Death and Taxes Blog

As I've discussed before, there's no "one size fits all" solution for estate planning. Rather than steer my clients toward a particular type of planning, I go through the positives and negatives of having a simple Will, having a living trust, etc. Most of my clients choose to create a living trust, but they do so only after we've discussed it in some depth.

So imagine my surprise in reading this Christian Science Monitor article on estate planning, and learning the following:

"It is absolutely essential to have a will and at least a living trust," says Kraig Kast, CEO of Atherton Trust in Redwood Shores, Calif. He notes that a living trust avoids probate, a costly, time- consuming process. "Probate only benefits attorneys, never the heirs," he warns.

If you are a regular reader of this blog, you realize what a stupid statement this is, although this type of stuff gets said all the time by living trust mills (groups of people who give living trust seminars and then try to sell you an overpriced form document). I assumed that Atherton Trust was just such a company, but the reality is actually worse -- Atherton Trust and Mr. Kast appear to have almost nothing to do with estate planning. A visit to Atherton's website reveals that they are "the leader in real estate wealth management." A further web search reveals that Mr. Kast is happy to speak about how oil prices and the Iraq War have affected investment real estate (here), and about the value of office property in global investing (here). But as far as I can tell, nothing about estate planning or probate. So shame on Mr. Kast for saying stupid things, and shame on the Christian Science Monitor for choosing a real estate investment guru to opine on what probate is or isn't.

To cleanse the palate, I would recommend this Newsday article from Lynn Brenner about the truth re. probate fees (here is her follow-up about situations where probate is expensive).

I've stayed away from blogging about the Anna Nicole Smith situation so far, as I'm not particularly interested in the tabloid aspects of Ms. Smith's life. However, another estate planning attorney e-mailed me a copy of Ms. Smith's Will (here as a pdf), and I had to take a look. I found it fascinating for reasons other than the fact that Ms. Smith lived a very messy life.

My first and biggest observation is that the Will is a mess. And the attorney who drafted it has some serious explaining to do.

Let's start with the strangeness of the disinheritance, in ARTICLE I. Ms. Smith says that "Except as otherwise provided in this Will, I have intentionally omitted to provide for my spouse and other heirs, including future spouses and children and other descendants now living and those hereafter born or adopted, as well as existing and future stepchildren and foster children." It always raises a red flag for me when there are references in a Will to relationships that don't exist. Ms. Smith wasn't married when the Will was signed -- why does this Article refer to her spouse? Ms. Smith didn't have stepchildren or foster children, did she -- why are they mentioned?

Ms. Smith's goal might have been to essentially shut out everyone but her son, but I question whether her estate planner really ran through the various scenarios with her. Did she REALLY mean to disinherit any child of hers born or adopted in the future?

Ms. Smith certainly deserves some of the blame if the above language does not match her intent, since she went through an entire pregnancy without changing her Will. But what really makes this Will a failure in terms of drafting is ARTICLE II, which states in relevant part that...

"All of the property of my estate... shall be distributed to HOWARD STERN, Esq., to hold in trust for my child under such terms as he and a court of competent jurisdiction may declare, such that my children are distributed sufficient sums for the [sic] health, education, and support according to their accustomed manner of living....

(Emphasis added.) Did Ms. Smith mean to benefit only her son Daniel? If so, I understand the reference to "child." But why mention "children" and "their," words that obviously refer to more than one child? Are these references intended to fall within the exception to disinheritance found in Article I? If so, then why was disinheritance of future children included at all in the Will?

If I had to guess, I'd say that the drafting attorney -- who, from this, doesn't appear to be an estate planner -- took a form, started tinkering with it, and produced something that is going to spark a ton of litigation. I'd call that a bad day's work.

I was recently reminded of another reason I prefer passing on most assets via a living trust rather than via joint tenancy or beneficiary designations. I met with a client who has maybe 20 different assets, 10 in her living trust and 10 in joint tenancy with her son or with her son as beneficiary. This will work fine so long as she predeceases her son (which is what's to be expected), but what if she doesn't? In that case, upon her son's death, she will become the sole owner of the joint tenancy property (which will require a probate at her death), and there will be no valid beneficiary on her beneficiary designation accounts (so they might also be subject to probate, depending on the default provision in the designation). By contrast, a living trust could be drafted flexibly, with provisions that apply if the son happens to predecease the client.

One fundamental question in estate administration is, who pays the debts and expenses? This may seem like a simple question, but given the various different kinds of assets -- some in the decedent's own name, possibly others in trust or in other non-probate forms -- it can get tricky.

The general rule in Illinois is for "equitable apportionment." This (according to one court case) is "the term... used to describe the process of distributing the burden of certain estate expenses among those beneficiaries in the same proportion as they respectively cause such expenses to be incurred." In other words, if you inherit 10% of a decedent's property, and the decedent's estate is subject to estate tax, you are responsible for paying 10% of that tax. And this payment must be made regardless of the nature of the property you inherited.

There's an exception to that general rule, which is that a decedent may specifically direct from which assets taxes should be paid. The application of this exception is addressed in Malik v. Lashkariya, a First District appellate court case. The opinion (available as a pdf here) was issued on December 26 of last year. In Malik, the decedent's Will said "all taxes shall be paid by my estate." But does "estate" here mean "my probate estate," or does it mean "my entire estate, probate and non-probate"? The court decided that the decedent meant "my probate estate." In other words, those who inherited the decedent's non-probate assets were not required to pay a proportionate share of taxes.

I'm a little torn about this case. On the one hand, the language included in the Will obviously seems to apply only to probate property. On the other hand, did the decedent's attorney really explain how taxes would be paid from the decedent's assets, and did the decedent understand the import of this language? I hope so.

I've taken a closer look at Illinois SB 297, which is intended to create the Nonprobate Transfer Act (the "Act"). The full text of the Act -- which is not yet law -- is here.

A few comments:

1. As I've discussed here many times, probate is a trade-off. It takes some time and money -- that's the downside. The upside is that it's a system, with court supervision, and works in an orderly manner. If someone has doubts about whether the decedent meant to give property to someone (was he or she incapacitated or subject to undue influence?), there's a procedure to deal with that. If someone has a claim against a decedent, there's a procedure for having that claim resolved.

2. The intent of the Act appears to be to loosen the requirements for making a transfer upon death. For instance, Section 40 of the Act allows the use of a deed "that conveys an interest in real property to a grantee designated by the owner [and] that expressly states that the deed is not to take effect until the death of the owner," and specifies that such a deed can (and should) be filed with the recorder's office before the owner dies. Section 45 allows for the transfer of tangible personal property in a similar manner, by a statement "executed by the owner and acknowledged before a notary public or other person authorized to administer oaths."

3. In many ways, the Act seems pretty irrelevant. You can already avoid probate by leaving property via beneficiary designations. This has been done for a long time with respect to retirement benefits and insurance, and is now being done more often with respect to other types of property (like investment accounts).

4. My concern as a probate attorney is that the Act -- and beneficiary designations in general -- make it more difficult for the interested parties I mentioned above to monitor property in which they might have an interest. For instance, let's say that Jane Smith is incapacitated, but her granddaughter, Chloe Smith, is able to force Jane to designate Chloe as beneficiary of all of her property when Jane dies. Section 110 of the Act says that "[a] beneficiary designation... that is procured by fraud, duress, or undue influence is void," but how do the rest of the members of Jane Smith's family find out about the nature and extent of these transfers? Section 110 goes on to say that you can petition the court if you are an interested person, but I'm unclear as to how you'd do that. Would it be in the probate court, even though Section 10 of the Act says that beneficiary designations are supposed to be "exempt from the requirements of the Probate Act"?

5. What about creditors of an estate? Section 160 has an answer, and it isn't pretty:

Each recipient of a recoverable transfer of a decedent's property shall be liable to account for a pro rata share of the value of all property received, to the extent necessary to discharge the... claims remaining unpaid after application of the decedent's estate, including expenses of administration and costs...

In other words, let's say that you are a creditor of a decedent who left everything to his family via beneficiary designations. Let's say that the decedent owed you $50,000. You as creditor evidently have to track down every piece of property passed by the decedent via beneficiary designations, so that you can figure out each beneficiary's pro rata share of the $50,000. And if those beneficiaries don't have the money anymore?

The ISBA Transactional Law listserv is abuzz about Senate Bill 297. Here is the synopsis:

Creates the Nonprobate Transfer Act. Authorizes a transferring entity to act as an agent for an owner of property subject to a nonprobate transfer. Provides that a nonprobate transfer is nontestamentary and is exempt from the requirements of the Probate Act of 1975 and lists the provisions allowed for the nonprobate transfer. Outlines the transfer, registration, and revocation procedures for nonprobate transfers. Provides that prior to the death of the owner, a beneficiary shall have no rights in the property by reason of the beneficiary designation. Provides that, if a beneficiary disclaims, in whole or in part, the nonprobate transfer, then the disclaimant is treated as having predeceased the owner, unless the beneficiary designation provides otherwise. Disqualifies a beneficiary designation in the event that it is procured by fraud, duress, or undue influence. Sets out rules. Provides that recipients of a recoverable transfer shall pay a pro rata share to cover statutory allowances and claims due by the estate.

The full text is here.

I'll have more on this Bill tomorrow, after I've read it in full.

Last year The Office had my vote for best comedy on TV. This year it's a toss-up between How I Met Your Mother (particularly for this), and 30 Rock. If you haven't tuned in to 30 Rock, you're missing great performances by Tracy Morgan (channeling Martin Lawrence) and Alec Baldwin, who plays Jack Donaghy, "G.E. Vice-President of East Coast Television and Microwave Programming." In last week's episode ("Up All Night," available at iTunes), Jack and his wife, Bianca (played by Isabella Rossellini), were attempting to finalize their divorce, and Jack decided to play hardball:

Bianca: I want our divorce to be final.

Jack: All right. I want back all the jewelry I ever bought you.

Bianca: Fine.

Jack: I want the art supplies that I gave you on your 40th birthday, and any subsequent art projects you made with them.

Bianca: Fine.

Jack: I want all of our love letters.

Bianca: (chuckling and waving her hand) Oh, fine.

Jack: I want all of your parents' love letters.

Bianca: Fine.

Jack: I want full stake in the Arby's franchises we bought outside of Telluride.

Bianca: Oh, damnit Johnny, you know I love my Big Beef n' Cheddar!

Bianca eventually relents and gives Jack everything, even though she has a lawyer present (and Jack doesn't). Maybe microwave programming executives really are skilled negotiators!

I was sitting in court this morning for what seemed like an eternity (1 hour and 15 minutes, actually), when it struck me that paying an attorney for probate is like buying a sandwich. (I know, it's a stretch, but bear with me.)

Despite my long wait today, I can pretty much tell you how long it's going to take for me to open a probate estate (have an intial client meeting, prepare the documents and get them signed, go to court). I can also pretty much tell you how long it's going to take to close out an estate. After all, I've been a practicing probate lawyer for almost 11 years, and I've opened and close who knows how many estates.

The breakdown for me is usually something like this:

Opening the estate: 6 hours @ $225 per hour = $1,350

Estate administration: ?

Closing the estate: 6 hours @ $225 per hour = $1,350

Here's where the sandwich part comes in. I know what opening the estate will cost. I know what closing the estate will cost. What I don't know is what comes in the middle. What do you envision having on your sandwich?

-The works? If you have a decedent with complicated assets or litigious family members, or an executor or administrator who needs a LOT of hand-holding, then maybe what comes in the middle is going to be (and going to cost) a lot.

-Just a couple slices of meat and cheese? In a "typical" scenario, the executor or administrator might handle most of the ongoing administration, and call on me only with the occasional question. Could be an hour ($225) or two hours ($450) or five ($1,125).

-Just bread? The executor or administrator handles pretty much everything, and there's really not ANYTHING in the middle.

I'm happy to put as much or as little on your sandwich as you want, and this is something I discuss with all of my probate clients.

At the beginning of this year, I made a list of all of the individuals who have inquired about my services over the years, but then didn't take the next step. Some of these people just sent me an e-mail, asking whether we could meet. Some actually met with me, and some of these people retained me and had me prepare and send out draft documents to them.

But for whatever reason, the people on my list never got back to me in order to finish their estate plans. In most cases, I've contacted these individuals on occasion, to pass along my newsletters and/or to ask whether they wanted to go forward. However, this was my first systematic attempt to list all of their names and information.

What surprised me was the number of individuals on my list: 53! That's 53 people who made inquiries about estate planning, but never followed up.

Presumably some of these people hired other attorneys, but my sense is that most have simply done nothing. What a shame!

What I try to impress upon these people is this: I understand estate planning isn't fun, and lends itself to procrastination, but it is VERY necessary. Hopefully my message will get through to at least some of the 53.

On Friday night I attended a dinner with the partners of a large Chicago law firm. The topic turned -- as it often does at such dinners -- to "crazy" associate salaries. (Two big Chicago law firms, including my former employer Sidley Austin, have recently raised the salaries for first-year associates to $145,000. The Chicago Tribune has the story here.)

Some thoughts:

1. Maybe it's because I'm not a partner at a large law firm, but I can't get as up in arms over this issue as my dinner companions. Are first-year associates "worth" $145,000? I don't know what "worth" means here. Presumably the law firms offering these salaries aren't stupid -- they think the economic value of the associates is more than $145,000. If these associates are billing 1800 hours per year at $200 per hour (which the Tribune article mentions as a possible hourly rate), we're talking about $360,000 produced. Of course there are other costs besides salary (benefits, office space taken up) -- still, I assume the economics make sense (if not in the short term, then in the long term).

I suppose that you could separate this argument from the market, and ask whether first-year associates "deserve" $145,000, or "deserve" to charge clients $200 per hour? I don't know whether this is a worthwhile endeavor, though. People are paid based on what their clients THINK their services are worth, not on what society SHOULD think a person's services are worth. We don't pay teacher $1 million per year, even if we should, so it doesn't make sense to whine about it.

2. Big law firms have a "vicious circle" problem:

Law firms raise salaries

Law firms expect more from associates, often raising billable hour requirements and hourly rates (and always raising expectations). Put another way, law firm partners don't want to pay for increases in associate salaries; rather, they want to pass these costs on to the clients

Associates rebel against the pressure, and leave -- for less demanding jobs or for a bigger paycheck elsewhere ("after all, if I'm going to work all the time, why not get paid as much as possible?")

Law firms, reacting to the loss of associates,... raise salaries, and the circle begins again

3. Note the link between increasing associate salaries (and increasing billable rates) and my post from a few weeks ago re. the decline of estate planning departments at big law firms. My former colleague Richard Brown made that link explicit in Peter Lattman's article on the Wall Street Journal Law Blog :

Because individuals, and not corporations, pay [trust and estate, or T&E] lawyers’ bills, it’s often more difficult for them to raise their billable rates. “You can charge a company whatever you want but if you do the estate planning for a CEO he’ll look at every line charge,” said a T&E partner at big Chicago firm. Also, T&E clients are often fiduciaries – such as a trustee or an executor to an estate. “Those fiduciaries have obligations to the beneficiaries,” said Sonnenschein’s [Robert] Cockren. “So expenses are something they have to careful about.”

Consider the case of [Richard] Brown, who says he was asked to leave Sonnenschein after more than five years as a partner. Brown, 61, who worked for more than two decades at Jenner & Block before joining Sonnenschein, says his rates were recently raised to $525 an hour, an amount he couldn’t justify to most of his clients. At his new firm, 17-lawyer Harrison & Held in Chicago, he bills at $395 an hour.

“When you’re doing cutting-edge work, those hourly rates are justified,” said Brown. “But when you’re doing very vanilla documents, the client isn’t getting the best value.”

4. Why do law firms engage in the vicious circle mentioned above? Mostly because of ego, I think, which manifests itself in a couple different ways.

a. Law firms want to be the best. If a top-tier law firm raises its salaries, and another firm is (or thinks it is) in competition with that top-tier law firm, then doesn't that firm also need to raise its salaries?

b. Note that starting salaries aren't raised for ALL first-year associates, just for first-year associates with the resumes to get into big law firms. Law firms can justify big salaries for first-year associates to their clients if the associates in question are from Harvard Law or schools with similar reputations.

5. Is there a solution to this craziness? Of course, but it's going to involve a change in culture. You have to start with the end in mind, which is to get good first-year associates that you can train and turn into more senior associates and, eventually, partners. I would suggest some of the following ideas:

a. Don't just recruit from "name" law schools. Look at the best students at law students that aren't typically associated with big law firms. Do the best students from Chicago-Kent or DePaul or Loyola or NIU compare with the best students from Harvard and Yale? Even if they don't, I bet the differences aren't as big as many law firms think. Take a Moneyball approach to recruiting associates -- look to add quality players to your team by exploiting market inefficiences.

b. Offer different tracks for success. Yes, one track can be "maximum hours and maximum salary." But also be willing to embrace the associate who wants to work from home some days, or who wants to work 3/4 time (or even 1/2 time). Don't be afraid to alter salaries accordingly -- I think you'll be surprised how many associates will appreciate your efforts.

I met with a potential client last week, to talk about revisions to her estate plan. We reviewed her current documents, which show a local bank as successor trustee of her living trust. This struck me as odd, as the woman (a widow) has three grown children and a fairly short, fairly easy-to-handle list of assets (house, investments accounts, insurance). According to the woman, her previous attorney had an affiliation with the local bank, and placed the trustee language into the document on his own. The woman hadn't met with anyone from the bank (other than the attorney), and hadn't seen their fee schedule -- basically, she didn't know anything about the bank.

To me, this is a huge conflict of interest, and really no different from the attorney naming himself as trustee. Actually, it's no different from the attorney leaving money to himself from this woman's trust.

I've said it before and I'll say it again...

Q: What time is it when your attorney seeks to name himself or an entity with which he's affiliated in your estate plan?

A: Time to find a new attorney, and time to report your old attorney to the Illinois ARDC.

NUTS AND BOLTS

12. The person setting up the 529 plan account (usually a parent) is called the account owner. The person who will be using the account to attend school is called the beneficiary.

13. One solution to the problem of overfunding a 529 plan is to change the beneficiary on the plan. If child #1 finishes her education and assets remain in the 529 plan account, switch the beneficiary of the account to child #2, to yourself, to your spouse, or to another relative.

14. Anyone can contribute to a 529 plan. So you can set up the plan and make contributions for the benefit of your children (a separate plan for each?), and your parents and your spouse's parents can also contribute.

ESTATE AND GIFT TAX

15. 529 plans interest both financial planners and estate planners. Why estate planners? Because of the gift element. Here's another tax advantage to 529 plans -- you can currently give up to $12,000 per year to any given person without any gift tax implications. The rules for 529 plans allow you to "front load" five years of these annual gifts into one big gift. So, you could kick off a 529 plan for each grandchild by giving $60,000 in year one. (Just be sure not to make any other gifts to the grandchild for the next five years.)

16. In most cases, if the account owner dies, the 529 plan account will not be included in his estate for estate tax purposes.

RESOURCES

17. Illinois has two main 529 plans: Bright Start Savings and Bright Directions.

18. The Bright Start Savings website is here.

19. Bright Direction is a newer program -- its website is here. As scary-looking Illinois State Treasurer Alexi Giannoulias puts it, "This plan allows your [professional financial] advisor the flexibility to build your college savings as aggressively or conservatively as you see fit."

20. Saving for College seems to be the most popular website for researching 529 plans.

INTRODUCTION

1. A 529 college savings plan is a tax-favored plan that allows you to save money for college.

2. "529" refers to a section in the Internal Revenue Code (here).

3. Each state has a 529 college savings plan (most states have more than one), and you can enroll in the 529 college savings plan of any state.

4. The 529 college savings plan discussed here (and hereinafter referred to as a "529 plan") differs from a prepaid tuition plan, which is referenced in the same section of the Internal Revenue Code. As its name suggests, a prepaid tuition plan allows you to lock in tuition rates at a state college.

5. With a 529 plan, you make deposits into an account. Those deposits are then invested (and hopefully grow). You can then use the money in your 529 plan account to pay for "qualified higher education expenses": tuition, room and board, mandatory fees, books.

ADVANTAGES

6. Tax advantage #1: Earnings on assets deposited into a 529 plan account are not subject to income tax.

7. Tax advantage #2: You don't pay income tax on assets withdrawn from a 529 plan account for qualified higher education expenses.

8. Tax advantage #3: In some states (like Illinois), if you enroll in a 529 plan in the state where you reside, you get a state income tax deduction for contributions made to the 529 plan.

DISADVANTAGES

9. Disadvantage #1: It may be hard to wade through all of the different state 529 plans, which have differing managers, fees, etc.

10. Disadvantage #2: Once you are in a 529 plan, investment options may be limited.

11. Disadvantage #3: This is the biggie -- the fact that if you withdraw assets from a 529 plan account for something other than qualified higher education expenses, you get a double whammy. The earnings portion of the amount withdrawn IS subject to income tax, PLUS there's an additional tax equal to 10% on this portion. Some states have additional penalties. The general problem here is in guesstimating how much you'll need to sock away. If I save too little, then I haven't taken full advantage of my 529 plan (and I'm on the hook for my daughter's education). If I save too much, what happens if she goes to a fairly inexpensive state school? Or decides to skip college altogether?

[Note: Edited to make it clear that the income tax and the 10% penalty apply only to the earnings portion of the amount withdrawn.]