Death and Taxes Blog

Katarinna McBride has a nice article in this month's ISBA Trusts & Estates newsletter on the "hot" estate planning issue of what happens (or should happen) if a person dies in the midst of a divorce but before the divorce is finalized. I'm going to sidestep that issue for now and focus on how Illinois estate planning and probate law reacts to a divorce. In doing so, I'm going to issue a major caveat: IF YOU GET DIVORCED, YOU NEED TO SEE AN ESTATE PLANNING ATTORNEY, TO MAKE A NEW ESTATE PLAN. This is important for two reasons: (1) to make sure that your ex doesn't inadvertantly inherit property you don't want him or her to get and (2) to coordinate your estate plan with your divorce settlement, incorporating any new obligations (like a requirement to maintain life insurance). So don't let the fact that Illinois law tries to help out divorced folks make you think that you are in the clear from an estate planning perspective.

Anyway, there are two main laws at work here:

1. Section 4-7(b) of the Illinois Probate Act.

... dissolution of marriage or declaration of invalidity of the marriage of the testator revokes every legacy or interest... given to or nomination to fiduciary office of the testator's former spouse in a will executed before the entry of the judgment of dissolution of marriage or declaration of invalidity of marriage and the will takes effect in the same manner as if the former spouse had died before the testator.

In other words, if you have a Will and name your husband as your executor (with your brother as successor) and as 50% beneficiary of your property (the other 50% going to your children), and you then get divorced, your brother will be the executor and your children will receive all property passing under your Will.

2. The Trusts and Dissolution of Marriage Act (760 ILCS 35/0.01 et seq.).

Section 1 of this act says that:

Unless the governing instrument or the judgment of judicial termination of marriage expressly provides otherwise, judicial termination of the marriage of the settlor of a trust revokes every provision which is revocable by the settlor pertaining to the settlor's former spouse in a trust instrument or amendment thereto executed by the settlor before the entry of the judgment of judicial termination of the settlor's marriage, and any such trust shall be administered and construed as if the settlor's former spouse had died upon entry of the judgment of judicial termination of the settlor's marriage.

It goes on to say that "[t]he phrase 'provisions pertaining to the settlor's former spouse' includes, but is not limited to, every present or future gift or interest or power of appointment given to the settlor's former spouse or right of the settlor's former spouse to serve in a fiduciary capacity."

Perhaps the most important part of the Act is the part where it tells what types of trusts are excluded from the Act. The most important of these land trusts and beneficiary designation accounts (sometimes referred to as POD or TOD accounts, or as Totten Trusts).

What's an affidavit of heirship?

It's a signed statement, submitted to the court in a probate matter, setting forth information (facts) about the decedent's family.

Why is it submitted?

So that the probate judge can determine the decedent's heirs (closest relatives).

Why is heirship important?

Under Illinois law, heirs have certain rights in a probate matter, even if the decedent died with a Will and didn't leave property to the heirs. These rights involve notice of the proceedings, and the ability to intervene (for instance, to file a Will contest.)

And of course, if the decedent died without a Will, then the decedent's heirs inherit the decedent's property (pursuant to §2-1 of the Illinois Probate Act).

Who signs the affidavit?

The signer should be a person with knowledge of the decedent's family.

What are the relevant Illinois laws on the subject of heirship?

Section 5-3 of the Illinois Probate Act talks about the process of determining heirship -- so does Cook County Circuit Court Rule 12.2. Section 5-3 also talks about different ways in which heirship can be proved besides the use of an affidavit.

Anything else?

Affidavits of heirship can be tricky. It's one of the few probate documents for which there is no form (at least in Cook County) -- that's because almost every decedent's family situation is different. I think the key is to keep in mind something that Probate Judge Jeffrey Malak has said in seminars he's given: "I'm not a mind reader." You as the attorney need to make sure that the affidavit answers all questions, so that the judge feels he or she can enter an order declaring the decedent's heirship.

You really have to "tamp down" all portions of the affidavit.

-how many times was the decedent married?

-if more than once, how did each marriage end?

-how many children were born or adopted in each marriage?

-how many children were born to or adopted by the decedent outside of marriage?

You follow this same procedure for every potential heir, as well.

What happens if some or all of the decedent's heirs are unknown?

You have to publish a notice for unknown heirs in a local newspaper.

What happens if the decedent simply had no heirs?

The decedent's property escheats to the government under §2-1(h) of the Illinois Probate Act.

In my series on irrevocable life insurance trusts (ILITs), I spoke about the need to give beneficiaries notice every time a contribution is made. This is a bit of a hassle, especially if you have numerous beneficiaries. One option that just came to my attention is called TrustManager. According to Kevin J. O'Connor, who evidently works for the company that runs this site, TrustManager will automatically take care of sending out the necessary notices:

Once the program has been populated with all of the necessary information (it takes about 20 to 30 minutes) the system runs automatically. The only things necessary are that the trustee needs to go on line to acknowledge that the gift has been received and to pay the annual fee. Everything else is programed so that it all happens automatically and all of the records are kept for the duration of the trust.

Mr. O'Connor adds that the fee for the service is "$50 per year / per trust. That fee is
the same regardless of the number of beneficiaries or gifts."

In Part 4 of my series on irrevocable insurance trusts (ILITs), I wrote that one of the biggest ILIT-related mistakes I see is "the failure of the grantor to understand that 'irrevocable' means 'can't amend or revoke.'" The Roth & Company tax updates blog mention this post here, stating that "[i]rrevocable means 'you can't revoke.' It's amazing how many people have trouble with that."

It's also important to remember that irrevocable means you can't amend. Every ILIT I've ever seen includes -- for good reason -- language saying that the trust can't be amended or revoked, and yet this appears to be confusing for clients AND practitioners. A couple of weeks ago I was reviewing a potential client's documents, and stumbled upon this document, drafted by a general practice attorney, which should strike fear into the heart of estate planners everywhere:

FIRST AMENDMENT TO THE [JOHN SMITH] IRREVOCABLE INSURANCE TRUST DATED DECEMBER 20, 1997

This same attorney had drafted the initial ILIT as well. Evidently she doesn't read or understand her own documents.

Just a few quick follow-up notes on things I've already discussed in this series:

1. As I said in Part 1, the main reason people create ILITs is to pass more of their assets on to their beneficiaries free of estate tax. But that's not the only reason -- another reason is liquidity. Let's say that you die with a taxable estate and a family business that can't be liquidated easily to pay your estate tax bill. What to do? If you set up an ILIT correctly during your lifetime, the trustee of the ILIT can purchase assets from your estate or from the trustee of your living trust, and can pay cold, hard cash for these assets (which the ILIT trustee received when he or she collected the insurance proceeds on your life). Your executor or the trustee of your living trust can then use this cold, hard cash to pay your estate tax bill.

2. In Part 3, I talked about one of the "dangers" in transferring existing whole life policies to an ILIT. Another problem -- more of an inconvenience, really -- is that those policies have a value for gift tax purposes. You can find out this value by requesting a Form 712 from your insurance company. This value will need to be included on your gift tax return, and is equal to (wait for it) the policy's "interpolated terminal reserve value" plus any premiums you've paid for a time period after the date of the gift. Fun!

3. The biggest mistakes I see with ILITs are:

(a) the failure of the grantor to understand that he or she no longer owns or has any interest in the property;

(b) the failure of the grantor to understand that "irrevocable" means "can't amend or revoke"; and

(c) the failure of the trustee to continue to administer the trust correctly, by preparing income tax returns, by sending notice of each contribution to beneficiaries, and by keeping good, clear records of what has been done.

The typical ILIT would be set up as follows:

-Grantor signs ILIT document, with grantor's spouse as trustee, and spouse and children as beneficiaries

-Grantor makes annual contributions to the ILIT, and trustee gives notice of contribution to beneficiaries

-Trustee purchases whole life insurance policy on grantor's life, and uses annual contributions to pay premiums

-When grantor dies, death benefit is paid to trust

Does an ILIT always have to work this way? Not really. Four variations on a theme:

1. Instead of setting up an ILIT, grantor gives money directly to his children, who collectively purchase a life insurance policy on the grantor's life. When grantor dies, the children split the death benefit. This variation isn't used very often, mostly (in my opinion) because it seems a little uncomfortable for all parties involved. But the big advantage: no need to have an attorney involved.

2. The trustee purchases a term life insurance policy instead of a whole life policy. The premiums will be lower, but the "danger" (is that the right word?) is that grantor may not die during the term of the policy, thereby making the value of the ILIT disappear.

3. The grantor transfers a current policy (or policies) to the ILIT instead of having the trustee purchase a new policy. This may be necessary if the grantor is now uninsurable, but the downside is what's known as the "three-year rule": if you transfer a whole life insurance policy to an ILIT and die within three years of the transfer, the insurance proceeds are included in your estate for estate tax purposes (as a gift made "in contemplation of death").

4. How about a 1/2 ILIT, 1/2 gift trust hybrid? By this I mean that (to take one possibility) one-half of grantor's contribution is used to purchase life insurance on the grantor's life, and the rest is invested by the trustee. Now you have the protection of the insurance if grantor dies in the near future, and the protection of appreciating investments if grantor doesn't.

I try to read one Charles Dickens novel per year. Last year I chose Bleak House, mostly because I knew it centered on a probate matter. (I posted a review here.) This year I chose David Copperfield, mostly because our bookcase contained a copy of it. Imagine my surprise when I found that it also contains references to probate matters. In the middle of the book, Copperfield becomes a law clerk in the Doctor's Commons. It becomes clear (in Chapter XXVI) that Copperfield's work involves probate when Copperfield speaks with his boss, Mr. Spenlow:

I asked Mr. Spenlow what he considered the best sort of professional business? He replied that a good case of a disputed will, where there was a neat little estate of thirty or forty thousand pounds, was, perhaps, the best of all. In such a case, he said,... the costs being pretty sure to come out of the estate at last, both sides went at it in a lively and spirited manner, and expence was no consideration.

Later (in Chapter XXXI), Copperfield helps his old nurse Pegotty after the death of her husband, Mr. Barkis:

But I am afraid I had a supreme satisfaction, of a personal and professional nature, in taking charge of Mr. Barkis's will, and expounding its contents.

I may claim the merit of having originated the suggestion that the will should be looked for in [Mr. Barkis's] box....

[Mr. Barkis's] property in money amounted to nearly three thousand pounds. Of this he bequeathed the interest of one thousand to Mr. Peggotty for his life, on his decease, the principal to be equally divided between Peggotty, little Emily, and me, or the survivor or survivors of us, share and share alike. All the rest he died possessed of, he bequeathed to Peggotty, whom he left residuary legatee, and sole executrix of that, his last will and testament.

I felt myself quite a proctor, when I read this document aloud with all possible ceremony, and set forth its provisions.... I examined the will with the deepest attention, pronounced it perfectly formal in all respects, made a pencil-mark or so in the margin, and thought it rather extraordinary that I knew so much.

One of the themes running through the estate and gift tax laws is control.

Can I give money to charity but retain control of it?

Can I get a marital deduction for a gift to my spouse at my death while still retaining control of how the money is used?

Can I give money to my children without gift tax consequences while still retaining control of those gifts?

I want to focus on this last goal, and how it works in an ILIT scenario.

There is an annual gift tax exclusion. This amount is currently $12,000, which means you could write a check for $12,000 to as many people as you wish and not owe any gift tax (or even need to file a gift tax return). This exclusion is found in §2503(b) of the Internal Revenue Code. You will note that the language of this section specifically excludes "gifts of future interests in property." In other words, if you set up a trust for your child and contributed $12,000 to that trust, this gift wouldn't qualify for the annual gift tax exclusion because it is a gift of a future interest (i.e. your child doesn't have immediate access to the gift).

Enter the concept of the "crummey trust" (named after a family that went to court with the IRS over this issue). A crummey trust is simply an ILIT or other irrevocable trust that contains provisions allowing a beneficiary to withdraw all or a portion of any contribution to the trust within a given time period after the contribution is made (maybe 60 days?). If the withdrawal right isn't exercised, then the right lapses (disappears).

Giving the beneficiary this withdrawal right means that the beneficiary has indeed received a present interest in the gifted property, so the gift tax annual exclusion may be used. And of course, the idea is that a beneficiary will never (upon penalty of future disinheritance) withdraw the contribution, meaning it will remain in the trust, to be used to pay life insurance premiums or otherwise invested.

Two other points:

1. Notice of a contribution (and the right to withdraw all or a portion of that contribution) should be given in writing every time a contribution is made.

2. The language of the crummey trust must be drafted with care in order to avoid a situation where the beneficiary who doesn't exercise his or her right of withdrawal is deemed to have made his or her own (possibly taxable) gift to the trust.

Over the next week or two, I'm going to be talking in some depth about irrevocable life insurance trusts (often referred to as ILITs by estate planners). Today I'd like to talk generally about these types of trusts.

There are many reasons to set up revocable trusts, such as living trusts: avoidance of probate, privacy, and controlling when your beneficiaries receive their inheritance are just three. By contrast, most people set up irrevocable trusts, such as ILITs, for only one reason: to pass property to beneficiaries at your death free of estate tax. This works because an irrevocable trust is, well, irrevocable. And that irrevocability goes not only to the trust document you sign, but to any property you contribute to the trust. You no longer own it, which means you can't get it back or control it in any way. This is why property held in a correctly-drafted irrevocable trust will not be subject to estate tax when you die -- because it's no longer your property.

How does a typical ILIT work? Here's an example:

1. Grantor (Mr. Grant), a 47-year-old, signs an ILIT with his sister (Ms. Trust) as trustee.

2. The trust provisions are for the benefit of Mr. Grant's three children, and are similar to the provisions in Mr. Grant's living trust.

3. Mr. Grant contributes $15,000 per year to the trust.

4. Ms. Trust uses the yearly contributions to buy a life insurance policy on Mr. Grant, with the trust as beneficiary. (I'll talk about types of life insurance at a later time, but let's assume $15,000 per year would be enough to pay the premiums on a $1 million whole life, or "permanent," policy.)

5. Mr. Grant dies, and the insurer pays $1 million to his beneficiary (the trust). Mr. Grant has passed $1 million to his three children free of estate tax and income tax.

There's obviously a leverage aspect at work here. If Mr. Grant dies in three years, he's paid $45,000 (in premiums) to "get" $1 million (to his kids as an inheritance). Of course, if Mr. Grant dies in 40 years, he's paid $600,000 to get $1 million -- not the best return.

Next time I'll talk about ILITs and gift tax.

When I draft a living trust for a client, I make it clear that the client still needs to have a Will. "But why?" clients will sometimes ask. "Isn't the living trust taking the place of the Will?"

My answer to that question is, yes, the goal of the living trust is to replace your Will as the primary vehicle by which you dispose of your property. But we don't live in a perfect world, and it may be that all of the client's property isn't retitled in the name of (or made payable to) the client's living trust before he or she dies. Sometimes this is because of an oversight on the part of the client. Sometimes it's because the client unexpectedly acquires property (like an inheritance) right before his or her death. Whatever the reason, the issue is property that for some reason doesn't pass under the living trust upon the client's death. If you don't have a Will, such property passes by intestacy, regardless of what your living trust says. That can be a really bad result, since your property will go to your heirs under Illinois law instead of to the beneficiaries you've chosen.

Enter the "pourover Will." This is a fairly short (maybe 4 or 5 page) document designed to clean up any of your estate's "loose ends." The main provision of a pourover Will would say something to the effect of this:

I give any property I own in my own name at my death to the trustee of the Joel A. Schoenmeyer Trust dated November 20, 1970....

Why "pourover"? The idea is that your living trust is like a big bowl, and funding your living trust is like filling up the bowl. A pourover Will completes this process at your death, by pouring over -- into your living trust -- any property that wasn't placed in your living trust during your lifetime.

The big news in the Chicago legal community this week was the announcement (see this article -- registration may be required) that the firm of Mayer, Brown, Rowe & Maw is getting rid of 45 partners. (The partners will either be fired or demoted.)

Last month I blogged about the possible death of estate planning groups at large law firms in Chicago. My plan (since Mayer Brown surely won't announce which partners have been fired or demoted) was to track whether any of the 45 were estate planning or probate attorneys. But when I went to Mayer Brown's website and did a search for estate planners, I discovered that the death I blogged about last month must have happened some time ago.

The website for Mayer Brown (the third-largest Chicago-based firm, according to this site) says it has 1,400 attorneys worldwide. How many in the firm's Wealth Management group (their fancy name for its trusts and estates practice)? Eleven (5 partners, 3 associates, 3 counsel).

The second-largest Chicago-based firm, Sidley Austin Brown & Wood, has over 1,700 attorneys, only 15 of whom do estate planning and probate work.

The largest Chicago-based firm, Baker & McKenzie, has more than 3,400 attorneys worldwide, and doesn't seem to have anybody who does estate planning and probate work. (Maybe I'm wrong, but I don't see anything on this list of practice groups even close to estate planning.)

Of the Big 5 Chicago law firms, only one -- McDermot Will & Emery -- has a significant trusts and estates practice (about 40 attorneys in their "Private Client" group, out of approximately 1,000 attorneys). (The fifth-largest Chicago-based firm, Kirkland & Ellis, has about 1,300 attorneys, and nine trusts and estates attorneys.)

When I posted last month, I thought I was reporting on something that would happen in the future. But it turns out -- and I wish I had a Sullivan's Law Directory or Martindale-Hubbell from 10 or 15 years ago to prove it -- that estate planning attorneys left the large Chicago law firms quite some time ago.

Today I encountered a situation where a client executed a Will (maybe 10 years ago) and, instead of seeing an attorney when she need to make changes, had (5 years later) written changes on the Will in pen. This is a bad idea for a few reasons:

1. The changes to the Will were not signed by the testator in the presence of witnesses, so they aren't valid.

2. Even if the changes had been considered valid, because they were written in (and the testator had poor handwriting), they were hard to read (thereby making it hard to understand what the testator was trying to do).

3. The changes could potentially be viewed as a revocation of the original Will. Under the Illinois Probate Act (here), a Will "may be revoked... by [the testator] burning, cancelling, tearing or obliterating it."

The best way to amend your Will is to have a new Will or a codicil prepared.