Death and Taxes Blog

A husband and wife in their first marriage, with children, are pretty easy to handle from an estate planning perspective. That's mostly because their beneficiaries are exactly the same: the survivor of them, and their children (in that order).

Things get a bit more difficult when you are talking about a situation where the husband and/or wife have children from a prior marriage. In many cases the beneficiary situation will be something like this:

For husband: wife if she survives, otherwise to my children

For wife: husband if he survives, otherwise to my children

A slight but important difference. The concern for the first to die is to make sure his or her children don't lose out. There are a few ways to do this. Some thoughts:

1. Consider current property ownership. In many cases, the ways other married couples hold property (jointly, or as each other's designated beneficiaries) aren't appropriate AT ALL. Upon the death of the first to die, everything goes outright to the survivor. The survivor can then alter his or her estate plan to leave all of his or her property to his or her children only. Not what the first to die wanted, and arguably not fair.

2. One solution is a trust. Instead of getting the property of the first to die outright, the survivor gets the benefit of it for the rest of his or her life. But when the survivor dies, the trust property reverts to the children of the first to die. (The survivor's children would get all of his or her property via the survivor's trust at this same time.) This can work, but how well it works depends on how the survivor approaches the trust. Let's say that John and Mary Smith both have children from a prior marriage (two each), and trusts containing $1 million each. John dies. How should Mary pay living expenses for the rest of her life? May Mary drain John's trust of its assets before she starts taking assets from her own trust? This will lead to a situation where John's children can be disinherited.

Another important point: who's the trustee of the trust for the survivor? Is it Mary? One of John's children? Mary AND one of John's children? I can see problems with all of those possibilities. A corporate trustee may be helpful.

3. Agreement. Another option: a written agreement between the two spouses to make the children of both of them the ultimate beneficiaries of the estate. So, to go back to the John and Mary Smith example:

John dies. His property is held in trust for Mary's benefit for the rest of her life.

Upon Mary's death, the remainder of John's trust passes equally to his two children AND Mary's two children. And the remainder of Mary's trust passes in the same way.

One problem: what if Mary wants to remarry (no pun intended)?

Most Wills and trusts I draft follow a pretty basic framework:

-first, the decedent can give away specific gifts of cash and/or property, if he or she wishes;

-then, the decedent disposes of the so-called "residue" of his or her estate. The residue is what's left after specific gifts are made and debts and expenses are paid.

Sometimes clients ask about this. "Why can't I just give away every piece of my property, period, and not include a gift of the residue?" There are a few reasons:

-What happens if, at death, you no longer own a piece of property given away in your Will?

-What happens if, at death, you own a piece of property not given away in your Will?

-A lot of estate planning involves drafting for flexibility, and making a lot of specific bequests may mess up the relative values received by each beneficiary. If you have a specific goal (like, "my wife gets 75% of my estate and my sister gets 25%"), what happens if the property you bequeath to your sister grows a lot in value while the property bequeathed to your wife doesn't?

This article is really a cut above most "you need to have an estate plan" articles -- good use of detail and examples.

One part I wanted to focus on:

In event of your disability, give someone you trust the power to manage your property. It's called a power of attorney (although the person doesn't have to be an attorney).

But there's a problem: Some financial institutions won't accept powers of attorney created more than six months before. You're unlikely to renew a power of attorney this frequently. For a better solution, ask an estate planning attorney to draft a living trust for you. (The cost is probably $1,500 to $3,000.) The ownership of all your property is changed from your name to the trust's name. As the sole trustee, you can do anything you like with the property.

But if you become disabled, a person named in your trust steps in as successor trustee to manage the property on your behalf and for your benefit. All financial institutions accept this, no matter when the trust was written.

I haven't had a problem getting "old" powers of attorney (done in the last 5 years) accepted by financial institutions, but a living trust really works better than a property power of attorney in the case of disability. Or, rather, I should say that a fully funded living trust works better. If you transfer ownership and change beneficiary designations to your living trust and then become disabled, your successor trustee really can step right in and handle your property for your benefit. If you set up a living trust but don't fund it, and then become disabled, your property power of attorney can (hopefully) be used to fund your living trust at that time. I always include specific language allowing an agent under a property power of attorney to take care of this funding.

And, of course, a health care power of attorney is very important as well.

Let me put it simply: If you become disabled, having a fully funded living trust and powers of attorney will save you and your family a lot of time and money.

The general rule in Illinois, as I learned it when I started practicing law, is that a valid estate plan requires the client to sign his or her living trust before signing a Will that references such living trust.

A typical scenario is for an individual to have a Will leaving the residue of his or her estate to the trustee of his or her living trust. If, when the individual signed his or her Will, the living trust wasn't in existence, then the gift to the living trust is said to have failed.

A new First Division Appellate Court case (Phelan v. Baskin, available online as a PDF here) casts some doubt on the above rule. The case involves the Will and living trust of a man named John Phelan. At trial in Cook County, Judge Malak found that Mr. Phelan executed his living trust after he executed his Will, meaning that the living trust wasn't "in existence" when the Will was signed. Therefore, the residuary gift in Mr. Phelan's Will (to the living trust) failed, and the residue of his estate had to pass via intestacy.

The Appellate Court reversed Judge Malak's finding, stating that the living trust WAS "in existence" when the Will was signed. The Court's ruling is based on things like the fact that the Will and living trust were part of the client's "total estate plan," and were signed "contemporaneously."

This is a ridiculous opinion, the kind that gives judges a bad name. The Appellate Court has essentially disposed of a bright line rule that everyone knew in favor of a touchy-feely test. I can understand staying with the current rule. I can also understand overthrowing the current rule, and simply saying that there's no requirement that a trust be "in existence" when it is referenced in a Will (as long as it's in existence when the testator dies, who cares?). What I can't understand is coming up with a new rule that is based on the facts and circumstances of every particular case, just because you don't like the result in THIS case. So now we're going to see a lot of time devoted to analyzing what the court's opinion actually means -- What if the Will was signed one day (or one week) before the trust? Is a trust that I want to create but haven't created "in existence"? etc. etc.

That doesn't help the public or their attorneys.

Deirdre R. Wheatley-Liss has a nice post about nursing home admissions agreements on her You and Yours Blawg, here. It's amazing to me that people don't hire attorneys to review agreements like these before they are signed. Of course, when I practiced real estate law, I was horrified to see people sign listing agreements with realtors without having an attorney do a review. Most of these clients also didn't read the agreement or think about its import.

I have a few clients who are residents of a nearby assisted living facility. The facility requires a "down payment", a portion of which is then refunded in part following the termination of the agreement with the client (which usually happens as a result of the client's death). Unfortunately, the agreement (a) isn't specific about when the refund occurs and (b) requires the payment of certain monthly changes for two months AFTER the agreement terminates. These problems could be rectified by using an attorney to help negotiate the agreement, or at least review it for problems.

A few weeks ago, I posted (here) about obtaining lender approval when placing property into a living trust. I then received an interesting e-mail from reader Richard Barid of the Savannah, Georgia law firm of Smith Barid, LLC. Mr. Barid pointed me to a portion of the US Code (12USC1701j-3(d)(8), which can be found here) that seems to indicate lender approval isn't needed. To quote the relevant parts of 1701j-3 (the emphasis added is mine):

(a)(1) the term “due-on-sale clause” means a contract provision which authorizes a lender, at its option, to declare due and payable sums secured by the lender’s security instrument if all or any part of the property, or an interest therein, securing the real property loan is sold or transferred without the lender’s prior written consent;

(b)(2) Except as otherwise provided in subsection (d) of this section, the exercise by the lender of its option pursuant to such a clause shall be exclusively governed by the terms of the loan contract, and all rights and remedies of the lender and the borrower shall be fixed and governed by the contract.

(d) With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon... (8) a transfer into an inter vivos trust in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property
[.]

Mr. Barid adds that it's still a good idea to talk to a client's lender, for professional courtesy and to avoid surprises.

I sometimes get calls from people who have lost a spouse, asking to have a meeting about "probate." In most cases, these meetings don't involve much in the way of probate work; instead, they focus on planning for the widow or widower.

A well-drafted estate planning document for a married person discusses two scenarios:

-you die first (predecease your spouse); or -you die second (your spouse predeceases you).

And, of course, where your property goes when you die depends on which of these scenarios actually occurs. Most married people leave everything to their spouse in some way, shape or form -- they have a Will and/or living trust with the spouse as sole beneficiary, or have otherwise arranged to have their property pass to their spouse at death (via beneficiary designation or joint tenancy).

That's fine, but when one spouse passes away, it's a good time to update the survivor's estate plan. Maybe your children are older, and can handle their inheritance outright. Maybe there are new beneficiaries (like grandchildren or charities). Another reason to update: it's a good time to take stock of what you own, and how. If you want to try and avoid probate, now is the time to plan in order to do that. It's also a good time to involve a financial planner, who can organize your assets and help you figure out what you have (and don't have). This is especially important if the surviving spouse wasn't previously involved in the family's finances.

My wife introduced me to The Juggle, The Wall Street Journal's blog about "choices and tradeoffs people make as they juggle work and family." It's interesting stuff to read -- especially the comments -- although, of course, no conclusions are ever reached. This past week had two good posts related to estate planning:

1. Add This to the Financial Juggle: Your Parents' Retirement

2. Planning for the Worst-Case Scenario

Sometimes it seems like estate planners just invent terms and acronyms to confuse people. One of these cases involves a grantor trust, sometimes called an "intentionally defective grantor trust" or an IDGT.

So what's the deal with these things?

Basically, the term "grantor trust" relates to the taxation of a trust's income. Who pays the tax? If a trust is a grantor trust, then the grantor pays the tax (otherwise, the trust and/or its beneficiaries must have to pay the tax).

The grantor trust rules can be found here in the Internal Revenue Code (the "Code").

Estate planners use the grantor trust rules to take advantage of inconsistencies in the Code. In this case, the inconsistency is that you can set up a trust that is owned by you for income tax purposes (you pay the income tax) but not owned by you for estate tax purposes (the trust assets aren't includable in your estate).

Why would you want to do this? Because being viewed as the owner of a trust you set up means that you can pay the trust's income tax without such payments being considered an additional gift to the trust.

A revocable or living trust of which the grantor is acting as trustee will always be a grantor trust. The tax advantage discussed above is focused on irrevocable trusts (such as insurance trusts or gift trusts). Usually the goal of such trusts is to make sure that the grantor (i.e. the person who set up the trust) DOESN'T have any ownership interest in the trust. But there are certain provisions that can be included so the grantor can pay the trust's taxes. The term "intentionally defective" is misleading, since I don't think it's possible for a draftsperson to include grantor trust provisions by mistake (a more typical problem involves an inexperienced draftsperson who screws up the estate tax benefit by allowing the grantor to retain too much ownership interest in the trust).

I think the most typical provision used to make a trust a grantor trust involves giving a grantor "power to reacquire the trust corpus by substituting other property of an equivalent value" under Section 675(4)(d).

It can be a pain to have a last name like Schoenmeyer -- you have to get used to having your name pronounced in all different ways (my least favorite: "Shoe-in-my-ear"). But there is one surprising advantage: I'm easy to find. I note this only because yesterday's Wall Street Journal contains an article (here) about the very real problem encountered by folks with common names like Smith and Jones.

How does this relate to estate planning and probate? Well, it's important that the people named in your documents can be located if something happens to you. (It's especially important in the case of powers of attorney, which may be needed at a moment's notice.) If you are in a coma, and have named John Smith of Chicago, Illinois as your agent, with no further descriptive information, then you've got a problem.

I typically ask for names and contact information for all family members, as well as for all non-family members named in a client's documents. And, in most cases, if there's confusion about someone's identity, I try to provide more information in the documents themselves.

This morning I've been reviewing the current Will of a new client. The Will contains maybe 50 bequests of specific property, things like furniture, furnishings, and jewelry. My new client wants to change the Will (which was only executed last year) because some of her beneficiaries have died, and because she wants to remove and add others. With a Will, this must be done in a new document (a new Will or a codicil).

Dealing with tangible personal property is much easier if it's done within the context of a living trust:

1. As part of the living trust process, we assign the client's tangible personal property to the trust.

2. The trust includes a provision allowing the client to leave a written direction, telling where specific items will be distributed upon his death. The trust also contains a default provision for items not listed in the written direction.

3. Because the written direction is not part of the Will, it isn't subject to the execution formalities of a Will. The above written direction can be changed as often as the client wishes, by the client (so no attorney involvement is needed) -- it's really just a note, left with the client's other important papers.

Article 1: A nice summary of how small estate affidavits work in Illinois, by attorney (and CPA) Stephen A. Frost.

Article 2: A Forbes article -- complete with annoying ads! -- on an executor's duties, and how to choose one.

I recently blogged (here) about the effect of divorce on a person's estate planning documents. That post referred to a testator's divorce from his or her spouse, but there's also a different way in which divorce can affect your estate plan. Every family is different, but in some close-knit families a spouse of a family member (like a sibling's spouse) is named as a fiduciary or even a beneficiary. For example: you name your sister's husband as successor executor and trustee, and name him and your sister as guardians of your children if something happens to you and your husband.

That's admirable, but it's important to think about whether you'd still want to have someone named in your estate planning documents if the person ceases to be married to your family member. For instance, you might want to make your sister's husband a fiduciary only so long as he is married to your sister (or was married to your sister at the time of her death).

"Family settlement agreements" are one of those great ideas that rarely get used. The concept is that the family (parents and kids) sits down and discusses what will happen after the parents pass away, and everyone agrees to accept the way in which the parents' estates or trusts will be handled.

This article covers a similar concept, but involves siblings agreeing on the care for a parent if he or she becomes incapacitated. This type of sibling agreement can cover issues such as "where Dad will live [if he is incapacitated], how his savings will be spent and even how he will die."

"Per stirpes" and "per capita" are two terms that often appear in estate planning documents. What do they mean?

Both terms relate to a situation where you leave property to a group of people, some of whom die before you do. For instance, let's say that you have five children. Four of your children survive you; one of your children (Stanley, who has five children of his own) predeceases you.

PER CAPITA

You could leave your property "in equal shares per capita to my descendants who survive me." In this case, nine equal shares will be created, one for each living descendant (so one for each child of yours, and one for each child of Stanley). That overcompensates Stanley's children for their father's death, doesn't it? More than 50% of your property would pass to that family line.

Another option used in bigger families would be to leave your property "in equal shares per capita to my children who survive me." Here, only four shares are created, and no share is created for Stanley (he didn't survive) or his children (they aren't your children). Doesn't this undercompensate Stanley's children?

PER STIRPES

If you have left your property "in equal shares per stirpes to my descendants who survive me" in your will, then your property will be divided into five equal shares. Each surviving child receives a share, and Stanley's five children each receive one-fifth of his share.

If Stanley predeceased you but didn't have children of his own living at your death, then only four shares are created.

I think the preference of most estate planners is in favor of "per stirpes." "Per capita" is like a bowl of porridge, and can be "too hot" or "too cold." "Per stirpes" may not be "just right," but I think it's closer to what most decedents want to do.

In this month's Estate Planning & Probate Flashpoints newsletter from IICLE, Patricia Brosterhous mentions that the Northern Trust's estate planning formbook is online, here. Most estate planners I know have their own way of drafting things, but it's always nice to take a look at other approaches. My favorite thing about these forms is that they include notations, explaining why provisions are included and how they can be changed.

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).

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 f