The Law Office of Craig Willford
ESTATE PLANNING AND TRUST MANUAL OUTLINE


This OUTLINE: What is it and what is it not.

This manual is a brief overview of estate planning and trusts. It cannot, by its short nature, cover all things about estate planning. It is not intended to teach you how to become an estate planner as though you were the attorney. Much training and experience goes into that. It is, however, intended to help you see some of the issues involved in estate planning that you might take with my guidance. I hope that it helps.

Q: What is a Trust?

A: A Trust is a relationship in which a Trustee (or more than one Trustee acting together) are "trusted" to hold assets for the benefit of the Beneficiary or Beneficiaries. The person who places the assets into the possession of the Trustee is called the Settlor (and can also be called the Trustor, but that gets a bit confusing to have two titles so similar to each other). For tax purposes, the Trust is treated very much like a separate entity. The assets held, however, are held by an individual(s) [human people or corporations]: the trustee(s). However, when a trustee dies or resigns, the Trust does not fail; rather the assets continue to be held "in Trust" by whoever becomes the successor trustee. This is true even if a successor trustee is not named; a Court would appoint a successor.

Q: What is a Living Trust?

A: A Living Trust is another word for an Inter Vivos Trust. "Inter Vivos" is a fancy way of meaning "within life"; a Trust you create while you are alive. This is to distinguish Trusts which spring into existence after you die by terms you may have placed in a Will. Those Trusts are called Testamentary Trusts (stemming from the word, "testament," as in "Last Will and Testament").

Q: Are there different kinds of Inter Vivos Trusts?

A: There are as many different kinds of Inter Vivos Trusts as the imagination can generate. However, some broad divisions can be generically described. Perhaps the biggest distinction is between a Revocable Trust and an Irrevocable Trust.

Revocable Trusts mean just that: they can be revoked or modified. The Revocable Trusts are typically used where you don't want to lose power over your property during your life but you want to obtain some of the benefits of probate avoidance or federal estate tax minimizing and collateral purpose of lessening the possibility of needing a conservatorship in the event of incapacity.

Irrevocable Trusts on the other hand are not revocable or modifiable and are typically used where you wish to make an outright gift (which is also irrevocable: the law doesn't allow you to take back the gift) but you don't want the donee (the recipient of the gift) to have full power over the gift. Perhaps you don't trust their management skills or their ability to resist the desire to squander all the money. Perhaps they are too young, have a medical problem that is aided by medical care paid by government aid, or have an addiction.

The answer to this question only hits some of the highlights and some of the most commonly used reasons for having Revocable or Irrevocable Trusts.

Q: What's so great about these Trusts anyway? Why all the talk about them and why would I want one?

A: Good question. Most people have a desire to pass to their heirs the greatest amount of their property they possibly can, with very little disappearing to administrative costs and taxes. Further they want to avoid administrative hassle such as with a probate.

Q: What is a probate?

A: I have a whole separate web page addressing the specifics of Probate, but in a nut shell, probate is a procedure by which the Court supervises the passing of assets that stand in the decedent's name to his heirs or Will beneficiaries. The whole purpose of a probate is to make sure that fairness is accomplished in that passing. The word "probate" comes from a root word meaning "to prove".

In a probate one must prove that the Will presented really is the Will of the decedent; that the he/she really was competent when he/she signed it (although the law initially presumes this); that it really was witnessed as it was supposed to be; that he/she wasn't under the undue influence of anybody (again, the law presumes this initially); that these children who appear before the Court really are the children of the decedent and that these assets and debts really are the assets and debts and the only assets and debts of the decedent. It also provides for a Court supervised method in which the accounting is tendered so that it makes it more difficult for the executor to steal from the estate.

Since probate is a creature of statute, the legislators of our state have purposely created this process that many view as a hassle. They are not sadists; they simply recognize that decedents' estates are ripe for abuse and so need some protection in some instances. In the legislators' discretion, they have decided that only those estates that are over $150,000.00 in size need to be probated with some exceptions. The legislature feels that estates smaller than this are not such "ripe apples" for theft as would warrant consistently requiring the hassle of probate.

In other words the probate is there for a reason: it's there to protect your estate from wrongdoing of others in the passing of assets from your generation to the next. To "side step" this process is to increase the risk (in the view of the legislators) that wrongdoing will occur.

Q: When you say the value of the estate has to be over $150,000.00, what do you mean by "the value"? Are life insurance proceeds included? How about joint tenancy? How about bank Trust (payable on death) accounts?

A: The assets which are counted toward the inclusion (called the probate estate) are those assets which stand in the decedent's name alone or in a form that requires probate such as tenants-in-common. Joint tenancies do not pass by the decedent's Will or by intestacy statutes but instead pass immediately to the other co-owners, by a simple Affidavit-Death of Joint Tenant document outside of probate. Life insurance proceeds are similarly contractually paid directly to the beneficiary and also pass outside the probate estate. Bank Totten Trust Accounts or "payable on death" (POD) accounts are also special creatures of contract between the depositors and the bank. The Totten Trust Account money flows to the beneficiaries immediately on death (subject to documentation to the satisfaction of the bank). Totten Trust Accounts are not true Trust Accounts, since the assets are held for the benefit of the depositor, not held for the benefit of the survivor.

Q: So, does a Trust avoid probate?

A: Yes, if you have placed enough assets in the Trust so that the assets outside the Trust in your own name (the probate assets) are under the probate threshold level (currently $150,000.00). A mere creation of a Trust, without adequately funding it will not avoid probate. If you feel quite confident that the trustee who would wind up the loose ends of your Trust, would not steal from the estate and would handle the passing of the property fairly, the avoidance of probate by a Trust is an acceptable thing to do.

Q: What does a Probate cost my estate?

A: The statutory attorney's fees for doing the ordinary tasks of probate are fixed by statute to the following schedule:

4% of the first $100,000.00 of the estate,

3% of the next $100,000.00

2% of the next $800,000.00

1% of the next $9,000,000.00

0.5% of the next $15,000,000.00

and then judge discretion for any estate above that. Thus for an estate of $200,000.00, the statutory attorney's fee would be $7,000.00.

The estate to which these percentages apply is the gross estate and so the existence of debt against the estate is not subtracted before the computation is made. In the extreme case, a $200,000.00 gross estate could have a $200,000.00 debt against it leaving no net estate at all to pass to the heirs and yet the statutory fees would still be $7,000.00 to the attorney.

The statutory commission of the personal represenative (administrator or executor) is the exact same statutory percentage formula. However in some cases the administrator or executor would choose to waive his/her fee, as where he/she is an only child and would receive the monies anyway. If he/she takes the fee, it's earned income that is reportable on his/her income tax return; whereas if he/she receives it by inheritance instead, then he/she receives it free of that tax.

In addition to these statutory fees, either the attorney or the administrator or executor or both can qualify for "extraordinary" fees (in the discretion of the judge) for work that is beyond the normal estate. Such extraordinary work typically involves the sale of real property, 706 Estate Tax Returns, 1041 Fiduciary Income Tax Returns, litigation involved in the estate and other special handling above and beyond the normal duties.

Thus, in order to establish what the costs of probate of your estate would be, it's necessary for you to try to anticipate whether your executor or administrator would waive his or her fee and what sort of extraordinary services that will have to be rendered.

Q: How does that compare to, or contrast against, the cost of creating a Trust? Does a Trust get resolved cost free after my death, or is the cost of winding up the trust after my death part of the cost that an attorney charges to set up the trust in the first place?

A: I know of no attorneys that charge a single fee to both set up the trust and then promise to wind it up after your death, "price included". Different attorneys charge different prices to create a Trust for you. Many factors may go into the manner in which the attorney sets his/her price. Included in those factors would certainly be his/her experience and training for which he/she might expect a higher fee than those with less experience or training. It would be difficult, as a client, to know what is the experience of a lawyer the client was considering hiring.

You could simply ask him/her what percent of his/her practice is in that field and how long he/she has been practicing in that field. Another way, since 1990, is to ask if he/she is certified by the State Bar of California as a specialist in the Probate and Estate field. The State Bar only recognized this field for certification beginning in 1990.

There are many other factors that would go into the establishment of an attorney's reasonable fee, but the parties are free to contract for any fee they can agree on. So it's possible for an attorney without much experience or training, without any other factors, to charge a fairly high fee.

Q: Okay, so I should be as careful a consumer of lawyer services as I should be of everybody's services. Is it justified for me to spend these monies just to avoid probate where no tax savings are involved?

A: That's a matter for your judgment. Typically however many people do not establish Trusts merely to avoid probate and to do so in the state of California only when their estate is such a size that they risk federal estate taxation upon the death of the last marital partner. These people usually have only Wills. Clearly the children are financially better off (if no one does anything naughty) if their parents spent the money to get a trust, even if there are no taxes (but the parents themselves save little or no money by doing the trust, with some exceptions involving incompetency, stepped up basis for long term capital gains, and other issues).

Q: I've heard that federal estate taxation is not really a problem until your estate goes over a certain amount. Is that true? And should I then skip having a Trust until my estate is over that threshold?

A: It's true. $5,000,000.00 is the 2011 threshold (and adjusted for inflation in subsequent years) for estate taxation. However, the technique of avoiding some or all of estate taxes that is found so desirable by most becomes unavailable if not planned and implemented while both spouses are still living. Thus, if your estate is under $5,000,000.00 now but it will be over $5,000,000.00 (or whatever is the threshold then) by the time the last of the two spouses die, then creating a Trust now should be considered. (There is also a new estate tax concept called "portability" that changes some of what is discussed in the next sentences.) Some of the considerations then would be the rate of income on your principal investments, the rate of inflation, and the ages, health, and the life expectancies of both the husband and the wife and also your expectations of what the federal government might do in the future for the Federal Estate Tax exemption equavalent to the credit in effect.

Q: How does a Trust save on taxes?

A: Technically, the Trust doesn't save the taxes. The Trust implements a method of preserving both "by-pass" amounts of both spouses.

The estate tax is a tax upon the estate of a person at death. If the husband dies first (in my examples, the husband seems to always die first [ha ha]) leaving all his half of the community property plus his separate property assets to his wife and if their assets combined (husband's and wife's) were $10,000,000.00, and his assets at his death were half that, or $5,000,000.00, which is exactly the federal estate tax threshold on his passing, there would be no estate taxes on his death, whether he leaves it to his wife or leaves it to the kids. However on the wife's death, she will not only have her $5,000,000.00 estate but she will now have the $5,000,000.00 estate of her deceased husband stacked upon hers for a total of $10,000,000.00 sending her $5,000,000.00 over the threshold. That extra $5,000,000.00 will be taxed at substantial rates.

If instead the husband had left his $5,000,000.00 estate to his children, his estate would not be taxed because it was below the threshold and when the wife passed away her estate would also pass to the children tax free because her estate would be only $5,000,000.00 also (barring inflation, appreciation and accumulation).

Q: Who wants to do that? I want to make sure my spouse is taken care of first! The kids can wait their turn!

A: You're not alone in that view and that's where the Trust comes in. With a Trust you can get the tax benefits of leaving the estate to the children in two pieces (each under the threshold) and yet retain a lot of the benefit in both halves to the wife for her life, getting almost all of the cake and eating it, too.

Q: You said almost all of the cake. What does that mean?

A: If you were to truly give the surviving wife all the same rights (if you give her all the cake) she would have had if you had just given it to her, the IRS will treat it as though it was actually owned by her and they will tax it at her death as such. So her rights must be somewhat constrained and the rules by which they are constrained are well defined. She may have the right to all the income and she may have a constrained right to dip into the principal if she really needs it. This is the so called "ascertainable standard" for her health, education, food, housing, clothing and the necessities of life according to the standard of living to which she had become accustomed while you were living.

What this means is that the surviving spouse can have all of the beneficial use of all of the income from the deceased spouse's half and in addition to that also have a somewhat limited power to dip into the principal. This is very close to outright ownership and yet it isn't treated as ownership for the purposes of inclusion in the surviving spouse's federal taxable estate upon her death and so you get almost the benefits of both worlds.

Q: Do we then cut the estate into two perfectly equal halves?

A: Not always. You might choose not to or you might not be able to. There are so many different considerations going into the decision that it's almost impossible for a standardized descriptive piece of literature such as this to go over all the different possibilities. Let's attempt to tackle some of the most common possibilities.

Q: Okay, I am about 50 years old, as is my wife. We're both in good health. We have nothing but community property, that is that neither of us have inherited or been gifted any funds or property and everything we have has been earned by us together during our marriage (neither of us has any separate property). We have two adult children and neither of us have any children born of any other relationship. We both want to protect each other primarily and then on the death of the last of us we want our kids to get everything equally. Our estate is now about $900,000.00 of net equity and we wish to base our estate plan on the presumption of inflation at about 10% to 12% per year until the death of the last of us based on normal mortality tables. What should we be considering doing?

A: You present one of the simplest examples possible. By your scenario, you're likely not to live long enough that your estate would go over the current estate taxable threshold (but the estate tax threshold was scheduled to go to $1,000,000.00 in 2011 until a last minute change in December 2010. Federal estate tax planning would, in my opinion because of the recent volitility in the government's setting of the threshold, be indicated. You could, if you wished, plan to split the estate into halves at the death of the first spouse, so as to hedge against the possibility that inflation might send the surviving spouse's one-half over the threshold. One of the disadvantages to splitting the estate into halves is that it constrains the surviving spouse's access to the deceased spouse's half that might not have been required if inflation does not send her half of the estate close to the threshold.

Another alternative would be to take your best guess at life expectancy and inflation probabilities and fund the surviving spouse's portion with just the right amount to be just slightly under the anticipated tax threshold, putting into the deceased spouse's portion whatever is left). The advantage for this uneven division is that, if you guess correctly about the tax threshold, rate of inflation and the length of the lifetime, then you have freed up to unfettered access by the surviving spouse a greater portion of the estate. The down side is that if you guess wrong you potentially incur some federal estate tax upon her death.

Another alternative would be to be super-cautious in avoiding taxation by funding the deceased spouse's by-pass trust with exactly the estate tax threshold amount and leave the surviving spouse whatever is left (in this case, nothing, if he dies today). This alternative gives the surviving spouse the least freedom, but hedges against the possibility that she might inherit money or be such a prudent and successful investor that by the time that she dies, she will somehow have accumulated enough value of her own to be over the estate tax threshold by the time of her death.

For those families whose estates are over twice the exemption equivalent to the unified credit so that each half is already over the threshold of federal estate taxation, then the difference in taxation is relatively minor between dividing the estate in exact halves (and suffering some taxation upon the death of the first spouse but lowering the brackets of taxation over all) or dividing the estate into the tax free portion on the death of the first spouse and the larger balance going into the marital deduction Trust [or trusts] (thus delaying all estate taxes until the death of the second spouse, but taxing the excess in higher brackets). The increase in tax is usually viewed as acceptable considering that it gives the surviving spouse unfettered access to a larger chunk and avoids all taxation until the death of the last spouse.

All of these options involve some guess work about what Congress and the President might do in the future about the Estate Tax laws too. Planning can be tricky.

Q: What can we expect for the future of the estate tax law and Exemption Equivalents?

A: Who knows? The threshhold was $1,000,000 until the year 2004 when it rose to $1,500,000, then it rose again in 2006 to $2,000,000 and then to $3,500,000 in 2009 then to infinity in 2010. Should you make fixed plans based on today's estate tax threshold? Well, you have to make some decision! What decision is up to you, but the law can be changed with just the cooperative efforts of Congress and the President. Who knows what they'll do. Clearly you can make plans based on what the law is now, then adjust it in the future depending on what the future holds.

Q: What about making lifetime gifts to my kids?

A: Lifetime gifting is another option that should be seriously considered for the larger estates. This subject is left to another separate treatise. I look to posting something about that in the future.

I hope that this has answered some of your basic questions. If you have other questions, please write them down so that you'll remember them when we have our interview appointment.

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The Law Offices of Craig Willford

Copyright July 23, 1998 - November 2, 2014