What is Estate Planning? Is it a legal exercise? Is it a psychological exercise? Well, truthfully, there are a lot of both.
The first question that I ask of individuals who come to see me is, what do you want to do with all of your widgets? You say we don't have widgets. What you have are a lot of things. These things either create opportunities, cause problems, or a little bit of both. So, the first question is:
1. What exactly are the widgets?
Are they cash, stocks, bonds, and securities? Or are they closely held businesses that take a lot of management and expertise to make them work?
2. What do you want to do with your widgets?
Do you want everything to go to the surviving spouse? Do you want some to go to the surviving spouse and the balance to go to your kids? What if you are in a second marriage? What goes to the second spouse and what goes to the children? Do we have our children; his children; or her children?
If something happened to you, is there enough liquidity to support the surviving spouse and family, and to support the various widgets? If not, why not, and what do you plan to do about it?
What is the value of the widgets, and are any of these widgets subject to beneficiary designations such as life insurance, annuities, retirement accounts, PODs, or TODs on various accounts?
What happens if one of the persons on the TOD of POD dies before you; where does that widget go?
Are there any children with special needs; or any grandchildren with special needs? How do you provide for that?
What is the history of Alzheimer's, premature stroke, or dementia in your family? Do you have plans for that? You need to plan for that long in advance of such an occurrence.
When was the last time you looked at or updated your estate planning documents?
Were children even born when you did your first will? Are your children now grown and you still have guardians and trusts for 21-year-olds?
If you give money to your spouse or children, are they capable of managing it?
Do you have property in multiple states? If so, are you going to probate your will in all of these multiple states?
These are just a few of the things that you should be asking yourself before you meet with the planner so you do not waste a lot of time on these decisions. Remember, most of us charge by the hour, and if you are constantly having to think and rethink these things, it just increases the cost.
Many clients are worried about either the Department of Revenue or the Internal Revenue Service taking your property. As I will discuss, that is not going to happen in almost any family, especially in Mississippi.
Remember that most family wealth is lost within the family group.
A common problem is to place children in charge of management. Children either have no expertise in managing these assets, or greed takes over. We have quite a number of cases in our office now where children have simply taken advantage of adults suffering from Alzheimer's, dementia, cognitive problems, etc. They often use the leverage that my brothers and sisters have deserted you, and I'm the only one here to take care of you, so in exchange for that you need to give me everything that you have.
3. What are the plans for your business?
Is the plan to turn it over to your children? Is the plan to sell it, and if so, when do both of these occur?
If you give the business to your children, are they capable of managing it? Remember the old adage: the first one finds it, the second one makes it, the third one spends it.
If you turn the business over to the surviving spouse or your children, do they know how to run the business? What training has the next generation had in running a business? What discussions, if any, have you had with your children, about taking over the business? If the answer is none, then you have a very big problem.
What documents are in place to make sure that all of the widgets stay within the family? Do you have Buy-Sell Agreements; and Cross-Purchase Agreements; is the family stock and/or the membership interests clearly noted that they are subject to a binding Buy-Sell Agreement?
What if you give a business asset to a child and he or she goes through a divorce? How do you control that asset and keep it from becoming a marital asset, and thus have a stranger sitting at the table with you in a Board of Directors meeting?
What about death? Remember that every spouse is entitled to what is known as an elective share. That means if the Will does not adequately provide for him or her, then they can renounce the Will and take a child's portion of the estate, a year's support, and homestead rights in the Marital Home. Many people are surprised to see that assets are fractured in a family due to a second marriage because there is no Prenuptial Agreement. If you are contemplating a second marriage, do you have a Prenuptial Agreement? If not, why not? Are you betting on the surviving spouse doing what you want him or her to do? Remember if there is more than one she-bear in the room and more than one set of cubs, you will have a problem.
Are there any plans to sell the business if the children are not going to be involved; and if so, when do you think about selling the business?
To whom do you think about selling the business?
4. What are the basic documents in the typical estate plan?
a. A will and/or revocable trust with the will.
b. Financial power of attorney.
c. Advance directive for health care.
The Will and the Revocable Trust are somewhat self-explanatory. Many people want to avoid probate. If you have a Will, you are going to have probate unless the assets are structured to avoid probate; such as Joint Tenancies with Right of Survivorship, Pay on Death, Transfer on Death, or Beneficiary Designation through life insurance, retirement plans, or annuities. The Revocable Trust is simply the alter ego of a person and allows him or her to avoid a Conservatorship in the event of incapacity and avoid probate. One big caveat that seems to stop everybody is that all of your assets MUST be held by the Revocable Trust to make this work. This involves a lot of time, and regrettably, a lot of expense, to move these assets from your personal names into the Trust. For some reason, people balk at this cost. Realize this, you are going to incur the cost no matter what. It is just a matter of timing. Probate does the same thing; you have to move the assets from one name to another name; here we are simply moving the assets from one name to the Trust's name. Hopefully, that is the last time you will have to do that. I guess the reason for worrying about it now as opposed to later is, later it becomes the children's problem and not yours. You are dead.
So, what is the next step? The next step after you have decided all of the psychological things and all these other legal things, is to count up your widgets. How many widgets do you have? What are your widgets worth? Where will your widgets go based on what the widgets say? Who gets the widgets? And what do you think they will do with them when they get them?
Once you determine the value of the widgets, then you have to determine if you have a federal Estate Tax Problem. The State of Mississippi abolished the Estate Tax Law many, many years ago, so it is not a problem. If you have property in other states, you might want to see whether or not those states still have Estate Tax Laws. Most states, especially those in the south, have all abolished their Estate Tax which used to be based on what we call the Federal Tax Credit or a Pickup Tax. Once you determine the value of your widgets, do they exceed $13,610,000? That is the Federal Exemption for one person. If there are two of you, then the Federal Exemption is obviously twice that, or $27,220,000. You can also give away property up to $18,000 in value to as many people as you want without incurring a Gift Tax, and without using up any of your lifetime exemption (the $13,610,000 is the lifetime exemption).
If there are two of you, how do we avail ourselves of the over $27 million exemption? The answer is fairly easy under the current law. Anything that goes from one spouse to another is not taxed because of the unlimited Marital Deduction or Federal Estate Tax Exemption. Thus, a married couple has almost $27 million of exemption to use to pass assets Estate Tax-Free to anyone; primarily, the children. But what if the first estate is not big enough to use the $13,610,000? Then, you file Federal Estate Tax Form 706, which allows you to transport (portability) the unused Federal Estate Tax Exemption to the surviving spouse. Thus, in this instance, if the first spouse uses $3 million of his or her exemption in the first estate, then the simple math is that you have another $13,610,000 left over to add to the surviving spouse’s $13,610,000. However, it is necessary to file Form 706 to avail yourself of that benefit. The problem is many people do not do that.
One thing that is often missed in estates that do not have to file Federal Estate Taxes, is the property is not appraised to determine its Fair Market Value at death. As morbid as this may sound, if I have a widget worth $10 when I bought it, but it is worth $100 when I die, the new tax basis is $100, so if the successor in interest to this widget sells it for $100, there is no gain or loss. However, it is essential to have this property appraised as of the date of death to get that step up in basis. If someone died years ago, you could still obtain what we refer to as a retroactive appraisal to get the new basis.
Often, clients come to me, and in the desire to avoid probate, they have given away high value property with a low basis to their children. Congratulations! You have simply transferred the embedded Capital Gains Tax to your children, so they will now have to pay it. As morbid as it may sound, with low-basis property that has high values, you need to hold them until death or create a document that gives you a step up in basis as of the date of death, so children do not have to pay the Capital Gains Tax that you would have had to pay.
This problem is especially acute in parts of the Mississippi Delta where land values have gone from $700-$800 an acre to $6,000-$8,000 per acre. The ethanol scam has increased the value of former cotton land extraordinarily, and for some reason, the values have not come down.
One issue that I am constantly asked about is giving assets to charity. Quite frankly, giving assets to charity can make good economic sense, as well as sense in the estate tax arena.
Often clients have purchased assets many, many years ago and their basis in them is very low. Fair market value however is very high, so there is a significant amount of embedded gain in these assets. If they were to sell these low-basis, high-value assets, the state and federal taxes would be approximately 25%. Let’s say the gain is $1 million. That is a tax of $250,000 (excusing the 3.8% investment tax). Is there potentially a better way to do that? The answer oftentimes is to establish some form of charitable trust. By placing the asset in the charitable trust, you then get an income tax deduction based on the fair market value of the asset, reduced by the length of time before the charity gets the asset.
For instance, if we have $1 million of embedded gain in an asset, the immediate tax, as I have said, is $250,000. Could you defer that tax and pay the money out over a period of years? The short answer is yes. If you could earn 5% on $250,000 that you would otherwise have paid to the government, that is an extra $12,500 per year that you are making on the government's money. So, charitable giving does have its benefits.
Likewise, you do not necessarily have to name the charity at the time. You can follow the IRS's form either for a Charitable Remainder Annuity or Charitable Remainder Unitrust, name the charity either at, or before your death. There is tremendous flexibility in this regard. You could further set up your own foundation or a donor-advised fund, and then further control what the charity does with your money.
One thing to watch out for is that the current Federal Estate Tax Exemption of $13,610,000.00 per person is designed to sunset at the end of 2025. This means if those idiots in Congress do not get together on continuing the current Estate Tax Exemptions, the Estate Tax Exemption will go from about $14 million per person, down to approximately $7 million per person. Right now, approximately 2% of the estates in the entire United States have an Estate Tax problem. If the Estate Tax Exemption sunsets, that number will increase to around twenty percent (20%). Therefore, we may find that a number of our clients now have a "Federal Estate Tax Problem." You can certainly give those assets away to children; however, that uses up some of the exemption as well. Charitable giving is an immediate solution. If I give the excess over and above the Federal Estate Tax Exemption to charity, the donor and his or her spouse, receive income of between 5% up to even possibly 10%, and still qualify the gift for the Charitable Deduction. Remember that the actual value of the remainder interest has got to be at least 10% or more. In today's high-interest rates, it thus allows you to pay more income from the trust and still enjoy the benefit of the asset, though you have "given it away." Thus, from an economic standpoint, charitable giving makes perfect sense. If you are charitably minded, then there is a double benefit.
The biggest question I am asked about the sunsetting of the Estate Tax Exemption is, do you really think it will happen? Based on what I have seen for the last three (3) years going on in Washington, anything is possible. However, in the forty-two (42) years since I got my Master of Laws in Taxation, the Estate Tax Exemption has never gone backward. In 2010, President Obama threatened to move it from $13 million to $5 million, and everybody had a slight panic attack when that came up, but it did not happen. I am sure that if it does, lots of folks will notify you, and we will see it in the papers. The question is; should you do anything extraordinary now based on what might happen, and my continuous advice has been, no; there will still be plenty of time to take extraordinary measures if that is what we have to do.
Remember the age-old adage that most people do not plan to fail, they just fail to plan. You are going to have a plan, but will it be yours, or the State of Mississippi's?
BBJ provides full-scale estate planning solutions.
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