Estate planning is a process.
Begins with accumulation and ends with disposal of an estate.
Good estate planning is effective and efficient.
Attempts to eliminate uncertainties Attempts to maximize the value transferred Addresses non-financial concerns e.g., designation of guardian for minor children DePaul University All rights reserved. 2
Estate planning is not simply having a Will.
During life: an orderly arrangement of an individual's assets to provide most effectively for their economic needs while living.
At death: meeting the personal and economic needs of those to benefit from the estate.
Required knowledge includes the law and practice related to: wills descent and distribution trusts and future interests real and personal property gifts taxation of gratuitous transfers probate procedure and practice.
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In the context of financial planning, estate planning has several advantages: Clients get to choose the people that will receive their assets and know that their wishes carry the word of law. Clients can arrange their affairs to minimize the impact of taxes and other expenses on the family wealth. Clients enjoy the peace and satisfaction of knowing that their estate is in order and that their loved ones will not have to deal with a costly administrative nightmare.
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Whether the transfer of an asset has occurred depends on how, and in whose name, the asset is titled.
Assets can be titled in the name of a/an: Individual Multiple owners As tenants in common As joint tenants with rights of survivorship (JTWROS) Minor children Under custodial arrangements Married couple As joint tenants with rights of survivorship (JTWROS) As tenants by the entirety (TBE) As community property (certain states) Trust Other entity DePaul University All rights reserved. 5
Sole ownership means the property is owned by a sole individual (also called fee simple).
Easiest form of ownership to understand Owner retains all control – receives all income Assets are included in owner’s estate Gross estate for federal estate tax purposes Generally also for probate purposes Transferred during owner’s life for less than FMV results in a gift and possible transfer tax.
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Which of the following represents an advantage of individual ownership?
A. The sole owner retains full control of the asset.
B. The sole owner must generally report all income generated by the asset.
C. The sole owner must generally report part of the income generated by the asset.
D. Individually owned assets seldom go through probate. DePaul University All rights reserved. 7
Property owned by two or more adults where, upon the death of any owner, the property passes equally to the surviving tenants.
Each tenant deemed to own an equal, undivided interest in JTWROS property.
Contribution is ignored Each tenant has equal control Income split equally among tenants JTWROS supersedes a Will and thus the property is not subject to probate DePaul University All rights reserved. 8
What does “undivided interest” mean?
All tenants own a proportional piece of all assets in the joint or other shared arrangement.
Securities: ALL owners own a portion of ALL securities in the portfolio.
One tenant doesn’t own the good stocks while the other owns the losers.
Real estate: ALL owners own a portion of all parts of the property.
One tenant doesn’t own the downstairs while the other owns the upstairs.
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Ken and Len own a two-stock portfolio in JTWROS. The portfolio consists one half of Enron stock and one half of Apple stock. Which is correct?
A. Ken may own all the Apple while Len owns all the Enron.
B. Ken may own all the Apple while Len owns only a right.
C. Ken and Len each own one half of Enron and Apple respectively.
D. At the death of the first tenant to die, the portfolio will be subject to probate.
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For spousal joint tenancies (JTWROS), one half of the JTWROS property is included in the estate of the first spouse to die.
Tenancy must be exclusive (only spouses) Decedent’s half receives a step up in basis The survivor’s half retains its original basis (1/2).
Example: Mr. and Mrs. buy 1000 shares of XYZ stock @ $20/share as JTWROS. FMV on Mr.’s death = $60 per share. Mrs.’ basis = $40,000 ½ $60 x 1,000
1/2 of original $20,000 If Mrs. sells all shares at $80 per share, LTCG = $40,000 DePaul University All rights reserved. 11
Step-up in basis is mainly about: A. Federal estate tax B. Income taxation to the decedent C. Income taxation to the heir/beneficiary D. Both federal income tax and federal estate tax DePaul University All rights reserved. 12
For non-spousal joint tenancies, the ENTIRE value of the JTWROS property is included in the estate of the
tenant to die, unless: The decedent’s PR can
that the surviving tenants furnished consideration to acquire the property Otherwise, entire value included in first decedent’s estate, and entire property receives a step up in basis.
Example: Grandma bought property and named three grandchildren as JTWROS owners along with herself. At her death the property’s FMV is $240,000 – that full amount is included in Grandma’s estate. Each grandchild now has an $80,000 basis in the JTWROS property.
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Tenancy by the entirety (TBE) is a form of ownership available only to spouses in which the consent of both spouses is needed to dispose of the TBE property.
TBE assets are protected from the creditors of ONE spouse b ut not from a joint creditor of both spouses May be desirable approach to homeownership TBE dissolvable by: Mutual consent (both spouses) Divorce Death For tax purposes, treated same as spousal JTWROS DePaul University All rights reserved. 14
Which statement below best reflects the comparison of JTWROS versus TBE?
Both TBE and JTWROS are only spousal arrangements.
TBE generally offers better creditor protection than does marital JTWROS JTWROS property is seldom subject to probate while TBE property usually is.
Both TBE and marital JTWROS continue beyond the death of the first tenant. DePaul University All rights reserved. 15
Tenancy in common (TIC) is a form of ownership between two or more adults carrying no survivorship rights.
TIC parties are usually not spouses Siblings, children, friends, etc.
Ownership interests are NOT necessarily equal Each tenant may dispose of their interest freely by sale, by gift, or at death Decedent’s interest is included in the gross and probate estates .
Example: When s isters Terry and Sherry bought a summer house, Terry furnished 75% and Sherry furnished 25% of the purchase price. At Terry’s death the FMV of the house was $200,000, so $150,000 of value is included in her gross and probated estates.
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Jack and Mack want to buy a fishing cabin for $100,000. Older brother Jack has $60,000 to contribute to the purchase while younger brother Mack has only $40,000 to put in. They plan to use the cabin in proportion to their respective contributions to the purchase. It appears that ownership of the cabin should be: A.
Tenancy in common JTWROS Community property Fee Simple DePaul University All rights reserved. 17
Community property is a form of ownership recognized in 8 states under which each spouse is deemed to own an undivided ½ interest in every asset.
Subject to few exceptions, it is irrelevant which spouse earned or acquired the property Generally, all property earned/acquired during the marriage is community property Community property does not create a survivorship interest Survivorship can be created by contract Otherwise, at death each spouse may give their half interest as they please. DePaul University All rights reserved. 18
The community property states are: Arizona California Idaho Louisiana Nevada New Mexico Texas Washington Wisconsin
Note: States other than community property states are common law states.
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In community property states, the following items are
regarded as community property (also called separate property) so long as not commingled: Property acquired before the marriage Income earned before the marriage Gifts to one spouse Inheritances by one spouse Earnings on such separately received gifts or inheritances.
Note: Otherwise separate property or community property arrangements may generally be changed by formal agreement.
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While married to Jack in Wisconsin, Jill’s father died last year leaving her $500,000 in bank issued Certificates of Deposit. The CDs will earn $20,000 in interest in 2012.
BOTH the CDs and the $25,000 interest income are Jill’s separate property, so long as she does not retitle the CDs or commingle the interest.
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Property Classification Why
A computer your spouse inherited during marriage Your spouse's separate property Property inherited by one spouse alone is separate property A car you owned before marriage Your separate property A boat, owned and registered in your name, which you bought during your marriage with your income Community property DePaul University All rights reserved. Property owned by one spouse before marriage is separate property It was bought with community property income (income earned during the marriage) 22
A family home, which the deed states that you and your wife own as "husband and wife" and which was bought with your earnings
It was bought with community property income (income earned during the marriage) and is owned as "husband and wife" A camera you received as a gift Your separate property Gifts made to one spouse are that spouse's separate property A checking account owned by you and your spouse, into which you put a $5,000 inheritance 20 years ago Community property The $5,000 (which was your separate property) has become so mixed with community property funds that it has become DePaul University All rights reserved. community property 23
Ben and Jen are a married California couple. Ben is a movie star. Jen raises their twin girls. Ben just earned $1 million making a movie and deposits that amount into a checking account registered in his name only. Which of the following is true?
A. The $1 million is separate property due to the account registration in Ben’s name only.
B. The $1 million is separate property because Jen did not contribute to generating the income.
C. The $1 million is community property because all property of California married couples is deemed community property.
D. The $1 million is community property because it was earned by a spouse during the period of the marriage. DePaul University All rights reserved. 24
The following are typical types of community property: Income earned by one or both spouses during the marriage Separate assets commingled with community property to the point where it can no longer be determined which assets are separate Appreciation on property owned by one spouse where the efforts of the other spouse contributed to its appreciation.
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Jill earns $25,000 in interest on CDs willed to her (only) by her father. However, Jill deposits such interest checks into an account jointly owned with husband, Jack. The $25,000 in interest thus becomes community property.
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Pam inherited a 20-unit apartment building from her father. Her husband, Paul, manages the building by seeing to the maintenance, collecting rents, approving tenants and more. The building, worth $500,000 when Pam inherited it, is worth $800,000 when Pam and Paul file for divorce.
Due to Paul’s contribution, the building may be regarded as community property for divorce and other purposes. The court may deem Paul entitled to half the appreciation. DePaul University All rights reserved. 27
In general, property acquired as community property in a community property state is not automatically converted into non-community property when moving to a common law state. Community property retains its characterization when the couple moves from the community property state to a non-community property state.
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If property is obtained by one spouse in a non Community Property state, that property is considered separate property. If the separate property is brought with the couple when they move to a community property state, then the property remains characterized as separate. Separate property is not automatically converted into community property just because the couple has moved out of a non community property state to a community property jurisdiction. Again, if the separate property is exchanged or sold for money, then the property obtained will likely be considered separate property the owning spouse.
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Quasi-community property is property that is obtained by a couple living in a common law state that would have been shared property if they were living in a community property state. Quasi-community property is treated like community property when the couple moves into a community property state. Quasi-community property is treated just like community property when one spouse dies or if the couple divorces.
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The quasi community property states are: Washington California New Mexico Arizona DePaul University All rights reserved. 31
Unique to community property ownership is that upon the death of the first spouse, the basis of the entire community gets a step up to FMV at date of death.
Example, Jack and Jill own as community property stock originally acquired for $20,000. On the date Jack dies, the stock is worth $100,000. The basis of the stock “steps-up” to $100,000. Assuming Jack leaves his interest to Jill, she can sell the stock for $100,000 with no capital gain.
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Trusts are entities that can own property.
Trustee holds legal title to trust property.
Beneficiaries hold equitable/beneficial ownership in trust property.
Trust may or may not be a separate taxable entity.
Living (lifetime/inter vivos) trusts are made while the grantor (settlor, donor, trustmaker) is living Generally revocable Testamentary trusts created per will instructions DePaul University All rights reserved. 33
Frank transfers $1 million to his new living trust. From this information you can determine that Frank is the: A.
Grantee Grantor Beneficiary Fiduciary DePaul University All rights reserved. 34
“Property interest” refers to the extent of a person's or entity's rights in property. It deals with the percentage of ownership, time period of ownership, right of survivorship, and rights to transfer or encumber property State law creates property rights Federal law taxes the transfer of those rights DePaul University All rights reserved. 35
A life estate arises when a person possesses all the benefits of ownership in the property during his or her lifetime (or the life of another) with the property going to a remainder person after the death of the life tenant.
Contrast a “term interest” which extends for a fixed term of years.
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Life Interest Example (life estate): Stu set up a trust under which his wife, Carol, gets all trust income as long as she lives. After Carol dies, the remaining principal passes to Stu’s nephew.
Carol has a life interest.
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A remainder interest describes a future interest in an asset. It may be a: future interest created by a trust; a contingent interest when a life tenant surrenders a claim to an estate; or, a vested interest that becomes effective at a specified future date.
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Stu set up a trust under which his wife, Carol, gets all trust income as long as she lives. After Carol dies, the remaining principal passes to Stu’s nephew, Clark.
Clark has a (future) remainder interest Carol has a (present) life interest.
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A vested interest is a right that so completely and definitely belongs to a person that it cannot be taken away without the person's consent.
‘Vested’ means that the interest either already is or will eventually belong to the beneficiary.
If this occurs after the beneficiary dies, the property will go to the personal representatives of the beneficiary.
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Contingent interest refers to a future interest which is uncertain and typically depends upon the happening of an event. A contingent interest can only vest on the happening of a specified event.
Either the person who will enjoy the property, or the occurrence of the event, will be unknown and uncertain.
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Sidney makes a Will leaving his house to whomever among his children marries first. Sidney’s children thus have contingent interests.
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A reversionary interest includes a possibility that property transferred during life, or by a decedent: (1) may return to the transferor or to the transferor’s estate, or (2) may be subject to a power of disposition by the transferor Example: Hank places a house in trust for his mother for life, then title reverts back to him on her death. Under trust law, Hank has a reversionary interest in the house.
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A present interest describes the right of a gift recipient to have immediate possession or enjoyment of the gifted property.
Example: Calvin gives his daughter, Callie, a check for $7,500. She may do whatever she likes with the money right now. Callie has a present interest in the gift.
Note: Only present interest gifts qualify for the annual gift tax exclusion.
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A future interest describes the postponed right of use or enjoyment of property.
Often it is a right to property that may not be enjoyed until some time in the future when a certain event occurs.
A life estate often precedes the transfer of property to another individual having a future interest.
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Barry establishes an inter-vivos trust under which he will receive all income for life. Following his death, any remaining trust principal will go to his daughter, Barbie. Barry’s brother, Harry, is the trustee of this trust. Who holds the future interest in this trust? A.
Barry Barbie Harry Barbie and Harry DePaul University All rights reserved. 46
A legal interest generally describes a person’s ability to manage and or distribute property rather than benefit from it.
Trustees of trusts and executors/administrators of estates typically hold legal interests in the trust’s or estate’s property.
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Beneficial interest describes a persons current or future benefit from property.
Heirs of estates and beneficiaries of trusts hold beneficial (equitable) interest.
Note: One individual may hold both legal and equitable interest in a trust.
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The terms of Tony’s living trust entitle him to all trust income. He also named himself trustee. At his death, any remaining principal passes to his daughter, Tanya. Which of the following types of interest or interests does Tony hold in his trust? A.
Legal interest Beneficial interest Contingent interest Both legal and beneficial interest DePaul University All rights reserved. 49
Real property describes all land, structures, firmly attached and integrated equipment (such as light fixtures or a well pump), as well as anything growing on the land DePaul University All rights reserved. 50
Farmer Brown’s corn crop is: A. Real property B. Intangible real property C. Personal Property D. Contingent property (depending on harvest outcome) DePaul University All rights reserved. 51
Personal property (personalty) is generally any property that can be moved from one location to another.
Personal property may be tangible or intangible DePaul University All rights reserved. 52
Tangible personal property describes property that can generally be moved (is not attached to real property or land), touched or felt. Examples: Furniture, clothing, jewelry, art, writings, or household goods.
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Farmer Brown’s pigs are: A.
Real property Intangible personal property Tangible personal property Tangible property only if they are slaughtered while still owned by Farmer Brown.
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Intangible personal property or "intangibles" refers to personal property that cannot actually be moved, touched or felt, but instead represents something of value. Examples: negotiable instruments, securities, service (economics), and intangible assets including chose in action.
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When Janet inherited $1 million in AAA rated corporate bonds from her grandmother she was grateful for the bequest of this: A.
Real property Tangible personalty Cash equivalents Intangible personal property DePaul University All rights reserved. 56