California Probate Lawyer Blog

Articles Posted in Estate Planning

Martindale-Hubbell Peer Review Ratings recently came out with it’s rating of me. The Ratings are an objective indicator of a lawyer’s high ethical standards and professional ability. Attorneys receive a Peer Review Ratings based on evaluations by other members of the bar and the judiciary in the United States. I have been honored with an “AV Preeminent” rating which is a significant rating accomplishment- a testament to the fact that a lawyer’s peers rank him or her at the highest level of professional excellence. My piers gave me a rating of 5 out of 5 in all possible areas analyzed: Legal Knowledge, Analytical Capabilities, Judgment, Communication Ability, Legal Experience. I’m pleased and honored.

On November 9, 2012 the Joint Committee on Taxation released a report which, among other issues, examines the potential impact to the Treasury from potential changes to the estate tax, including the Obama administration’s proposals. Importantly, if the 2012 estate tax regime is extended into 2013, the Joint Committee estimates that there will be 3,600 taxable estates. Under the Obama administration’s proposed 45-percent estate tax and $3.5-million exemption, the number of taxable estates in 2013 is estimated to be 7,200. If the estate tax regime in 2013 reverts back to the 2002 regime (as it is currently scheduled to do), the number of taxable estates is estimated to be 55,200.

2012 provides a unique opportunity for making gifts using the federal estate, gift and generation skipping transfer (“GST”) tax exemption of $5,120,000 (reduced by any prior use of such exemption).

Unless Congress takes action, the exemption decreases to $1 Million on January 1, 2013 and there is a possibility that those who miss the opportunity will have lost the ability to make significant tax free gifts.

· Based upon the existing estate and gift tax rate of 35%, the additional taxes from not taking advantage of the gift exemption of $5.12 Million that could expire on January 1, 2013 as compared to the $1 Million gift tax exemption that is scheduled to be effective on January 1, 2013 could be over $1.4 Million.

· If estate, gift and GST tax rates are increased to 45%, additional taxes from not taking advantage of the $5.12 million tax exemption could be over $1.8 Million.

· For couples who each retain their $5.12 million of remaining gift tax exemption (total of $10.24 million), the potential gift tax savings by making use of the 2012 exemption could be as much as $3.7 million (assuming the gift tax exemption is reduced to $1 million and gift tax rates increased to 45%).

These computations disregard the additional tax benefits of removing future appreciation on assets gifted from future estate, gift and GST taxes.

If you believe you can afford to make gifts in 2012, you must carefully select assets to gift and understand the consequences if such gifts are determined to be undervalued in the event of an IRS audit.

For legal assistance, call a qualified tax attorney. Call Mitchell A. Port at (310) 559-5259.

Are you married?

Estates of married individuals dying after 2010 must file an estate tax return to pass along their unused estate & gift tax exclusion amount to their surviving spouse.

Available for the first time this year, the new portability election allows estates of married taxpayers to pass along the unused part of their exclusion amount, normally $5 million in 2011, to their surviving spouse. Enacted in December, 2010, this provision eliminates the need for spouses to retitle property and create trusts solely to take full advantage of each spouse’s exclusion amount.

A married couple might want to take into consideration a very important aspect of the 2010 estate tax law. Under the law, each partner’s individual estate tax exemption of $5.12 million becomes “portable,” or it allows the first partner who passes away to transfer his or her individual estate tax exemption to his or her surviving spouse.

The IRS expects that most estates of people who are married will want to make the portability election, including people who are not required to file an estate tax return for some other reason. The only way to make the election is by properly and timely filing an estate tax return on Form 706. There are no special boxes to check or statements needed to make the election.

The purpose of this provision is to ensure that the surviving spouse does not incur an estate tax on property that would normally be covered by the estate tax exemption. This provision operates with the martial estate tax exemption, which allows the first spouse to pass away to transfer his or her assets to the surviving spouse without incurring an estate tax. Because of this provision, the first spouse to pass away does not need to use the $5.12 million exemption.

However, if a couple wants to take advantage of the portability provision, the executor of the estate must file an estate tax return on the first spouse to pass away to preserve the exemption. Even if the estate is worth less than $5.12 million exemption, the executor might still want to file an estate tax return preserving the exemption just to be cautious. The surviving spouse might gain a windfall and, notwithstanding other facts, use the preserved exemption to pass that windfall to the heirs of the surviving spouse.

Speak with an estate planning attorney for help. Call Mitchell A. Port at (310) 559-5259.

In November, 2010, a court action was filed in the U.S. District Court, Southern District of New York, seeking a refund of the estate tax levied on a married same-sex couple, which would not have applied to a married straight couple and which arguably violated the United States Constitution. The plaintiff in that action, Edith Schlain Windsor (“Edie”) challenged the constitutionality of section 3 of the Defense of Marriage Act (“DOMA”) which required Edie to pay federal estate tax on her same-sex spouse’s estate.

Edie met her late spouse, Thea Clara Spyer (“Thea”), nearly a half-century ago at a restaurant in New York City. Edie and Thea went on to spend the rest of Thea’s life living together in a loving and committed relationship in New York.

After more than forty years, Thea and Edie were finally legally married in Toronto, Canada in 2007. Having spent virtually their entire lives caring for each other in sickness-including Thea’s long battle with multiple sclerosis-and in health, Thea and Edie were able to spend the last two years of Thea’s life together as married.

New York State legally recognizes Edie and Thea’s marriage and provided them with the same status, responsibilities, and protections as other married people. However, Edie and Thea were not considered “married” under federal law because of the operation of the statute known as DOMA, and, as a result, Edie was forced to pay more than $350,000 in federal estate tax that she would otherwise not have had to pay if Edie and Thea’s marriage were recognized under federal law.

This month, the District Court upheld Windsor’s constitutional challenge to section 3 holding that it violates the Equal Protection Clause of the United States Constitution thereby allowing for the marital deduction.

This is a rapidly evolving area of the law. If you are an executor in a similar situation, you should move quickly to file protective claims.

For tax help from an experienced attorney, call Mitchell A. Port at (310) 559-5259.

Currently, on account of the enactment of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “2010 Tax Act”), the Federal estate tax exemption is $5.12 million, or twice that for a married couple.

It was and is common practice for a married person to provide if his or her surviving spouse survives to have his or her estate to be divided into two broad portions. One part is made equal to the estate tax exemption. That part is exempted from estate tax when that spouse dies on account of the so-called unified or applicable estate tax credit (which may be translated into a dollar exemption of $5.12 million). That part may be placed into a trust of which the surviving spouse is a beneficiary but need not be included in the gross estate of the survivor. Typically, that trust is called the “credit shelter trust” (because it is protected from type by reason of the unified credit), “estate tax exemption trust” or a “bypass trust” (because it “passes by” the estate of the surviving spouse for estate tax purposes).

The second part of the estate of the surviving spouse usually passes to or in a marital deduction trust for the surviving spouse and avoids estate tax when the first spouse dies by reason of the estate tax marital deduction. The property that passes to or in trust for the surviving spouse under the protection of the estate tax marital deduction is included in the gross estate of the survivor (unless consumed, given away or dissipated before the survivor dies). (In some cases, this second part of the estate is also divided by directing an amount equal to the otherwise unused generation skipping transfer tax (GST) exemption of the first spouse to die to pass into a separate qualified terminable interest property (QTIP) trust described in Section 2056(b)(7) of the Internal Revenue Code (Code). A QTIP trust qualifies for the estate tax marital deduction only by affirmative election.

As mentioned, the 2010 Tax Act increased the Federal estate tax exemption to $5.12 million for this year. That Tax Act also made other changes to the Code including adopting a “portability” system under which the surviving spouse may “inherit” any unused estate tax exemption of the first spouse to die, by an affirmative election on the United States estate tax return of the spouse dying first, and use it to protect the survivor’s later gifts from gift tax or his or her estate at death from Federal estate tax.

But under the 2010 Tax Act, the Federal estate tax exemption is scheduled to decline to and remain at $1 million at the end of this year. Moreover, under that act, portability will disappear. However, many think that Federal legislation will be enacted that will increase the Federal exemption to at least $3.5 million and make portability permanent.

Under Revenue Procedure 2001-38, 2001-1 CB 1335, the IRS ruled that the estate of the surviving spouse is permitted to “undue” or “reverse” any QTIP election made in the estate of the first spouse to die which was unnecessary to reduce the Federal estate tax marital deduction. In other words, if the spouse dying first directed the amount by which his or her Federal estate tax exemption exceeded the amount needed to eliminate Federal estate taxes back into the marital deduction trust, then over-funding the QTIP trust can be undone so that no part of the over-funded amount will be included in the survivor’s gross estate.

If both portability and Rev. Proc. 2001-38 are available, two additional considerations need to be taken into account. The first is that all appreciation with respect to the assets excluded from the estate of the surviving spouse, by reason of enacting the revenue procedure, occurring after the death of the first spouse to die up to the death of the survivor on those assets, would be excluded from the gross estate of the survivor. In contrast, in the case of portability, all appreciation on the assets passing to the surviving spouse with respect to the ported amount of Federal estate tax exemption would be included in the survivor’s gross estate. The second is that, in the case of portability, the property inherited by the surviving spouse will receive automatic change in income tax basis pursuant to Section 1014 of the Code. On the other hand, if revenue procedure is invoked, the basis of that property will not be adjusted at the survivor’s death.

Ethical Wills are documents designed to pass ethical values from one generation to the next. It is not a legal document and typically it is in the form of a letter written by parents to children or grandchildren. It is drafted by you, not me or any other attorney. Today it does not need to be in the form of a letter but could be an audio or video recording.

Ethical wills often contain meaningful family stories, personal values and beliefs, statements of faith, blessings, advice, and expressions of love. They may even share regrets, apologies, and final requests. There are no rules or laws about the length or content of an ethical will. It can be a few lines, or paragraphs or many pages in length.

Every ethical will is unique. And, while there is no standard format for writing one, samples of ethical wills can be found at this link.

The process of writing the ethical will can be rewarding. The centerpiece of the letters I have seen are a few short sentences about what values are important to the individual. However, what most distinguishes an ethical will from a will dealing with one’s assets, is that there is a explanation of how these values came to be important, whether they were passed down from previous generations or, learned through real life lessons.

Wikipedia has a terrific article on ethical wills covering these topics:

Medieval – 18th Century
Modern Uses
Content of an Ethical Will

Rights of publicity pass to the heirs of celebrities who are residents of California when they die. A hologram performance by Tupac Shakur (who died in 1996) at this year’s Coachella Valley Music and Arts Festival is a right which passed to his mother when he was shot.

Proper estate planning in California can help direct where revenue from those rights will go long after the person died.

California Civil Code section 3344 is for the publicity rights of living persons, while Civil Code section 3344.1, known as the “Astaire Celebrity Image Protection Act,” grants statutory post-mortem rights which prohibit the unsanctioned use of the “name, voice, signature, photograph or likeness on or in products, merchandise or goods” of any person.

Civil Code Section 3344.1 requires any person claiming to be successor-in-interest to the rights of a deceased personality under Section 3344.1 register the claim with the Secretary of State’s Office. This is not a mandatory filing, however.

There is some question as to how those rights should be value and taxed at the time of death. If holograms become profitable, the IRS might start looking into taxing them. This may not be too different from commercials, endorsements and other publicity which can be very valuable assets worth taxing at death.

For tax planning by an experienced California lawyer, call Mitchell A. Port at (310) 559-5259.

Tax specialists are paying attention to how half a dozen of Facebook’s top names, including founder Mark Zuckerberg, appear to be using a perfectly legal maneuver called a grantor-retained annuity trust, or GRAT, to avoid at least $200 million of estate and gift taxes on their own Facebook shares.

A grantor retained annuity trust may be an effective means for a wealthy client who wants or needs to retain all or most of the income from a high-yielding and rapidly-appreciating property to transfer the property to a child or other person with minimal gift or estate tax. GRATs are particularly indicated where the client has one or more significant income-producing assets that he or she is willing to part with at some specified date in the future to save federal and state death taxes and probate costs, to obtain privacy on the transfer, and to protect the asset against the claims of creditors.

A GRAT is created by transferring one or more high-yield assets into an irrevocable trust and retaining the right to an annuity interest for a fixed term of years or for the shorter of fixed term or life. When the retention period ends, assets in the trust (including all appreciation) go to the named “remainder” beneficiary (ies). In some cases other interests, such as the right to have assets revert back to the transferor’s estate in the event of the transferor’s premature death, may be included.

Facebook’s prospectus cites eight separate “annuity trusts” set up by insiders Dustin Moskovitz, Parker, Sheryl, Reid Hoffman, Michelle Yee (Hoffman’s wife) and Zuckerberg over the past four years. All told, these trusts hold about 22 million shares that will be worth more than $690 million if Facebook goes public at $31.50 a share, the middle of its projected range.

GRATs provide a fixed annuity payment, usually expressed as a fixed percentage of the original value of the assets transferred in trust. For example, if $100,000 is placed in trust and the initial annuity payout rate is 6 percent, the trust would pay $6,000 each year, regardless of the value of the trust assets in subsequent years. If income earned on the trust assets is insufficient to cover the annuity amount, the payments will be made from principal. Therefore, the client-transferor is assured steady and consistent payments (at least until principal is exhausted).

All income and appreciation in excess of that required to pay the annuity accumulate for the benefit of the remainder beneficiary (ies). Consequently, it may be possible to transfer assets to the beneficiary (ies) when the trust terminates with values that far exceed their original values when transferred into the trust and, more importantly, that far exceed the gift tax value of the transferred assets.

Facebook offers a good vehicle for describing the inner working of GRATs to sidestep estate and gift taxes.

In essence, these trusts transfer asset appreciation from one taxpayer to others, virtually tax-free.

The benefit can be huge. If the Facebook insiders didn’t use GRATs for those shares, but held them until they died or gave them away to friends or relatives after the offering, then the gift or estate tax owed on the shares would be more than $200 million. (This calculation assumes a $31.50 share price and the current top gift- and estate-tax rate of 35%; rates are scheduled to rise to 55% next year.)

The gift tax value of the transferred assets is determined at the time the trust is created and funded using the “subtraction method.” The gift tax value is determined by subtracting the value of the annuity interest (and, in some cases, other retained interests, such as the right to have the assets revert back to the transferor’s estate if he or she does not live the entire term of the trust) from the fair market value of the assets transferred in trust. How the annuity interest and any other retained interests are valued depends on who the remainder beneficiary (ies) is (are) and who retains the annuity and other interests relative to the transferor. There is a more restrictive and less appealing set of valuation rules when family members are beneficiaries and certain family members retain interests in the property both before and after the trust is created than when unrelated parties are involved.

Here is an example, using figures from the Facebook offering document: Zuckerberg and Moskovitz each disclosed “annuity trusts” holding 3.4 million and 14.4 million Facebook shares, respectively. The value of each share when the trusts were set up was less than $1.85, according to the prospectus.

After contributing their stock to the GRATs, the two founders would, over time, take payments equal to the original value of the gift plus a small return. Without knowing information that’s unavailable-such has how long the trusts will run or exactly how they are structured-it’s impossible to say what payments have already been or will be made.

But it is possible make an educated guess as to the appreciation that’s being shifted from the two founders’ estates. Given a $31.50 share price, a conservative estimate of it is $29 per share, or about $100 million for Zuckerberg and more than $415 million for Moskovitz.

At current top rates of 35%, that means estate-and gift-tax savings of about $35 million for Zuckerberg and $150 million for Moskovitz. Other Facebook insiders and investors appear to be saving $20 million or more with their GRATs.

What if Facebook stock declines? The stock would then be returned to the original owner.

The person who sets up the GRAT is not really worse off, because he paid little or no tax in the first place. Either he wins or it’s a tie-except for the lawyer’s fees. The principal risk with a GRAT is that the owner will die before the term is up.

If family members are involved, the gift tax valuation rules of the Internal Revenue Code may apply. Under these rules, certain types of retained interests, such as the right to have trust assets revert to the transferor’s estate in the event of the transferor’s premature death, may be valued at zero when computing the gift tax value of the transfer. As a general rule, every retained interest but a “qualified interest” is assigned a value of zero for gift tax valuation purposes.

Since the GRAT permits payment of both income and trust principal to satisfy the annuity payments you have retained, the GRAT should be treated as a grantor trust for income tax purposes. This means you (the transferor-annuitant) are taxed on income and realized gains on trust assets even if these amounts are greater than the trust’s annuity payments. This further enhances this tool’s effectiveness as a family wealth-shifting and estate-tax-saving device. In essence you are effectively allowed to make gift tax-free gifts of the income taxes that are really attributable to assets backing the remainder beneficiary’s interest in the trust.

By making assumptions about income to be earned by the trust in the future, and future capital growth, it is also possible to project the future value of the principal remainder that will be payable to the beneficiaries at the end of the term of the trust. If limited partnership interests, minority stock interests, or other fractional or non-controlling interests have been contributed to the GRAT and appropriate discounts claimed for lack of voting power or lack of marketability, it may also be useful to illustrate the future economic growth of the pre-discounted value of the principal, and to compare the present value of the remainder for gift tax purposes (including appropriate discounts) with the projected future value of the principal remainder (without discounts).

A successful GRAT requires several ingredients: a person worth millions-or potential millions-who wants to avoid gift or estate tax and is willing to part with assets to do so; an asset that will rise in value while in the trust; and, if possible, low interest rates.

With these elements in place, the taxpayer sets up a GRAT with a set term of two years or longer and gives the asset to it before its value surges. Set-up costs include appraisal and legal fees.

Over the life of the trust, the person who set it up gets annual payments adding up to the asset’s original value plus a return based on a fixed interest rate determined by the Internal Revenue Service. That is currently 1.6%, near a record low.

Meanwhile, ideally, the asset soars in value, and that growth is outside of the grantor’s estate. When the GRAT’s term ends, the asset goes to the beneficiaries-usually into another trust set up for their benefit.

The result: no gift or estate tax on the appreciation, even though it has been transferred.

One question remains: neither Zuckerberg nor Moskovitz have children. So who are these trusts’ beneficiaries? It is possible to name unborn children-as well as future spouses and current friends or relatives-as beneficiaries of a GRAT.

Although this blog is focused primarily on matters of interest involving California probate, there are related topics worthy of discussion.

For example, while probate is the California court’s supervision over the transfer of property from the deceased person’s estate to the rightful heirs or beneficiaries, when that person is still alive he or she may not have the ability to make decisions about the property belonging to him or her. When we are alive but incapacitated (by a stroke, heart attack, auto accident, debilitating disease or some other reason), someone ought to be given the power to make decisions regarding our property when we are not able to make those decisions ourselves.

In those instances, a durable power of attorney for property management and financial affairs is useful. That type of California document “endures” our incapacity and continues to remain in effect. The person named in the durable power of attorney – the attorney in fact – steps into our shoes and is empowered to make decisions regarding our property.

There are basically two types of California durable powers of attorney. One becomes effective immediately upon being signed. In that case, the attorney in fact may exercise his or her powers even when we may still be competent. So, when using this type of power of attorney, be sure to give the power to someone who will not misuse it.

The second type of durable power of attorney becomes effective upon our becoming incapacitated. The power “springs” up when and as needed. The primary draw-back to a “springing durable power of attorney” is the common requirement that the attorney in fact must also present notes from two physicians declaring our incompetency. Getting those type of notes may be a challenge which could render the durable power of attorney ineffective.

Here’s a sample free form.

For more information, call a California attorney. Call Mitchell A. Port at (310) 559-5259.