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Estate Planning

Are you a business owner and considering creating an Estate Plan?

If you want to prevent your business or businesses from being wrapped up in litigation, handicapped with tax liabilities or even run by people who have little understanding of what your goals are for the business then you should consider this when creating an estate plan.

You should plan for incapacity and avoid guardianship. Who would you want to run your business if you become unable to manage the day to day affairs? He or She should be designated through a power of attorney or revocable trust. If you do not designate someone in advance upon your incapacity you leave the decision-making power of your business to who the guardianship court appoints. Some very important business decisions may also require advance court approval. Planning to avoid guardianship can help ensure that the business will continue to be effectively managed if you are unable to do so.

One key component to creating an estate plan and considering your closely held business is to avoid probate. Any property in your name is generally subject to probate following your death. Assets which may be included in probate including their fair market values become public record. Being stuck in probate is long drawn out process which may take longer than a year or more before your business can be transferred to your loved ones.

What about your estate tax liability? Currently the law states that anyone with over 11.18 million will be subject to estate tax within nine months of death.  Several closely held businesses exceed that value, often triggering a substantial tax liability. Without advance planning your estate may need to borrow or sell assets to raise the funds.

Planning to minimize estate tax can involve many complex measures, including life insurance, buy-sell agreements, and sales or gifts to trusts. An attorney with experience should be involved when making these decisions.

What about my personal income tax? Death is difficult to go through, however, it also can bring income tax benefits. Planning may eliminate income tax benefits. Many high net worth individuals make gifts of business interests to the next generation in order to remove appreciating assets from the donor’s estate. The estate tax savings is generally expected to outweigh the loss of income tax savings.

To avoid the painstaking process of probate you should have an attorney create a revocable trust and transfer the title of your business to that trust. Therefore, your assets are now in a trust and are not public record and do not require the probate court to become involved.

The Pros of the Prenup

The Pros of the Prenup

Scrolling through the news items of today, I could not get off my mind, “How did Jeff Bezos, of all people, not have a prenup?” As it turns out, he married his current spouse before he created Amazon, and now she stands to be the richest woman in the world. We live in a turbulent world, and this current event still brings up the subject of a pre-marital agreements for many people who are considering marriage – even if they don’t have billions of dollars.

Currently, divorce statistics are declining, and the married population is getting older and more educated.  These changing demographic trends seem to indicate that matrimony is becoming more exclusive in terms of socio-economics, particularly amongst “Millennials”.

Furthermore, studies suggest that marriage is becoming more and more of an achievement of status, rather than something people wanted to do, like in the “old days.” Couples are waiting to marry until they are more economically stable, with some poorer Americans not marrying at all. In my day, we had kids first and then realized we couldn’t afford them…

There are probably many reasons for this trend. For the Millennials, perhaps they witnessed their parents’ divorce and remember how terrible it was for them. Coincidentally, now they want to be more financially secure before they marry, and in case they get divorced. Undoubtedly, financial disputes are the number one reason for divorces in America.  Without a pre-marital agreement, these divorces can be messy, long, and very expensive.

I try to tell clients a pre-marital agreement is not a sign of distrust or a document only the elite can afford. On the contract, most pre-marital agreements are designed to identify financial concerns and establish expectations, rather than planning for divorce, which they do. A well-drafted pre-marital agreement can actually serve as divorce prevention.

Having a pre-marital agreement is like buying insurance - you hope you never need it but it is there in case you do. Having this agreement can also be helpful to a spouse with fewer assets because individuals will often quit a job or relocate prior to a marriage. A pre-marital agreement can ensure that the non-working spouse is made financially stable in the event of a divorce.

A very common question asked by a spouse is, “Why is he or she asking me to sign a prenup? Don’t they trust me?” Having a pre-marital agreement can be a win-win for both parties. In fact, one of the biggest misconceptions of a prenup is that one of the parties is actually untrustworthy. I explain to many couples that a prenup can be a road map for their financial future.

An engaged couple should plan for their financial future and be able to agree upon financial issues before hand. By planning and taking the stress out of their relationship beforehand, couples can focus on what is most important to them in their relationship. A pre-marital agreement can build trust throughout the relationship on both sides and can always be modified as a couple’s financial future changes.

One of the biggest mistakes couples make is to just write down the division of assets on a piece of paper. While certain exceptions may apply, there is no “DIY prenuptial” and oral agreements are unenforceable. Like many other states, Nevada follows the Uniform Prenuptial Agreement Act (“UPAA”), which sets forth the rules for pre-marital agreements. In sum, a pre-marital agreement must provide a full and fair disclosure of each party’s assets, it must be notarized, signed voluntarily, and each spouse must be represented by separate and independent counsel.

Under the UPAA, Nevada has outlined some specific terms that can be contained in a pre-marital agreement. Some examples include:

·      the rights and obligations of each spouse to property either spouse owns, the right to buy, use, sell, transfer and control property;

·      the ownership of property upon separation, divorce, death, or any other event;

·      The elimination or modification of alimony or spousal and support;

·      the making of a will or trust to carry out the goals of the prenuptial agreement;

·      which state law governs the agreement; and,

·      any other term that does not violate public policy or the law.

There are many legal issues which are not allowed in a pre-marital agreement in Nevada, such as:

·      A Nevada prenuptial agreement cannot negatively affect a child’s right to child support;

·      An agreement may be unenforceable if the agreement was unconscionable when the couple entered into the agreement;

·      The spouse seeking the prenuptial agreement filed to disclose his or her property and financial obligations in a fair and reasonable manner;

·      The agreement was not entered into voluntarily; and,

·      The agreement eliminates or modifies spousal support or alimony to the extent that the spouse becomes eligible for public assistance.

A pre-marital agreement should also outline how the growth in value of non-marital assets will be treated. Recently, courts have taken a closer look at this valuation and have determined that the appreciation in those assets value is shared, rather than individual property.

Of course, signing a prenup does not mean you will not end up in court should you divorce, or that your interests would be protected as intended. However, having an attorney provide you with a pre-marital agreement will provide you with peace of mind that the agreement complies with the law, and allows you to focus on more important things, like how to pay for taking your kids to Disneyland.

Wrong advise about trusts

Many advisors recommend clients set up trusts for their children or grandchildren to take advantage of new large estate-tax exemptions.

But that advice is often overly simplistic, and sometimes it’s based on outdated strategies. Other than the uber wealthy, why would any client set up a trust for grandchildren? In most cases, that makes no sense because the same goals can be achieved through other strategies.

Worse yet, it seems that too many advisors have forgotten the unhappy clients who similarly pursued inappropriate strategies in the mad rush to do estate planning in 2012 before the exemption was supposed to decline from $5 million to $1 million in 2013 (which it didn’t). Clients that made large gifts to children or grandchildren, or trusts for them, later regretted those gifts because they could no longer access those assets.

So how can your clients have their cake and eat it too?

To plan better, advisors first need to identify how a client’s goals might be different today because of the 2017 tax changes. They may want to consider the following strategies:

  • The current estate, gift and GST tax exemption is a whopping $11.8 million, but that amount is halved in 2026, so clients should try to use as much as feasible before it is reduced. Using the exemption requires the client to make a gift that removes funds from the client’s estate (in tax parlance a “completed gift”).

  • Does the client need access to the assets given away? Without access, many clients will be uncomfortable making the large gifts necessary to use some of the expiring exemption.

  • Consult with the client’s estate planner and CPA to determine if the client would benefit from using traditional grantor trusts (the client setting up the trust and making gifts pays the income tax) or non-grantor trusts (the trust, not the client, pays income tax on trust income). Some plans, like those involving life insurance, are best held in grantor trusts. Other plans may seek to circumvent the income tax restrictions in the new law, for example to maximize charitable contribution deductions, salvage state and local tax deductions on real property or increase the 20% deduction under new Code Section 199A on pass-through business entities. Those strategies require the use of non-grantor trusts. This distinction between grantor and non-grantor trusts is critical as it requires different trust provisions. Advisors need to understand the nature of the trust’s structure, as it affects not only income tax planning but asset location decisions, as well.

Achieving any of those goals can be complicated, and doing so requires fine-tuning in the preparation of the plan and trust document. Too many articles about planning after the 2017 tax law have glossed over all of this. While financial advisors don’t need to be experts in all the nuances (after all, they can also rely on the client’s attorney), many advisors are active participants in the tax planning process and need some understanding of the nuances to do that.

All advisors, whatever role they take in tax planning, need to understand the big picture so that they can confirm their clients are getting the best planning.

If making a completed gift sounds inconsistent with preserving the client’s access to those funds, it isn’t. It just requires careful planning and drafting. Don’t advise the client to gift outright to an heir as that provides no protection or access. Instead, have the client gift to a trust to both protect the heir, and assure the client access.

Addressing the subject of mortality can be tough — but advisors can help make the conversation less painful.

A common non-grantor trust plan used for years is the intentionally non-grantor trust or “ING” trust. These trusts have been used by high-income taxpayers to shift certain income out of a high-tax state. ING trusts may remain a great plan for ultrahigh-net-worth taxpayers who have already used all of their estate tax exemptions. But for most wealthy taxpayers, securing exemptions before those exemptions decline by half in 2026 (or sooner by a new administration) may be best.

These taxpayers need a different type of ING trust than the uber-wealthy use. If an ING approach is used it must be fundamentally different from all traditional ING trusts, which were incomplete gifts (and thus, did not use the exemption), so that transfers constitute completed gifts which use the exemption before it declines. Otherwise, a fundamental goal of the planning will be lost. This is why, when a client’s attorney recommends a type of trust, planners need to understand the nature of that trust. They also need to be cautious recommended ING trusts for all clients because this technique, unless modified, is not optimal for everyone.

Location matters: When clients set up a new trust, remember to ask the question: What state is being recommended for the trust? The client’s home state? In many cases, the type of planning the client will need will require that the trust be formed in what are called “trust friendly” jurisdictions.

There are about 17 states, of which Alaska, Delaware, Nevada and South Dakota are the most popular, that permit clients to set up a trust and be a beneficiary of that trust, yet have the trust assets be removed from their estate. This type of trust might be warranted for a single client that wants to assure access to assets transferred by using a self-settled domestic asset protection trust or DAPT. ING trusts discussed above also need to be formed in these states to work. If a client wants to save state income tax forming a trust (or moving an existing trust) to a no-tax state may be essential to the plan.

Forming a trust in a state other than the client’s home state will often require naming an institutional trustee in that better state. Planners should not deter such planning for fear of undermining their client relationship. Rather, financial advisors should establish relationships with purely administrative trust companies based in the better trust states, so that their clients can get the best planning without creating unnecessary complications or competition for the advisor.

Trusts should also often include a trust protector to provide flexibility. This might include the power to change institutional trustees and states where the trust is governed and administered. Other persons might be given the power to add a beneficiary or loan the client money from the trust. But be careful as the latter two powers may characterize the trust as a grantor trust for income tax purposes (which in some cases now is not desired).

There are also different views as to whether the trust protector should act in a fiduciary capacity (with the level of responsibility of a trustee) or not. If a person is acting in a fiduciary capacity, they may not be able to add a new beneficiary, for example, as that might dilute the interests of the beneficiaries they have a duty of loyalty to. While financial advisors do not need to be experts in all these matters, they should at least ask questions to be sure the attorney has considered these issues.

Given the current high estate tax exemptions, for many clients the trusts should be created to last forever or a very long time (dynastic) and the client’s generation skipping transfer (GST) exemption should be allocated to protect gifts to the trust. This can keep the trust assets outside the estate tax system for many generations or forever. Rarely should trusts be planned for wealthy clients that pay out large sums at specified ages (e.g. 30).

Overall, there are more variations of trusts than ever before, which means clients and their families have more strategies they can benefit from. That said, the expansion of these options has also increased the complexity of trusts as planning tools, and identifying the best option for clients is not always an easy task.

Planners should remain proactively involved in the estate and trust planning process to make sure that in the end, a client’s plan does not merely recycle older trust strategies, but rather it uses the latest options to build a tailored plan suited to modern times.

Martin M. Shenkman

Martin M. Shenkman, CPA, PFS, JD, is a Financial Planning contributing writer and an estate planner in Fort Lee, New Jersey. He is founder of Shenkman Law. Follow him on Twitter at @martinshenkman