like it was in the 2001 law. This structure is easier to understand and planning can be more straight-forward.

3. Generation-Skipping Transfer Tax: Having the same levels makes planning for multiple generations simpler (but still not without traps for the unwary).

4. Indexing: The exemption amounts are indexed for inflation, providing even longer term clarity in planning that is aligned with real economic effect.

5. Rate: The current maximum estate tax rate for estates with more than $5,250,000 in 2013 is 40%. Yes, I see this as beneficial. Perhaps it’s my age but is seems like it was only yesterday that the maximum estate tax rate was 55% (actually 60% for estate between approximately $10 and $20 million).

6. Portability: Portability permits a surviving spouse to use a deceased spouse’s unused exemption amount. Caution! To take advantage of this benefit, an estate tax return must be filed for the deceased spouse. This is a simple concept but tedious to complete. In other words, easier said than done.

7. Grantor Trusts: Plans can be designed that require the grantor to pay income tax on a trust that is not included in their estate upon death. In effect, each year that the Grantor pays taxes for the trust, the trust is growing tax-free for the beneficiaries. Over the long run this is an enormous benefit. Note: President Obama has proposed that this strategy be eliminated.

8. Perpetual Trusts: Many states like New Hampshire provide ways to create a trust that will last as long as the assets survive. In the days of olde, all trusts were required to terminate at a specific time in the future, most often measured by “lives in being.” If this notion intrigues you I encourage you to pick up a copy of Loring and Rounds, A Trustee’s Handbook (2013). No, I do not get paid for the product placement! Note: President Obama has proposed that perpetual trusts be eliminated.

9. Tax Leveraging Trusts: Without getting into a technical explanation, we can still use two year rolling GRATs (Grantor Retained Annuity Trusts – call us if you would like to learn about GRATs). In the right situation these are very powerful wealth transfer tools. Note: President Obama has proposed that a minimum term for GRATs be 10 years which eliminates much of the benefit from them.

10. Predictability: Not because I have run out of things to say but because it’s worth stating twice. OK, if you want something new: we still have the step-up in basis – that’s a huge benefit from a capital gain tax standpoint and from an administrative standpoint.



How the Lifetime Bypass Trust Works: Attention CPAs

Cutting taxes

Many of my clients are interested in the Lifetime Bypass Trust. And some are vetting the concept through their CPAs. Here is an email (with the names removed) I have sent to several CPAs to clarify this amazing but simple planning strategy.

The structure we are proposing is a lifetime bypass trust. The concept is the same as used with an A/B trust, or bypass trust.

When a bypass trust is created upon the death of a spouse, it is funded with the deceased spouse’s share of property up to the then death tax exclusion amount. The surviving spouse is usually the trustee and the primary beneficiary of the bypass trust.

The benefits of the bypass trust are:

1) Assets in it (and all future growth) will not be subject to the death tax at the deceased spouse’s death or at the surviving spouse’s death because the trust was funded using the deceased spouse’s death tax exclusion, and

2) Assets in it will be significantly protected from lawsuits and divorce claims against the surviving spouse.

The use of a bypass (A/B) trust is a tried and true estate planning strategy.

The Lifetime Bypass Trust is based on the same principal, except that we are creating and funding it now, to take advantage of the $5.12M gift exclusion available this year, rather than waiting until a spouse dies. One of my client’s calls it an “early bypass trust.”

Just like the at-death bypass trust, the lifetime bypass trust would name spouse as trustee and spouse and children as beneficiaries.

Just like the at-death bypass trust, the assets in the lifetime bypass trust would be exempt from estate tax when the grantor spouse dies, when the surviving spouse dies and, if generation skip exemption is used, even when their children die – two generations of no estate tax on the gifted asset and future appreciation.

Just like the at-death bypass trust , we can give the surviving spouse a limited power of appointment to change the remainder beneficiaries, limited to a certain class of people, like descendants. However, with the lifetime bypass trust, we could also include the grantor spouse as a permissible beneficiary. (Can’t do this with bypass trust created at death b/c the grantor spouse is dead.)

The grantor spouse, after the creation of the trust, can be named a remainder beneficiary if done correctly. This will not cause estate tax inclusion unless there is an implied understanding between grantor and trustee at the time the trust is created.

We recommend drafting the lifetime bypass trust to give an independent third party/trust advisor the authority to add and remove the grantor spouse as beneficiary.

The lifetime bypass trust uses the tried and true principles of a standard at-death bypass trust, but it uses the gift exemption now, while it is $5.12M, rather than at death, when the death tax exclusion is scheduled for a big drop (under current law $1M).

The downside to the lifetime bypass trust is the loss of step up in basis at death. But since the estate tax rate (35%-55%) has historically been a much higher rate than the capital gains tax rate (15%-20%) , most people would rather avoid the estate tax. In addition, the Democrats and the President have expressed their intent to do away with the step up in basis for inherited assets. So losing the step up in basis may happen anyway.

Finally, we may look back and realize 2012 was the best and easiest time in history to reduce or eliminate estate tax. If the estate and gift tax exclusions drop as scheduled on January 1, planning will get much more complicated and much more expensive.

Gift Now and Avoid Estate Tax

Grim reaper

If you have a net worth of $1M or more (or as a couple, $2M or more), and act now, you could forever remove the threat of estate tax. But if you don’t act by the end of the year, you will miss a historic opportunity.

The 2012 estate tax exclusion and gift tax exclusion are both $5,120,000 – way higher than they have ever been. But unless Congress and the President act, both will crash to $1M on January 1, 2013.

If you die with more than $1M after December 31, 2012, every dollar over $1M will be taxed at 55%. If you die with a $2M estate, your children will get $1,450,000 and the government will get $550,000.

But here’s your big chance: If you gift assets out of your estate before December 31, you can remove up to $5,120,000 (double that for married couples) from your taxable estate.

Don’t think this opportunity is only for rich people. If you have assets that will appreciate – like real estate, business interests, or other investments, you should take advantage of this historic opportunity to remove assets and all future appreciation from your taxable estate.

I know what you are thinking – ok, I get it, I should remove assets from my estate to avoid a future estate tax, but I need those assets. Can I gift them, but still benefit from them? The answer is YES.

A lifetime exemption trust, sometimes called a spousal lifetime access trust, can remove the asset from your estate and give you indirect access to the income. Here’s how it works:
* Create an irrevocable trust which names your spouse and children as beneficiaries.
* Your spouse can be the trustee and direct the investments and distributions.
* Transfer assets to it before the end of the year.
* Your spouse, as trustee, can distribute income from the trust to herself and deposit it in your joint account – which means you will have access to the trust income, even though you gifted away the assets.

Your spouse can also create a lifetime exemption trust which names you and your children as beneficiaries. However, this second trust must be drafted very carefully with different provisions than the first one to avoid the reciprocal trust doctrine. If the IRS determines the two trusts are identical, it will pull the gifted assets back into your estate.

This is just one of many gifting strategies available.

If you would like to leverage this historic gifting opportunity, you need to act now. Planning will most likely take a several weeks and time is running out.

Death Tax Resurrection

Top stories in Opinion

The Wall Street Journal editors have written a short piece on the death tax. In the swirl of the election, no one is talking about the estate tax (well, we have been), and they should. They start with this:

For all the worry in Washington and Wall Street about the January tax cliff, almost no one is paying attention to the impending reincarnation of the death tax. This is one more tax increase that will live or die depending on who wins on November 6.

Thanks to the Bush-era tax cuts, this much-loathed levy fell to zero in 2010, but President Obama insisted on bringing it back and Republicans compromised with him after the 2010 election on a 35% rate and a $5 million exemption for 2011 and 2012. In 2013 the rate is scheduled to rise all the way back to 55% with a meager $1 million exemption—where it was in 2001. Americans who have worked a lifetime to accumulate $1 million of savings or other assets will be surprised to learn that Washington thinks they are plutocrats.

They then explain how the estate tax impedes economic growth:

Abolishing the estate tax would also mean higher income-tax revenues. Under current law, billionaires like Warren Buffett and Bill Gates escape the tax by diverting their wealth into charitable foundations. But when income-generating assets are sheltered in this way, these foundations with a few exceptions don’t pay tax on the future income from dividends, capital gains or interest. Eliminate the death tax and fewer people will shelter their money in foundations, meaning the money will continue to earn taxable income.

Most important, because the estate tax is a penalty on saving and capital investment, the economy grows more slowly over time. This is why so many industrialized nations, including Canada and Russia, have thrown out this tax as more trouble than it is worth.

Consider the perverse incentives of the tax. When a business owner begins to consider retirement with perhaps $10 million of lifetime wealth, he can reinvest the profits in the business (which means growth and more workers) or live lavishly in retirement and spend the money down to zero.

In the first case, he is smacked with federal and state death taxes that can take away half of the wealth. In the second instance, he pays no tax. A new study by the Joint Economic Committee Republican staff estimates that because of this disincentive to save and invest “the estate tax has cumulatively reduced the amount of capital stock in the U.S. economy by roughly $1.1 trillion.”


If It’s Too Good To Be True, It Is – Tax Fraud

I’ve been an attorney for almost two decades, and I am always amazed, but never surprised, at how gullible some people, even supposedly smart people, like doctors and engineers, can be when it comes to estate planning and tax planning.

In U.S. v. Vallone, et al the founders and promoters of a complicated estate planning scheme were found guilty of conspiracy to commit fraud against the United States and were sentenced to prison terms ranging from 120 to 223 months. From the court opinion:

The trusts were marketed to and implemented for customers across the United States through a network of corrupt promoters, managers, attorneys, and accountants. Although prospective customers who bothered to seek independent advice as to the legitimacy of the Aegis system were routinely warned of its flaws, greed led many to overlook the system’s “too good to be true” attributes. Between 1994 and 2003, some 650 individuals purchased Aegis trust packages, at prices ranging from $10,000 to $50,000 or more. The diverse clientele included real estate brokers, doctors, public officials, and a variety of small-business owners. Among the purchasers was a co-founder of the Hooters restaurants chain, Lynn “L.D.” Stewart, who himself was later charged with tax evasion, although the charges were dismissed after his trial resulted in a hung jury. (Others were not so lucky; some Aegis clients were convicted and sent to prison.) The thousands of false income tax returns that were filed based on the use of the Aegis trusts are estimated to have cost the federal government more than $60 million in tax revenue.

Just like there are no legitimate get rich quick strategies, there are no legitimate pay-no-taxes strategies. If someone says he has a one, kick him out of your office or home and lock the door. Snake oil salesmen are still around. Sometimes they look like attorneys and accountants.

8. You Can Give Your Children Divorce and Asset Protection

This is part 8 in my series, Estate Planning – What You Need to Know.

Part 8 – You Can Give Your Children Divorce and Asset Protection.

Of the thousands of clients I’ve worked with, most know how they want to distribute their assets when they die:

 For married couples, it’s usually to the surviving spouse and then in equal shares to their children.

 For a divorced client or widow, it’s usually in equal shares to his or her children.

Is that enough planning? Does that protect your children?

Determining who gets what is only half the task of good estate planning. Equally, if not more important, is determining how your loved ones will receive their inheritance.

Divorcing Spouses and Plaintiffs

If your child receives his or her share of your estate outright, it will be subject to claims of divorcing spouses, creditors and plaintiff’s attorneys.

If your child is married and receives an inheritance, nine times out of ten, he or she will place the inherited assets (say a check) in a joint account with his or her spouse.

California is a community property state which means all property acquired during marriage is considered owned one-half by each spouse subject to a few exceptions. One of these exceptions is an inheritance.

Inherited property is separate property. However, the separate property is transmuted to community property when your son or daughter transfers it to an account owned jointly with the spouse.

No problem as long as the marriage is solid.

But if the marriage ends, the spouse will claim half of the inherited property as his or her share.

Most parents would not choose to leave half of their child’s inheritance to a divorcing spouse.

If your child receives the inheritance while single and subsequently gets engaged, does he or she write a prenuptial agreement to maintain the inherited property as separate property?

Without a prenuptial agreement, your son or daughter will have to keep the property in a separate account and field questions from his or her fiancé and then spouse about why it’s not in a joint account. (Question: “Why do you keep your inheritance in a separate account?” Answer: “Don’t worry honey, it’s just in case we get divorced.” I wouldn’t wish that conversation on anyone.)

In my experience, the only couples that sign prenuptial agreements are those that are on their third or forth marriage.

Another matter to consider is lawsuits. When your son or daughter receives an inheritance outright, the property is in his or her name. If he or she is ever sued, the inheritance is subject to the claims of the plaintiff. It’s fair game in a lawsuit.

Solution – Lifetime Inheritance Trusts

Instead of distributing your estate to your children outright, you should consider leaving their share to them in a lifetime protection trust.

Lifetime inheritance trusts are created with special provisions in your revocable living trust.

Your revocable living trust will include instructions for your trustee to create separate trusts (we call them “lifetime protection trusts”) for each of your children when you pass away.

The trustee will then allocate the inheritance to those separate trusts for each child, rather than outright to each child.

If your child is old enough, she can be the trustee of her own trust. The trust, rather than the child, will own the property.

The significance of this is truly amazing.

Divorcing Spouse. Let’s say your son has a rocky marriage. You were savvy enough to include lifetime protection trust provisions in your living trust. When you pass away, your son receives his inheritance in trust, not outright. So his divorcing wife will have a real tough time getting her claws on it.

The trust can also be drafted to distribute the trust property in separate trusts for your grandchildren upon the death of your child in a way that will avoid further estate taxes. This protects the original inheritance from more estate taxes and from a divorcing spouse, and it provides a legacy for the grandchildren.

To Prenup or Not to Prenup. If your daughter is engaged and receives her inheritance in trust, there will be less need for a prenuptial agreement with her fiancé. The inheritance is already set aside and significantly protected in the trust. Your daughter may not even have to address the issue.

Keep the Attorneys Away. The lifetime protection trust will also serve as a deterrent to plaintiff’s attorneys.

Your child does not really own the trust property – the trust does. If your son is sued, be it a professional business claim or a vehicle accident or you name it, the trust property will be significantly protected.

Your son has a right to receive trust distributions at the discretion of the trustee, but during a lawsuit, the trustee will make no distributions, so there will be nothing for the plaintiff to attach.

The trust substantially removes the inheritance from your son’s attachable assets.

Unless the estate is very small with no life insurance, I usually recommend my clients include provisions to create lifetime protection trusts for their children in their revocable living trust.

Bottom line. If you’re going to do your estate planning, why not take the extra step to protect the inheritance?

7. Funding Your Revocable Living Trust

This is part 7 in my series, Estate Planning – What You Need to Know.

Part 7 – Funding Your Revocable Living Trust

Now to get the benefit of your revocable living trust, you have to transfer your assets to your revocable living trust. This is called “funding your trust.” We tell our clients to think of their trust as a big container with instructions. The instructions will control how the assets in the container will be managed.

If the assets aren’t in the container, the instructions don’t apply. If you don’t fund your trust, your assets may still have to go through probate – and then you defeat the primary objective of establishing your trust.

How is property transferred to your trust?

As an example, when you establish a revocable living trust, you and your attorney will record a new deed, which will transfer title of your house from you and your spouse’s name to you and your spouse – as trustee of your trust.

You will also retitle your bank and investment accounts from your individual names to the name of your trust. All property that has title, such as bank and investment accounts, real property, and business interests must be retitled to your trust. Personal property such as furniture, jewelry and clothing has no formal title and can be transferred to the trust with a written statement.

When your trust is funded, the trust owns your property. Although as trustee, you still control everything.

For practical matters, nothing changes except the paperwork. The tax identification number for the trust is your social security number. Your tax returns are filed the same as before you created the trust.

The legal title to your assets is no longer in your name, but in your name as trustee of your trust.

 Example: Your home is titled in the name of you and your spouse:

 Jack Lee and Jill Lee, husband and wife, as joint tenants

 After recording a deed transferring the house to your trust, the title will read:

 Jack Lee and Jill Lee, Trustees of the Jack and Jill Lee Revocable Living Trust

 Avoids Conservatorship

When your trust owns your property, there is no need for conservatorship hearings or probate. If you become disabled, the trust contains provisions naming a successor trustee (most often your spouse, parent, brother or sister, friend or adult children). The successor trustee is authorized to manage your property on your behalf. As a result, there is no need for a conservator. Likewise, when you pass away, your successor trustee is authorized by the trust to administer your trust property, so there is no need for probate.

When your assets have been transferred to your trust, the trust owns it. The trust continues to own it if you become incapacitated and when you die. Because the trust owns your assets, there is no need to get court approval to manage or distribute them.

With a trust everything remains in-house. Upon your disability and death, your successor trustee will follow the trust instructions without the need for court approval or interference.

Brief History – Perspective

Before Revocable Living Trusts became popular, probate attorneys would charge a marginal fee to prepare a basic will knowing that if they outlived their client, they would make big fees on the probate. Now that more people are choosing to create living rusts rather than wills, probate attorneys have either evolved into trust attorneys or have limited their practice to probating wills of clients who never got around to creating a trust.

Bottom Line. With a revocable living trust, your assets can avoid the delays, publicity and costs of probate, which is why a revocable trust is the best choice for most people.

Next up is Part 8: How to Protect Your Children’s Inheritance from Divorce and Lawsuits.

3. What if You Don’t Have an Estate Plan?

Here is Part 3 of my series, Estate Planning – What You Need to Know.

What if You Don’t Have an Estate Plan?

Simply put, if you don’t have a will or a revocable living trust, then when you die, your assets will go according to state law found in the probate code.

If you live in California it goes like this:

  • if you are married, your assets will go to your spouse.
  • If you have children, your separate assets will go either one-half to your spouse if you have one child, and one-third to your spouse if you have more than one child. The rest will go to your child(ren).

If you are not married and don’t have children, your assets will go to your next of kin in the following order:

  • to your parents, if they are alive, then
  • to your siblings, if they are alive, then
  • to your aunts and uncles, if they are alive, then
  • to your cousins, if they are alive, then
  • to your crazy fourth cousin twice removed, if he isn’t alive, then
  • to the state. Believe it or not (or course you can believe it) if  there are no living family members, the state will take your assets. The sophisticated legal term for this is “escheat” – your estate will escheat to the state.

You get the picture. If you don’t have a will or a revocable living trust which states how you want your assets distributed, you have what is called an Intestate estate. Intestate estates are distributed according to the state probate code.


It’s bad enough to rely on the state to distribute your assets when you die, but it’s even worse to rely on the state to manage your assets while you are alive.

If you become incapacitated, which means you are no longer capable of managing your affairs, e.g. dementia, then someone else must manage your assets for you. For that someone to manage your assets, you must have already signed a Durable Power of Attorney.

A durable power of attorney is a document that gives the person you name the authority over your assets, like bank accounts and real property, if you become incapacitated. The person you name, your Agent, can take the durable power of attorney to your bank and get access to your accounts to take care of you – pay your bills, etc.

However, if you did not sign a durable power of attorney, no one will have the authority to manage your affairs. And once you become incapacitated, it’s too late to sign a durable power of attorney because you are incapacitated. Incapacitated people cannot sign legal documents.

So now what? Your loved ones will have to hire an attorney and petition the court to appoint one of them or someone the court chooses as your Conservator. A conservator is a person authorized by the court to manage your affairs, and in many cases must submit an account of her activities to the court for the judge to review. It is an expensive, tedious and nightmarish solution, which could have been simply avoided if you had signed a durable power of attorney.

Bottom line: If you don’t have an estate plan, state law will determine who gets your stuff, and if you become incapacitated, the court may end op overseeing the management of your assets.

Next up is Part 4.  Why You Need Guardians If You Have Young Children.

You Need Life Insurance to Protect Your Family

If you have young children, and you are not independently wealthy, you must get a big term life insurance policy.

If you died tomorrow, would your spouse and children be able to make ends meet comfortably, or would they have to scrape and claw their way?

If you have young children, chances are term life insurance will not cost you very much because you are relatively young and healthy. You should call your financial advisor and find out what it would cost to protect your family. I typically recommend both spouses get insurance for at least 7 times annual income.

Unfortunately, I’ve seen parents die in their thirties or forties. Families that had life insurance had no financial problems. Families that didn’t, had to face a huge struggle to make ends meet. Life insurance can’t bring mommy or daddy back, but it will eliminate the financial suffering.

When I give talks on estate planning, I tell the audience that parents with young children that do not have life insurance are committing parental malpractice. Yikes!

Hopefully you will buy a 20 year term life insurance policy and outlive the term. In which case, you will look back and say it was a bad investment. But unless you have super hero powers to see the future, it is a necessary investment and part of being a responsible parent and spouse.

DISCLAIMER. We do not sell life insurance. But we do care about you and your family.