Washington Estate Planning Law Blog : Washington Estate Planning Lawyer & Attorney : John Hugg Law Firm : WA Elder Law, Wills, Trusts : Seattle, Woodinville, Bellevue

Effective January 1, 2012, a number of changes to Washington law pertaining to trusts and estates will become effective. One of these changes is the codification of a trustee’s duty to notify the beneficiaries of the existence of a trust and keep those beneficiaries informed regarding the trust’s administration. This rule will apply to irrevocable trusts established after December 31, 2011, and to revocable trusts that become irrevocable after this date. Another important component to this change is that the maker of a trust, otherwise known as a “trustor”, cannot relieve the trustee of this duty. Previously, the law has been a bit unclear as to what, when and to whom information about a trust and its assets has to be provided.

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A number of my clients leave different amounts to children via their Wills. In my experience, this occurs most often after parents give one of their children money to help out while they are alive, but not all children. The thought behind giving more through a Will is to give the child who did not receive money while mom and dad were alive a little more at death to equal things out. Of course there can be other reasons for unequal bequests including estrangement or other non-financial issues. A recent Wall Street Journal article notes that when this situation occurs, you should take steps to reduce the likelihood of conflict. Two good ways to reduce the likelihood of a Will contest are writing or videotaping an explanation of the unequal distribution and, under certain circumstances, taking additional steps to show a clear mind when you signed the Will.

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This Wednesday, August 3, 2011, I will be conducting another “Are Your Affairs In Order?” class at the Maltby Church in Snohomish, Washington. The class focuses on all aspects of Wills, Trusts, Powers of Attorney and Living Wills. The program is sponsored by Evergreen Healthcare.

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In addition to the seminar on Advance Directives I am scheduled to give on April 15 at the Peter Kirk Community Center in Kirkland that was already posted, I am also speaking on general estate planning topics at two additional events. One is on April 21, 2011, from 6:30 p.m. to 7:30 p.m. at the Northshore Y in Bothell and the other is on May 11, 2011, at the Redmond Senior Center in Redmond, Washington.

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The changes to the federal estate tax laws on January 1, 2011, include a wonderful opportunity to gift away a portion of your estate without incurring gift taxes. Along with the increase in the federal estate tax exemption limit to $5 million per person, Congress increased the gift tax exemption limit to $5 million per person. The previous limit was $1 million per person. The annual exemption limit remains $13,000 per person, however, you may now give away up to $5 million of your estate while you are alive without paying any gift tax. Any gifts made in excess of this amount would incur tax at the newly reduced rate of 35%. Adding to the benefits of implementing a gifting strategy, Washington State does not currently have a gift tax. One caveat, this opportunity may not last. The current estate and gift tax laws are set to expire at the end of 2012.

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As most everyone knows by now, Congress and the President have reached an agreement to extend the Bush Era tax cuts for another two years. Included in this agreement is the return of the federal estate tax. The proposed reinstatement will carry an exemption of $5 million per person and a tax rate of 35%. This is good news for most people as a relatively small percentage of Americans will be hit with a federal estate tax. But remember, Washington State still has its own estate tax with a $2 million per person exemption and a top tax rate of 19%.

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As an estate planner, I see a lot of revocable living trusts. Either because I draft them for clients, assist clients with making changes to them or help with administration after a death. So what is a revocable living trust? What are the advantages and pitfalls of such a trust? And, when is it a good idea to use a revocable living trust?

Revocable living trusts go by a number of different names. Generally, they are referred to as Living Trusts or Family Trusts or some variation of those names. I’ll use the name “Living Trust.” A Living Trust is a trust that you create while you are alive. You are the maker of the trust, or grantor, you are frequently the trustee of the trust, so you maintain control over the assets of the trust, and you are the primary beneficiary of the trust. Thus you can use the assets or income of the trust while you are alive.

The key aspect of a Living Trust is that it is “revocable.” This means you can terminate or change the trust any time you desire. You can also add or remove property from the trust at any time. This can be a very handy tool to have at your disposal. For instance, most Living Trusts say that all trust assets will be used for the makers of the trust while either are alive then pass to children equally. However, if you have a falling out with a child, you can change the terms or the property of the trust to reduce or eliminate that child’s inheritance.

There can be many benefits to a living trust depending on your situation. The most universal benefit is that, if planned correctly, you can avoid probate and its costs and hassles. In Washington State, however, this may or may not be a big deal. Unlike some other states, probate in Washington is often a fairly streamlined process. Also, if you desire privacy, a Living Trust can be quite valuable. While probate is a public process, administration of a Living Trust is generally a private matter.

However, there are some pitfalls to Living Trusts. First, you generally cannot protect assets in a Living Trust from the IRS or other creditors. Second, this type of trust has no present income, gift or estate tax benefits because the IRS generally doesn’t even recognize the trust (that can change once one spouse dies). Additionally, at least in Washington, a Living Trust will not help you or your spouse qualify for Medicaid if that is something that needs to be done.

While there may be other reasons, a Living Trust is useful where you have real property in multiple states, as it can eliminate the need for a probate in two or more states. This will reduce cost and hassle. If you want privacy, the Living Trust is also very effective, and if you want to avoid probate in the state where you live the Living Trust may do that as well.
 

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I will be one of several presenters speaking at the Cascade Club at Trilogy at Redmond Ridge on Tuesday, November 9, 2010, from 6:00-8:00 p.m. Topics I will be covering include wills, trusts, probate and Medicaid planning.

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Recently, I was watching Cinderella with my three year old and thought – Wow, if only she was a trust beneficiary she wouldn’t be locked in the tower slaving for her step-sisters. For those who don’t recall, the setup for the story is that Cinderella’s mother passed away; then her father remarried the evil step-mother; her father dies and the step-mother squanders his estate on her two daughters. But had Cinderella’s father placed his assets in trust for his daughter and chosen a responsible, independent trustee, her step-mother would never have gotten her hands on the money. This may be an odd thing to take away from a children's movie, but lessons can be learned from almost any source. The lesson here is to plan your estate to protect your children.

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A number of wealth transfer strategies utilize interest rates published by the IRS. One such rate is the Section 7520 Interest Rate, and in October it will be only 2%. That’s tied for an all-time low. Other interest rates used for such strategies are near their all-time lows. These interest rates mean certain strategies, including Grantor Retained Annuity Trusts, installment sales to grantor trusts and intra-family loans, are particularly attractive. If you’ve been contemplating transferring assets such as business interests or real estate, or helping a family member with a loan, now is a good time to act.

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Last Sunday, the Seattle Times Newspaper, ran an article by syndicated columnist Chuck Jaffe that crystallized perhaps the best reason to plan your estate sooner rather than later. What I took from the article was you do not want to spend time thinking about getting your affairs in order if you only have a short time to live. Mr. Jaffe noted his late brother did his estate plan before becoming ill, and he was thankful he did not have to waste one precious minute worrying about wills, trusts and finances. When time is of the essence, you should focus on what really matters in life rather than the mundane details of what happens after death. There certainly is no better reason to plan sooner rather than later.

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Contrary to many people’s belief, your assets will not necessarily pass to the state if you don’t have a Will. In all likelihood, Washington State’s laws of intestacy will apply to pass assets to your heirs. Only if you have no heirs to receive your estate would your assets go to the state of Washington. In most circumstances an heir can be found. I was recently involved in a matter where much of the estate went to heirs located in Europe that the testator had never met. There are many reasons, however, why you might want to avoid this situation. If you want to make sure people you have never met do not receive your assets, a Will is very beneficial. Further, the intestacy laws will not help if you want a specific person to receive a specific asset, nor will they address estate tax or long term care issues; and, intestacy laws cannot ensure your minor children are taken care of by the person you desire. Those issues can only be addressed through a detailed estate plan captured in a Will, trust or both.

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With the estate tax in flux this year, you may want to revise your wills to make sure your bases are covered. If you have a will that leaves assets to a person based on an estate tax formula it may need revision. For instance, some wills leave assets to children based on an amount that can pass free of federal estate tax. If this is the case, in 2010, presumably all assets would pass to those children under this language. Such a scenario may leave little or nothing for a surviving spouse. Often this is not a person’s intent. Additionally, you may want to have language included to address an estate tax with a $1 million exemption limit or a higher limit, depending on what Congress does or does not do later this year.

You should also consider to whom your assets will pass and how they will be affected by the capital gains tax. If you are leaving more than $1.3 million to someone other than your spouse, you may want to make sure your executor knows how to allocate the step-up in basis, applicable to estates of persons dying in 2010. If the basis step-up won’t cover all such assets (so as to minimize future capital gains taxes on an asset’s sale), it may be wise to include language guiding the executor to allocate the basis step-up in a manner that minimizes the tax burden on all beneficiaries. Hopefully such language will reduce the potential for strife among family members.
 

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The evening of Tuesday, April 20, 2010, I will present an estate planning seminar at the Bellevue, Washington offices of Waddell & Reed. This presentation starts at 6:00 p.m. and is scheduled to run until 7:30 p.m. Also, on Friday, April 23, 2010, financial planner David Harry and I will conduct an estate and financial planning seminar beginning at 11:30 a.m. at the Northshore YMCA in Bothell, Washington. Each presentation will focus on estate planning in a world with and without the federal estate tax.

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On January 1, 2010, the federal estate tax was repealed. Currently, there is no federal estate tax. So, what does this mean for people in the State of Washington? It means several things. First, it means that if you die today, you may not owe any estate tax to the federal government; second, there is still an estate tax in Washington State that may apply; and, third your heirs may have to pay a substantial capital gains tax on property that is sold. Let’s look at each of these issues.

Federal Estate Tax

I say you may not owe federal estate tax because toward the end of 2009, Congress made a lot of noise about how they would simply bring the estate tax back in early 2010 and have it applied retroactively to January 1. So in actuality, if you die today and Congress creates a retroactive tax in May, you could still owe federal estate taxes.

If, however, Congress does nothing on the estate tax issue in 2010, the estate tax is automatically set to come roaring back in 2011. At that point, the estate tax exemption will be $1,000,000 per person as opposed to the $3,500,000 exemption in 2009. This means a lot more estates will owe taxes in 2011 than in 2009.

Washington State Estate Tax

Regardless of what happens with the federal estate tax, Washington still has its own estate tax. Here, the estate tax exemption is $2 million per person. So anyone with an estate in excess of that amount would owe estate tax to Washington State. Proper planning can minimize or even eliminate this tax in certain situations.

Capital Gains Tax

There is another wrinkle with estate tax repeal. This year, without the estate tax, you can only receive an increased tax basis on $1,300,000 worth of your property. What does that mean? Well, under the old estate tax laws, when a person died the tax basis in his or her property would increase from the amount paid for the item to the market value of the item at the time of death. But this is not the case in 2010. Now only $1.3 million of your property will qualify (with an additional $3 million exemption for property passing from one spouse to the other). If you have property worth more than that, a capital gain will be incurred on the sale of the asset, and that gain will be based on the original cost of the item.

Here’s an example under both the old and new systems: mom has $1.3 million in her retirement account; mom bought her house in 1980 for $50,000. Mom dies in 2009 and the house was worth $350,000. The tax basis increased from $50,000 to $350,000 and her heirs would owe no capital gains tax on the sale of the house in addition to having no estate tax to either the federal or Washington State governments.

Now let’s say mom died on January 1, 2010. If mom’s retirement account eats up her $1.3 million capital gain “exemption” then capital gain will be due on the sale of the house. The tax will be based on $300,000, the difference between the $50,000 original tax basis and $350,000, the current value of the property.

What will happen to the capital gains tax issue if the estate tax is reinstated retroactively? Presumably, it will go away. Confused? To deal with this mess I (with tongue in cheek) told one client earlier this week – “Don’t die in 2010!”
 

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Everyone has an estate plan, whether you know it or not. If you have a Will and/or related documents you know you have a plan. But even if you don’t have a Will, you still have a plan. That plan is set out by the government, and it is laid out in our laws of intestacy. Each state has its own laws of intestate succession. Generally those laws follow what the legislature thinks most people want. For instance, if you are married your property goes to your surviving spouse. If you are not married and have kids, your property goes to those kids in equal shares. If you are not married and have no kids, we look to parents, then siblings and so forth.

There are, however, major gaps in this “estate plan.” For instance, if you have a minor child, nothing says who will raise that child if both parents are deceased. Additionally, state laws leave property to a beneficiary outright even if a trust for such beneficiary would be more prudent (in the case of a minor child some form of conservatorship may be necessary). Another problem is a state’s laws of intestacy are not set up to deal with other major planning problems such as: estate tax issues, care for a disabled spouse or a special needs child and business succession issues for the self-employed.

This is where having a comprehensive Will that is tailored to your specific situation can be vital. Your Will sets out who will administer your estate, who will receive what property and in what percentages and who will raise your children. If you have a taxable estate, which in Washington today, is anyone whose estate is valued at more than $2 million, you can set up a trust for your spouse to make sure that you minimize or perhaps avoid estate taxes. If you don’t have a taxable estate, but think a surviving spouse may become disabled in his or her later years, a Will is one of the few tools that can be used to assist a loved one with care while not having to spend all your assets to qualify for assistance. In this instance we can often set up a trust for a surviving spouse or special needs child to assist with quality of life while allowing them to qualify or continue to qualify for Medicaid or other forms of assistance.

In short, your Will can accomplish many goals all at once. If you, like millions of other people, have put off making one, I encourage you to tackle this project in the new year.
 

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The Wall Street Journal ran an article recently about purchasing Will forms from various online or self-help services. The article has received criticism from some in the estate planning community. Here’s what I think people should understand about the estate planning process and where potential traps may lie.

The article outlines a couple with a non-taxable estate and no children, a house, life insurance and retirement accounts. The hypothetical couple apparently want to leave the house to the surviving spouse, one-half of the other assets to the surviving spouse and simultaneously leave the other half of the remaining assets to nieces and nephews. The author seems to feel this is a very simple situation. Of course, every one of my client’s believes their own situation is just as “simple.” However, after I meet with a client, and we discuss everything most say “Wow, I never knew it was so complicated.”

If Mr. and Mrs. Hypothetical want such an estate plan, I’d first ask why they want that specific plan. I’d mention that most married couples want their entire estate to pass to the surviving spouse, not merely the house and half of the other assets. The reason is simple – most spouses want to have as many resources, i.e., money and other assets, as possible for their future financial security. I’d probably recommend that the nieces and nephews only receive something if both spouses are deceased.

The next question could be, Should those nieces and nephews receive their inheritance outright or in trust? If they are minors and they receive the inheritance outright, their parent or guardian may control the funds for them until they reach age 18 or perhaps a guardianship or some form of conservatorship could be set up. At age 18, however, they are free to spend the money as they please. Most of my clients don’t want their children to receive their inheritance at 18 with no strings attached. A better alternative is some form of trust where there is guidance as to how the funds are invested and distributed to the beneficiary.

Another issue is the life insurance. Life insurance passes to the beneficiary designated in the policy, not pursuant to a Will. So if our hypothetical couple thinks part of the insurance proceeds will find its way to the nieces and nephews, it probably won’t happen. IRAs and 401k’s, as well as any type of account with beneficiary or payable on death provisions, also bypass your Will in most situations, unless your estate is the beneficiary. In many cases, you do not want your estate to be the beneficiary of such assets.

These are just some of the issues that would need to be addressed to produce an estate plan that truly meets the clients’ needs. So will the online estate plans accomplish what our hypothetical client desires? And, is want the clients want the best estate planning option? In all likelihood, the answer to both is probably no. But these clients wouldn’t know that without competent guidance.
 

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Recently, a number of cases have come out addressing when a gift of an LLC interest is really a gift of an underlying asset owned by the LLC. Two of these cases were decided right here in Federal District Court in Washington: Heckerman v. U.S., U.S. Dist. Ct., W.D. Washington, Cause No. C08-0211-JCC (July 27, 2009) and Linton v. U.S., U.S. Dist. Ct. W.D. Washington, Cause No. C08-227Z (July 1, 2009).

To summarize the cases very briefly, families in each case formed an LLC and the senior generation contributed various assets to the respective LLCs. On the same day the LLC contributions were made, gifts of LLC interests were made to trusts for their respective children. Each family claimed a valuation discount of the LLC interests for gift tax purposes. The IRS applied the indirect gift and step transaction doctrines to attempt to eliminate the discounts. In effect, the IRS said the parents made a gift of an actual asset and not an LLC interest. Valuation discounts apply to the latter. The IRS was successful in both cases.

The primary basis for denying the valuation discounts was the indirect gift doctrine. Application of this doctrine can frustrate a valuation discount if there is insufficient evidence to conclude what occurred first, funding the LLC or making gifts. In each case, with funding and gifting occurring on the same day, the necessary evidence was absent. An additional basis was the step transaction doctrine where a series of separate ‘steps’ are seen in substance as integrated, interdependent, and focused toward a particular result. There are three different tests used to determine if the step transaction doctrine applies in a given transaction: the “binding commitment test” where there is a binding commitment to undertake several different acts that, when viewed as a whole, are really one transaction; the “end result test” where one gleans an overriding transaction based on achieving an end result, such as tax savings; and the “interdependence test” where one act is ultimately fruitless without additional acts.

Can these problems be addressed with proper planning and drafting? Ultimately, the answer is somewhat unclear. What seems obvious is to set up an LLC or partnership first, then subsequently fund it with the assets desired. Other case law also indicates that when contributing property to the LLC the value of the asset should be attributable to the contributor’s capital account only. At a later point in time, seemingly the more elapsed time the better, a person would make gifts of the LLC interests. Presumably, if you are gifting to a trust, as is often the case, setting up the trust subsequent to the creation and funding of the LLC would seem prudent. Conducting affairs in this manner should automatically avoid the indirect gift doctrine and, assuming proper drafting, the “binding commitment test.” It should also go a long way to avoiding the “interdependence test,” however, given that the “end result test” can be apparently be satisfied by evidence of the “subjective intent” of the parties, it is unclear how one would plan to avoid this part of the step transaction doctrine. Stay tuned for further developments.
 

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In PLR 200937028, the IRS concluded that property held in an irrevocable grantor trust that was not included in the grantor’s estate at death does not receive a step-up in basis. Most individuals who own property in their own name at death receive a step-up in the tax basis of that property. For example, if you paid $200,000 for your home in 1995 and you die today with the house valued at $500,000 the tax basis increases to today’s value. Therefore, capital gain on the sale or future sale of the asset is either eliminated or minimized. However, if you transfer an asset to an irrevocable trust, even a grantor trust where the trust income is still taxed to the grantor, the asset is out of your estate and not eligible for a step-up in tax basis upon death. The beneficial trade off is that with the asset outside your estate, it is not included for estate tax purposes.

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• The birth or adoption of a child.
• A child(ren) having reached the age of majority who may now be able to assist in your estate plan as an executor, trustee, or act on your behalf under a power of attorney.
• A power of attorney that addresses only financial issues and not health care decisions.
• A power of attorney that does not have language that complies with the Health Insurance Portability and Accountability Act.
• A Living Will/Health Care Directive that no longer addresses all the relevant issues surrounding life sustaining treatment.
• The desire to provide for grandchildren.
• The potential for one spouse to require continuing care either at home or in an assisted living facility.
• The acquisition of assets located outside the State of Washington, such as a second home.
• Death of a spouse, sibling or other beneficiary.
• An increase in assets or the value of those assets that can cause an estate tax issue.
• An outdated estate plan developed for tax reasons that no longer apply.
• The need/desire to change the guardianship provisions in your Will.
• The desire to leave a business to your children.
• Changes in the law. For instance, the federal estate tax rules have changed almost every year of this decade.

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We’ve been waiting for changes to the federal estate tax for some time, however, we really have no idea what the changes will look like. Over the weekend the Wall Street Journal reported the issue is stalled in Congress with seemingly no consensus about what to do. The administration apparently wants to lock in the current exemption level of $3.5 million per person with a 45% tax rate and some Republicans are still looking for a complete repeal. Now there is a newer proposal for a $5 million dollar per person exemption with a 35% tax rate. But with so many members of Congress focused on the health care debate, this issue is decidedly low priority. Another very real possibility is that the Bush tax cuts will run their course as planned. With no action, the estate tax will be repealed for 2010 only, then return with only a $1 million federal exemption per person. Regardless of what happens at the federal level, Washington State appears wedded to its current $2 million per person exemption. If the federal exemption is rolled back to $1 million, I would expect a large number of estate plans will need to be updated.

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Here’s a brief article from the Wall Street Journal outlining the use of a trust as a beneficiary for an IRA. Many people name a spouse or children as outright beneficiaries of their IRAs. However, if properly set up those same people can receive their IRA benefits through a trust. As mentioned, this strategy can be particularly useful for beneficiaries who are minor children or those who have special needs.

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