Estate Planning and the American Taxpayer Relief Act of 2012 FAQs

 

1.Q. What is a will and who should have one?
2.Q. What are the advantages of a will?
3. Q. What does a will affect?
4. Q. What property is not distributable at death under supervision of the probate court?
5. Q. Is the net probate estate the same as the gross estate of the deceased?
6. Q. How does the gross estate of the deceased differ?
7. Q. Has the estate (death) tax been repealed?
8. Q. What is the situation in 2013 and beyond?
9. Q. How much can I leave to my spouse without paying taxes?
10. Q. Why not just leave everything to my spouse?
11. Q. What is the joint property trap?
12. Q. What is typically done with the remaining money that does not go into the credit shelter trust?
13. Q. If we each already have a will which gives to our children the exemption equivalent amount or sets up a credit shelter trust with the children as the sole beneficiaries, do we need to be concerned?
14. Q. What are the most important things for us to do in determining whether we need a will or will substitute?
15. Q. When is a simple will appropriate?
16. Q. When is a simple will with provisions for guardianship and a contingent trust appropriate?
17. Q. What is an living (inter vivos) trust?
18. Q. Why have a living trust?
19. Q. Is a living trust always effective?
20. Q. Does a living trust avoid estate taxes?
21. Q. What is an irrevocable trust?
22. Q. Why have an irrevocable trust?
23. Q. Is a living trust necessary?
24. Q. Are there any statistics which tell us how many people have a will as opposed to a trust?
25. Q. What amount can I leave to my child each year without incurring gift tax?


1. Q. What is a will and who should have one?

A will is your declaration of how you desire your property to be disposed of after your death.

A will is revocable during your lifetime.

Generally speaking, both you and your spouse should have a will

2. Q. What are the advantages of a will?

Among other things, a will can:

        explain how you want your property to be distributed to your spouse, your children, and others whom you desire to leave it to,

        identify who will care for your minor or special needs’ children,

        avoid estate taxes if either your estate or your and your spouse’s combined estates are greater than the exemption amount, and

        determine the manner by which you are leaving property to another and thus the amount of control (or protection) you will exercise either personally or by a third party over that property after your death.

3. Q. What does a will affect?

A will affects only your net probate estate at your death.

That is, it affects only the property distributable at death under supervision of the probate court.

4. Q. What property is not distributable at death under supervision of the probate court?

Lifetime dispositions of property are ordinarily beyond the purview of the probate court.

For example, the deceased may have purchased United States Savings Bonds payable at death to his child who survives him.

Or the deceased while alive may have designated his spouse as beneficiary of insurance on his life. At his death, she gets the death benefit.

Or the deceased may have owned the family home with his wife as tenants by the entirety with the right of survivorship. His share of the home passes at the deceased’s death to his spouse by operation of law.

Or the deceased during his life could have created a living (inter vivos) trust. At the deceased’s death, the property in the trust would be governed by the terms of the trust.

In each case, the property did not pass under the supervision of the probate court.

5. Q. Is the net probate estate the same as the gross estate of the deceased?

No.

6. Q. How does the gross estate of the deceased differ?

Generally speaking the gross estate includes anything:

        the deceased owns,

        used to own but still benefits from, or

        anything which the deceased had unlimited discretion to dispose of.

Thus, the gross estate of the deceased includes not only the value of the probate estate of the deceased, but also the value of property passing to beneficiaries of the deceased by way of will substitutes and other arrangements which are considered to be transferred at death for tax purposes.

The gross estate covers transfers by will (the net probate estate) and transfers by familiar will substitutes, including but not limited to:

        life insurance payable to the beneficiary;

        property owned as tenants by the entirety with the right of survivorship (such as the family home);

        bank accounts titled so that at the death of the owner the account is automatically payable on death to a specified beneficiary;

        property subject to a living (inter vivos) trust (over which the grantor retains a benefit or control); and

        savings bonds.

7. Q. Has the estate (death) tax been repealed.

No. Instead on January 2, 2013, the American Taxpayer Relief Act of 2012 became law. 

8. Q. What is the situation in 2013 and beyond?

The 2011 exemption equivalent (sometimes called “exemption”) amount of $5 million was allegedly made permanent and indexed for inflation. In 2013, the exemption is $5.25 million. The estate tax rate on the taxable portion of the estate, if any, is 40%.

Transfers to spouses remain exempt, but spouses can inherit any unused portion of the exemption from each other, so that the combined exemption for a couple is $10 million. But be sure to check with a CPA who handles taxes or a tax attorney if you desire to use part of your spouse’s unused exemption amount.

9. Q. How much can I leave to my spouse without paying taxes?

Since the passage of The Economic Recovery Tax Act of 1981, an unlimited amount.

But generally speaking, the marital deduction does not eliminate the estate tax, rather it defers it until the death of the surviving spouse.  But see 8, above.

10. Q. Why not just leave everything to my spouse?

The traditional answer to this question is the joint property trap.

11. Q. What is the joint property trap?

If the combined gross estates of you and your spouse are more than the exemption amount, then you are subject to the joint property trap.

If you leave everything to your spouse at your death, what you may be doing is simply deferring the estate tax until the death of your spouse, rather than passing property to your children free of tax.

If the surviving spouse’s taxable gross estate is more than the exemption amount, than upon the death of the surviving spouse, the sums greater than the exemption amount which are being passed on to your children or others will be taxed. But see 8 above.

Generally speaking, the joint property trap could traditionally be avoided by the first spouse to die leaving money to a credit shelter trust or "bypass trust" in an amount equal to or less than the exemption amount.

This sum would be placed in a trust which could be made primarily for the benefit of children or could be made for the benefit of the surviving spouse with certain limitations with the sums remaining going to the children upon the surviving spouse’s death without estate tax being paid.

Thus upon the death of the surviving spouse the, children would get, free of estate tax, the sum remaining in the trust, thereby avoiding the joint property trap.

Generally speaking, you can avoid the joint property trap and increase the money which will be passed on to your heirs, and decrease the money that will go to the government for taxes, by using a credit shelter trust or "bypass trust" when the total value of your and your spouse’s combined estates are more than the exemption amount.

12. Q. What is typically done with the remaining money that does not go into the credit shelter trust?

To take advantage of the marital deduction, the remaining money is typically given to the spouse either outright or in a trust that qualifies for the marital deduction.

13. Q. If we each already have a will which gives to our children the exemption equivalent amount or sets up a credit shelter trust with the children as the sole beneficiaries, do we need to be concerned?

Possibly. Some wills create a credit shelter trust (based on the exemption amount) that is created for the benefit of the children of the deceased spouse. It is often funded based on a formula that sought to pass as much as possible on to the deceased’s children without having to pay estate taxes.

The credit shelter trust share was typically funded by a formula using a fraction equal to the maximum amount of the exemption equivalent (the unified credit is the amount of tax computed on the exemption equivalent), and the remaining fraction was allocated to the share for the surviving spouse either by an outright gift or a trust in which the principal can be invaded for the surviving spouse’s benefit.

With the alleged permanent increase in the exemption equivalent amount, you need to make sure whether the surviving spouse is a beneficiary under the credit shelter trust, in what way he or she is a beneficiary, and whether there are sufficient funds in the surviving spouse’s marital deduction share to take care of his or her needs.

The increases in the applicable exemption equivalent amount may create a serious problem if the credit shelter trust share does not permit the trust to be invaded for the needs of the surviving spouse.

You may need to consider a cap on the amount of the credit shelter trust to prevent that share from growing to the full size of the applicable exclusion amount.

The amount of this cap will depend upon your goals, the needs of the surviving spouse, and whether the surviving spouse is to receive any of the income and can invade the principal (under an ascertainable standard) of the credit shelter trust.

The cap on the credit shelter trust can be drafted as a fractional share of the total residuary estate, or as a specific dollar amount.

An arbitrary cap on the credit shelter trust share, of course, may increase the surviving spouse's taxable estate depending upon what the exemption amount is the year the surviving spouse dies.

This increase could cause the surviving spouse's estate to be subject to estate taxes, if the combination of the surviving spouse's separate assets and the enlarged marital share exceed the surviving spouse's applicable exclusion amount.

Or the credit shelter trust could include as a beneficiary the surviving spouse and allow her to take out the income or invade the principal for her own benefit under an ascertainable standard, such as for the health, education, maintenance, and support of the surviving spouse.

14. Q. What are the most important things for us to do in determining whether we need a will or will substitute?

First, you need to review both your and your spouse’s assets to ensure that you are aware of the possibility of paying estate taxes.

        You need to remember that gross asset property includes such things as: the death benefit of your life insurance policies, your pension, and any property over which you hold a power of appointment.

        As to property owned jointly with your spouse, one-half of the value of the property is included in the first-to-die’s gross estate.

        As to property owned jointly with someone other than a spouse, that portion of the fair market value of the property, based on the proportion of the amount that you paid as compared to your co-joint owner, will be in your gross estate. If it can’t be determined who paid what for the property, the full value of the property is included in your gross estate.

Second, you need to decide whether you desire to name:

        the trustee of any trust created under the will or otherwise and

        the guardian of any minor children.

Third, you need to consider the amount of control (or protection) you desire to have over the property you leave to your spouse and others. Trusts whether set up by a will or otherwise can provide control and protection and are very useful in situations

        where there is likely to be a second marriage,

        where the intended beneficiary is infirm or financially unsophisticated, or

        where the intended beneficiary due to having lived a sheltered life, age, or potential infirmity might be easy pray for hucksters or other confidence men.

Fourth, you need to decide how you want your property distributed.

15. Q. When is a simple will appropriate?

Generally speaking, a simple will with no trust is appropriate if

        you have no minor children,

        your and your spouse’s combined estates are not subject to federal estate taxes (are less than the applicable exclusion amount), and

        you have little expectancy of substantial appreciation of estate assets or growth of the estate through other means, such as gift or inheritance, and will have no beneficiaries with special needs.

16. Q. When is a simple will with provisions for guardianship and a contingent trust appropriate?

Generally speaking, a simple with provisions for guardianship and a contingent trust is appropriate if

        you and your spouse’s combined estates are not subject to federal estate taxes (are less than the applicable exclusion amount),

        you have little expectancy of substantial appreciation of estate assets or growth of the estate through other means, such as gift or inheritance, and

        you have minor children, or

        you wish to provide for elderly parents or other relatives who may not be competent to manage finances.

17. Q. What is a living (inter vivos) trust?

A living trust is a trust which is created and exists while the creator of the trust is still alive.

The other common type of trust is a testamentary trust which is created by a will and goes into effect only after the person who makes the will containing the trust dies.

A living trust is created by the grantor transferring property to a trustee for the benefit of the person for whom it is established (called the donee or beneficiary). The grantor can also be the donee or beneficiary.

A living trust is created by a document which identifies the trust assets, the person for whom the trust is established, the trustee (and his or her successors), and the terms that must be observed in managing and spending the trust assets.

18. Q. Why have a living trust?

A revocable living (inter vivos) trust is sometimes used as a will substitute. It can also be used as a means of addressing property and income management as you grow older.

A revocable living trust is used to avoid probate taxes in states that have a high probate tax. Virginia’s probate tax is relatively inexpensive: ten cents on one hundred dollars.

A revocable living trust is not a means of avoiding estate taxes.

A revocable living trust is often the foundation of many individual’s estate plans where estate taxes may be owed. Such a revocable living trust is typically a tax-neutral trust in which the grantor is treated as the owner of the assets for income, gift, and estate tax purposes.

The revocable living trust can be

1.     basically unfunded (awaiting a pour-over from a will),

2.     partially funded (specific assets are put into it), or

3.     fully funded (all of the grantor’s assets are placed in it).

A living trust can not fully replace a will because the trustee, unlike an executor, does not have the authority to stand in the decedent’s shoes and marshal assets, administer the estate, and distribute the assets to the decedent’s beneficiaries. Thus, a living trust is typically used in connection with a pour-over will.

A living trust is sometimes used by wealthy older Americans as a will substitute or as a means to transfer their assets to their descendants or for asset protection purposes.

19. Q. Is a living trust always effective?

No. A trust is only effective if it is funded. That means at least some of your assets must be transferred into it.

It can be a hassle and an expense (often requiring a lawyer to prepare deeds) to transfer all of your assets into a living trust.

If you fail to transfer all of your assets into the trust that are not otherwise subject to a lifetime disposition, you will need a will unless you are willing to let your probate property that is not in the trust pass by intestacy.

Intestate property is that property which you have failed to dispose of by will. Intestate real estate passes under Va. Code 64.2-200. Intestate personal property passes under Va. Code 64.2-201.

20. Q. Does a living trust avoid estate taxes?

Generally speaking, no; unless you form an irrevocable living trust over which you do not retain any benefit or control. A living trust will be included in your gross estate and subject to estate taxes.

21. Q. What is an irrevocable trust?

Generally speaking, an irrevocable trust is a trust that cannot be terminated by the person who makes it.

22. Q. Why have an irrevocable trust?

Generally speaking, you would have an irrevocable trust for tax and asset protection purposes to remove completely your assets from your estate.

23. Q. Is a living trust necessary?

No. It depends upon your personal circumstances and your financial situation.

Not only can transfers to trusts affect Medicaid eligibility, but also they may or may not save money.

Typically, the very wealthy are the primary users of living trusts, although those with a history of Alzheimer’s in their families might want to consider them.

Unfortunately, living trusts are being aggressively marketed by some people. Some of them misrepresent the costs and burdens of probate. While in some states the probate tax can be significant, in Virginia it is only ten cents on a hundred dollars. Thus, you need to be an educated consumer and comparison shop when considering such trusts.

See, for example, "A Consumer’s Guide to Living Trusts and Wills" stock #D14535 which you can order by sending an e-mail to member@aarp.org.

24. Q. Are there any statistics which tell us how many people have a will as opposed to a trust?

An AARP poll found that 60% of responding adults age 50+ have a will, while 23% have a trust. However, those with a trust almost always have a will.

25. Q. What amount can I leave to my child each year without incurring gift tax?

The exemption equivalent amount from the estate tax applies to estates and lifetime inter-vivos gifts in the aggregate. The separate annual exemption per donee for inter-vivos gifts is indexed in $1,000 increments and has increased from $13,000 in 2012 to $14,000 in 2013.

I trust these Questions and Answers have helped clarify your understanding of Wills, Trusts, Estates, and American Tax Relief Act of 2012. Due to the rapidly changing nature of the law, information contained in these Questions and Answers can become outdated. These Questions and Answers are intended solely for educational and informational purposes. The information contained herein is general in nature and should not be a substitute for seeking the advice of an attorney. Please remember that individual circumstances may affect the manner in which the law applies to each situation. These Questions and Answers are not provided for use or reliance by you or any third parties and do not purport to be exhaustive or to render legal advice for your particular situation or any other specific case. They are meant merely to assist you in sharpening the questions you might ask of your legal advisor in your particular case. Please give me a call should you have any questions.

Tom Leggette