Category: Estates & Trusts

Estate Planning with Digital Assets in Mind

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“It’s ‘Bosco’!!”  Seinfeld fans will recall from “The Secret Code” episode that George Costanza created a good deal of chaos by being reluctant to share his secret code.  By the same token, failing to share the secret codes to your digital assets could put a wrench in your best laid estate plans.  This article will discuss various measures that you can implement to insure that your digital assets will pass in accordance with your desires.

Whether we like it or not, the world is changing at warp speed.  Paper statements for bank accounts and the like are going to the way of the dodo bird.  Those dusty old books that used to gobble up shelf space can now be stored on a device that fits in the palm of your hand.  Same goes for the vinyl records you bought with money from mowing lawns.  And who would have ever thought that you’d be able to share pictures of your children or grandchildren with your friends and family by posting them on Facebook?

As the world becomes more and more digital, so too do the assets which comprise your estate.  Digital assets encompass a wide variety of items.  The website www.digitalestateresourse.com defines digital assets to include the following:

  1. files stored on digital devices, including but not limited to, desktops, laptops,    tablets, peripherals, storage devices, mobile telephones, smartphones, and any    similar digital device which currently exist or may exist as technology develops;    and
  2. e-mails received, e-mail accounts, digital music, digital photographs, digital    videos, digital books, software licenses, social network accounts, file sharing    accounts, financial accounts, banking accounts, tax preparation service accounts,    online stores, affiliate programs, other online accounts, and similar digital items    which currently exist or may exist as technology develops, regardless of the    ownership of the physical device upon which the digital item is stored.”

Failing to properly catalogue your digital assets could have a variety of negative consequences.  By way of example, that rainy day savings account that you never told anyone about could go undetected by the executor of your estate; and those vacation photos which your family would so enjoy could be forever locked in a Shutterfly account.

So what needs to be done to insure that your digital assets are properly accounted for and that they go to their intended beneficiaries?  Taking the following steps will go a long way towards accomplishing your objectives: (1) keep a master list of your digital assets; (2) keep the master list current; (3) tell someone where you keep the master list; (4) determine whether your digital assets are transferable; and (5) consider making specific provisions for them in your Will.

(1) KEEPING A LIST.  The most important step in properly handling your digital assets is to create a master list of such assets.  I find Excel spreadsheets to be a helpful tool for creating and maintaining such lists.  For each of your digital assets, consider including the following information: (i) a description of the asset (e.g., TD Ameritrade Brokerage Account); (ii) where the asset is located (e.g.,www.tdameritrade.com); (iii) any account number or user name associated with the asset; and (iv) any password that is necessary to gain access to the asset.

(2)  CURRENT INFORMATION.  Creating a list of digital assets without keeping the information current is about as useful as having an ashtray on a motorcycle.  It doesn’t do your executor any good to know that the brokerage account you opened in 2004 was with TD Ameritrade.  Rather, he really needs to know that you transferred the assets to Fidelity Investments in 2009 and that is where the assets are currently located.  Ideally you should update the master list every time you change the location of the assets, change a password or make a similar change.  Short of that, you should review your master list at least once every three months and after you have done so, make a notation to that effect on the master list.  Something such as “Current as of 12/1/12” would work nicely.

(3)  LOCATION OF THE LIST.  Creating and maintaining the master list does your heirs no good unless you share its location with someone you trust.  As a best practice, you should tell your executor where the master list is located and you should keep a copy of the master list with your other valuable papers and documents.

(4)  NOT ALL DIGITAL ASSETS ARE TRANSFERABLE.  Unless you are the one person in 10,000 who actually reads the user agreement when you establish an online account, you should revisit each user agreement for your online accounts to determine which of your digital assets are transferrable upon your death.  By way of example, not all airlines permit the transfer of frequent flyer miles upon the death of the account holder.  Upon making such a determination, you should update your master list accordingly.

(5)  SPECIFIC BEQUESTS OF DIGITAL ASSETS.  Now that your executor knows your digital assets exist, they should pass in accordance with your overall estate plan.  Without making specific provisions for your digital assets, they will pass pursuant to the residuary clause of your Will.  So, while it is not necessary to make specific bequests of your digital assets, as a practical matter it may be advisable to do so.  For example, I know that my wife would love to have the family photos stored on my laptop, but I can promise you that she has no interest in the Alex Cross novels I’ve purchased for my Kindle Fire or the Johnny Cash albums I’ve purchased for my iPhone.

Digital assets are often an overlooked component of even the most complicated estate plans.  However, with proper planning you can make sure that all of your digital assets are properly accounted for and that they pass according to your wishes.  To assess the current health of your estate plan, including a determination of whether your digital assets are properly accounted for, consider scheduling an appointment with your estate planning attorney.

© 2013 by McBrayer, McGinnis, Leslie & Kirkland, PLLC

The Effect of the Fiscal Cliff Deal on Estate Planning

An article by Susan C. Minahan with Michael Best & Friedrich LLP, The Effect of the Fiscal Cliff Deal on Estate Planning, was recently featured in The National Law Review:

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In an attempt to avert the “fiscal cliff” at the end of 2012, the American Taxpayer Relief Act of 2012 (the “2012 Act”) was passed by Congress on January 1, 2013, and signed into law by the President on January 2, 2013. The 2012 Act has significant impact on all taxpayers, and is a game changing piece of legislation in the estate, gift, and generation-skipping transfer tax area.

The 2012 Act permanently extends the $5,000,000 unified federal estate, gift, and generation skipping transfer (GST) tax exemptions implemented under the 2010 Tax Relief Act for all such transfers occurring after December 31, 2012. All three exemptions are indexed for inflation. As a result, the exemption amounts in 2013 are $5,250,000. The 2012 Act increases the maximum tax rate from thirty-five percent (35%) to forty percent (40%) for any transfers in excess of the exemption amounts.

The 2012 Act also permanently extends portability of unused estate tax exemption for married couples. Portability, a concept introduced in the 2010 Tax Relief Act, allows a surviving spouse to “port” or add a deceased spouse’s unused estate tax exemption amount to the surviving spouse’s exemption amount without the use of a traditional credit shelter trust. However, portability, as noted in our client alert dated December 20, 2010, should not be solely relied on as an estate planning substitute for several reasons. First, the ported amount can be lost if the surviving spouse remarries. Second, portability does not provide the same asset protection after the first spouse’s death that is provided by traditional credit shelter trust planning. Third, portability does not apply to the GST exemption; therefore, to leverage GST planning, careful dynasty trust planning is still necessary.

It should be noted that the exemptions are “permanent” only as long as Congress chooses not to change them (no tax law change should ever be considered “permanent” with a new Congress every two years).

In light of the 2012 Act and the current estate planning environment, estate planning is still necessary, and the following are continuing opportunities for transferring wealth:

Low Interest Rate Planning

Historically low interest rates continue to present the opportunity for intra-family low interest loans or refinancing of low interest intra-family loans. The January 2013 mid-term applicable federal rate (for 3-9 year loans) is 0.87%. Low interest rate loans can also be combined with gifting, resulting in larger tax free transfers. Sales to intentionally defective grantor trusts (IDGTs) and grantor retained annuity trusts (GRATs) are commonly used techniques for this type of planning, and the 2012 Act fortunately did not impose limits on GRATs, IDGTs or valuation discounts that had been proposed earlier. Congress may impose limits on the use of these techniques in the future, but at least for the time being, the window of opportunity for these techniques remains open.

GST Planning

Dynasty trusts that utilize the GST exemption can be used to transfer assets from generation to generation for multiple generations of a family, avoiding estate, gift, and GST tax at each generation. With the high exemptions, a single person can protect $5,250,000 and a married couple can protect $10,500,000, indexed for inflation, in this manner. In addition, as previously noted, GST exemption is not “portable” and therefore, dynasty trusts are important for married couples in protecting the GST exemption of each spouse. Limitations on the number of years a dynasty trust can run were also not part of the 2012 Act.

Asset Protection

Trusts remain an important part of estate planning, even for smaller estates, because they provide means of asset protection. Trusts can be used to protect assets from a beneficiary’s creditors, including a divorcing spouse. Trusts can also protect assets in the event a beneficiary becomes disabled. Lifetime irrevocable trusts also provide an estate and gift tax “freeze” for a donor’s estate at the value of the trust as of the date of the lifetime gift.

Annual Gifts

In addition to the lifetime gift tax exemption, each taxpayer may make annual exclusion gifts to any number of donees. The annual exclusion was indexed for inflation with the 2001 Act, and in 2013 the annual gift tax exclusion amount is $14,000 per donee.

The following are some other notable provisions of the Act that impact individuals:

  • Extends tax cuts for individuals with incomes under $400,000 and married couples under $450,000;
  • Raises the ordinary income tax rate from 35% to 39.6% for individuals with income over $400,000 and married couples with income over $450,000;
  • Raises capital gains and dividend tax from 15% to 20% for individuals with income over $400,000 and married couples with income over $450,000;
  • Overall limit on itemized deductions are reinstated for individuals with income over $250,000 and married couples with income over $300,000, which may impact lifetime charitable giving plans;
  • Permanently indexes the alternative minimum tax (AMT) for inflation;
  • Expands employees’ ability to convert traditional retirement accounts such as 401(k)s and 403(b)s into Roth accounts; and
  • Extends through 2013 the tax free IRA “rollover” to qualifying charities after age 70½ (Note: special rules relate to actions that may be taken in January of 2013 to treat contributions as being made during 2012).

© MICHAEL BEST & FRIEDRICH LLP

Private Equity Fund Is Not a “Trade or Business” Under ERISA

An article, Private Equity Fund Is Not a “Trade or Business” Under ERISA, written by Stanley F. Lechner of Morgan, Lewis & Bockius LLP was recently featured in The National Law Review:

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District court decision refutes 2007 Pension Benefit Guaranty Corporation opinion letter and could provide potential clarity to private equity firms and private equity funds in determining how to structure their investments.

In a significant ruling that directly refutes a controversial 2007 opinion by the Pension Benefit Guaranty Corporation (PBGC) Appeals Board, the U.S. District Court for the District of Massachusetts held in Sun Capital Partners III, LP v. New England Teamsters & Trucking Industry Pension Fund that a private equity fund is not a “trade or business” under the Employee Retirement Income Security Act (ERISA) and therefore is not jointly and severally liable for millions of dollars in pension withdrawal liability incurred by a portfolio company in which the private equity fund had a substantial investment.[1] This ruling, if followed by other courts, will provide considerable clarity and relief to private equity funds that carefully structure their portfolios.

The Sun Capital Case

In Sun Capital, two private equity funds (Sun Fund III and Sun Fund IV) invested in a manufacturing company in 2006 through an affiliated subsidiary and obtained a 30% and 70% ownership interest, respectively, in the company. Two years after their investment, the company withdrew from a multiemployer pension plan in which it had participated and filed for protection under chapter 11 of the Bankruptcy Code. The pension fund assessed the company with withdrawal liability under section 4203 of ERISA in the amount of $4.5 million. In addition, the pension fund asserted that the two private equity funds were a joint venture or partnership under common control with the bankrupt company and thus were jointly and severally liable for the company’s withdrawal liability.

In response to the pension fund’s assessment, the private equity funds filed a lawsuit in federal district court in Massachusetts, seeking a declaratory judgment that, among other things, they were not an “employer” under section 4001(b)(1) of ERISA that could be liable for the bankrupt company’s pension withdrawal liability because they were neither (1) a “trade or business” nor (2) under “common control” with the bankrupt company.

Summary Judgment for the Private Equity Funds

After receiving cross-motions for summary judgment, the district court granted the private equity funds’ motion for summary judgment. In a lengthy and detailed written opinion, the court made three significant rulings.

First, the court held that the private equity funds were passive investors and not “trades or businesses” under common control with the bankrupt company and thus were not jointly and severally liable for the company’s withdrawal liability. In so holding, the court rejected a 2007 opinion letter of the PBGC Appeals Board, which had held that a private equity fund that owned a 96% interest in a company was a trade or business and was jointly and severally liable for unfunded employee benefit liabilities when the company’s single-employer pension plan terminated.

A fundamental difference between the legal reasoning of the court in the Sun Capital case compared to the reasoning of the PBGC in the 2007 opinion is the extent to which the actions of the private equity funds’ general partners were attributed to the private equity fund. In the PBGC opinion, the Appeals Board concluded that the private equity fund was not a “passive investor” because its agent, the fund’s general partner, was actively involved in the business activity of the company in which it invested and exercised control over the management of the company. In contrast, the court in Sun Capital stated that the PBGC Appeals Board “misunderstood the law of agency” and “incorrectly attributed the activity of the general partner to the investment fund.”[2]

Second, in responding to what the court described as a “creative” but unpersuasive argument by the pension fund, the court concluded that the private equity funds did not incur partnership liability due to the fact that they were both members in the affiliated Delaware limited liability company (LLC) that the funds created to serve as the fund’s investment vehicle in purchasing the manufacturing company. Applying Delaware state law, the court stated that the private equity funds, as members of an LLC, were not personally liable for the liabilities of the LLC. Therefore, the court concluded that, even if the LLC bore any responsibility for the bankrupt company’s withdrawal liability, the private equity funds were not jointly and severally liable for such liability.

Third, the court held that, even though each of the private equity funds limited its investment in the manufacturing company to less than 80% (i.e., 30% for Fund III and 70% for Fund IV) in part to “minimize their exposure to potential future withdrawal liability,” this did not subject the private equity funds to withdrawal liability under the “evade or avoid” provisions of section 4212(c) of ERISA.[3] Under section 4212(c) of ERISA, withdrawal liability could be incurred by an entity that engages in a transaction if “a principal purpose of [the] transaction is to evade or avoid liability” from a multiemployer pension plan. In so ruling, the court stated that the private equity funds had legitimate business reasons for limiting their investments to under 80% each and that it was not clear to the court that Congress intended the “evade or avoid” provisions of ERISA to apply to outside investors such as private equity funds.

Legal Context for the Court’s Ruling

Due to the distressed condition of many single-employer and multiemployer pension plans, the PBGC and many multiemployer pension plans are pursuing claims against solvent entities to satisfy unfunded benefit liabilities. For example, if a company files for bankruptcy and terminates its defined benefit pension plan, the PBGC generally will take over the plan and may file claims against the company’s corporate parents, affiliates, or investment funds that had a controlling interest in the company, or the PBGC will pursue claims against alleged alter egos, successor employers, or others for the unfunded benefit liabilities of the plan that the bankrupt company cannot satisfy.

Similarly, if a company contributes to a multiemployer pension plan and, for whatever reason, withdraws from the plan, the withdrawing company will be assessed “withdrawal liability” if the plan has unfunded vested benefits. In general, withdrawal liability consists of the employer’s pro rata share of any unfunded vested benefit liability of the multiemployer pension plan. If the withdrawing company is financially unable to pay the assessed withdrawal liability, the multiemployer plan may file claims against solvent entities pursuant to various legal theories, such as controlled group liability or successor liability, or may challenge transactions that have a principal purpose of “evading or avoiding” withdrawal liability.

Under ERISA, liability for unfunded or underfunded employee benefit plans is not limited to the employer that sponsors a single-employer plan and is not limited to the employer that contributes to a multiemployer pension plan. Instead, ERISA liability extends to all members of the employer’s “controlled group.” Members of an employer’s controlled group generally include those “trades or businesses” that are under “common control” with the employer. In parent-subsidiary controlled groups, for example, the parent company must own at least 80% of the subsidiary to be part of the controlled group. Under ERISA, being part of an employer’s controlled group is significant because all members of the controlled group are jointly and severally liable for the employee benefit liabilities that the company owes to an ERISA-covered plan.

Private Investment Funds as “Trades or Businesses”

Historically, private investment funds were not considered to be part of an employer’s controlled group because they were not considered to be a “trade or business.” Past rulings generally have supported the conclusion that a passive investment, such as through a private equity fund, is not a trade or business and therefore cannot be considered part of a controlled group.[4]

In 2007, however, the Appeals Board of the PBGC issued a contrary opinion, concluding a private equity fund that invested in a company that eventually failed was a “trade or business” and therefore was jointly and severally liable for the unfunded employee benefit liabilities of the company’s defined benefit pension plan, which was terminated by the PBGC. Although the 2007 PBGC opinion letter was disputed by many practitioners, it was endorsed by at least one court.[5]

The Palladium Capital Case

In Palladium Capital, a related group of companies participated in two multiemployer pension plans. The companies became insolvent, filed for bankruptcy, withdrew from the multiemployer pension plans, and were assessed more than $13 million in withdrawal liability. Unable to collect the withdrawal liability from the defunct companies, the pension plans initiated litigation against three private equity limited partnerships and a private equity firm that acted as an advisor to the limited partnerships. The three limited partnerships collectively owned more than 80% of the unrestricted shares of the defunct companies, although no single limited partnership owned more than 57%.

Based on the specific facts of the case, and relying in part on the PBGC’s 2007 opinion, the U.S. District Court for the Eastern District of Michigan denied the parties’ cross-motions for summary judgment. Among other things, the court stated that there were material facts in dispute over whether the three limited partnerships acted as a joint venture or partnership regarding their portfolio investments, whether the limited partnerships were passive investors or “investment plus” investors that actively and regularly exerted power and control over the financial and managerial activities of the portfolio companies, and whether the limited partnerships and their financial advisor were alter egos of the companies and jointly liable for the assessed withdrawal liability. Because there were genuine issues of material fact regarding each of these issues, the court denied each party’s motion for summary judgment.

Significance of the Sun Capital Decision

In concluding that a private equity fund is not a “trade or business,” the Sun Capital decision directly refutes the 2007 PBGC opinion letter and its reasoning. If the Sun Capital decision is followed by other courts, it will provide welcome clarity to private equity firms and private equity funds in determining how to structure their investments. Among other things, both private equity funds and defined benefit pension plans would benefit from knowing whether or under what circumstances a fund’s passive investment in a portfolio company can constitute a “trade or business” thus subjecting the private equity fund to potential controlled group liability. Similarly, both private equity firms and private equity funds need to know whether a court will attribute to the private equity fund the actions of a general partner or financial or management advisors in determining whether the investment fund is sufficiently and actively involved in the operations and management of a portfolio company to be considered a “trade or business.”

The Sun Capital decision was rendered, as noted above, against a backdrop in which the PBGC and underfunded pension plans are becoming more aggressive in pursuing new theories of liability against various solvent entities to collect substantial sums that are owed to the employee benefit plans by insolvent and bankrupt companies. Until the law becomes more developed and clear regarding the various theories of liability that are now being asserted against private equity funds investing in portfolio companies that are exposed to substantial employee benefits liability, it would be prudent for private equity firms and investment funds to do the following:

  • Structure carefully their operations and investment vehicles.
  • Be cautious in determining whether any particular fund should acquire a controlling interest in a portfolio company that faces substantial unfunded pension liability.
  • Ensure that the private equity fund is a passive investor and does not exercise “investment plus” power and influence over the operations and management of its portfolio companies.
  • Conduct thorough due diligence into the potential employee benefits liability of a portfolio company, including “hidden” liabilities, such as withdrawal liability, that generally do not appear on corporate balance sheets and financial statements.
  • Be aware of the risks in structuring a transaction in which an important objective is to elude withdrawal liability.

Similarly, until the law becomes more developed and clear, multiemployer pension plans may wish to devote particular attention to the nature and structure of both strategic and financial owners of the businesses that contribute to their plans and should weigh and balance the risks to which they are exposed by different ownership approaches.

[1]. Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, No. 10-10921-DPW, 2012 WL 5197117 (D. Mass. Oct. 18, 2012), available here.

[2]. Sun Capital, slip op. at 17.

[3]. Id. at 29-30.

[4]. See e.g., Whipple v. Comm’r., 373 U.S. 193, 202 (1963).

[5]. See, e.g., Bd. of Trs., Sheet Metal Workers’ Nat’l Pension Fund v. Palladium Equity Partners, LLC (Palladium Capital), 722 F. Supp. 2d 854 (E.D. Mich. 2010).

Copyright © 2012 by Morgan, Lewis & Bockius LLP

2012 Wealth Transfer Tax Laws: The Window of Opportunity is Rapidly Closing

An article by Glen T. Eichelberger, Mary Elizabeth Mason, Bridget O’Toole Purdie, and Brian P. Teaff of Bracewell & Giuliani LLP recently had an article featured in The National Law Review regarding Wealth Transfer:

The window of opportunity to take advantage of the currently applicable wealth transfer tax laws is rapidly closing, and once shut, it is possible that we may never see such generous estate planning opportunities again.

The unique estate planning opportunities currently available are a result of the “Tax Relief, Unemployment Insurance Authorization, and Job Creation Act of 2010” (2010 Act). The 2010 Act introduced the following:

  • $5,120,000 exemption per person for Federal estate, gift and generation-skipping transfer (GST) taxes
    • Highest exemptions ever available
  • 35% maximum marginal rate for the estate, gift and GST taxes
    • Lowest rate in decades
  • “Reunification” of estate, gift and GST tax exemptions
    • Greater Planning Flexibility
    • Acting together, a couple can give up to $10,240,000 of assets (outright or in trust)

In addition, President Obama’s 2013 Budget Proposal contains proposed rules which would restrict a person’s ability to transfer wealth to their children and more remote descendants. The 2013 Budget Proposal includes the following rules:

Restrict grantor retained annuity trusts (GRATs) to a minimum of 10 years

Elimination of the availability of certain valuation adjustments associated with family limited partnerships

The generous provisions of the 2010 Act are temporary and without further Congressional action, these provisions will expire on December 31, 2012.  Act now before it is too late, so that you can benefit from the current advantageous estate opportunities and ensure you are not affected by the proposed rules from the 2013 Budget Proposal.

© 2012 Bracewell & Giuliani LLP

Impact of New Medicare Investment Tax on Trusts and Estates

As part of the Patient Protection and Affordable Care Act enacted in 2010, Section 1411 was added to the Internal Revenue Code. Beginning in 2013, this section imposes an additional tax on individuals and on trusts and estates. It is a tax on net investment income tax. Net investment income includes capital gains.

It has generally been reported that the tax on individuals does not apply unless their modified adjusted income exceeds $200,000 ($250,000 for a married couple).

What is less well known is that this new investment tax applies to trusts and estates at a much lower income level. Section 1411 provides that the new tax applies when income reaches the level at which it is taxed at the highest marginal rate. In 2012, the highest marginal tax rate is reached when undistributed net income reaches $11,650. This figure will be adjusted for inflation in 2013.

Depending upon what the income tax rates are in 2013, a trust or estate which has a substantial amount of undistributed net taxable income may find itself paying federal income tax of 43.4 percent (39.6 + 3.8) on much of that income. This is in addition to any state income tax (6 percent on income in excess of $9,000 in Missouri).

This makes careful income tax planning for estates and trusts more important than it has ever been.

© Copyright 2012 Armstrong Teasdale LLP

Once Is Not Enough: The Importance of Regular Communication Between Testators and Their Lawyers

 

When it comes to estate planning, an ounce of prevention is worth a pound of cure. Equally important, continuing consultation with a knowledgeable lawyer need not be time consuming or costly. Periodic reviews can ensure that estate papers provide for changes in circumstances and the law that would later prove difficult and expensive to resolve when the testator’s wishes must be implemented.

The example of George Wagner serves as a cautionary tale. In 1961, George, a childless bachelor, executed a last will and testament providing for a testamentary trust on his death, without a residuary clause. He appointed a corporate trustee as his trustee and executor, and bequeathed his property on his death to the trustee, in trust, for the benefit of his sister, Elizabeth, while she lived. On Elizabeth’s death, the trustee was to end the trust and distribute its property “only” to the “Ancient Free and Accepted Masons of Maywood, Illinois, Maywood Lodge No. 869,” with no interest to vest until the “the day upon which the Trust herein created shall terminate.” When George died in 1978, his will was admitted to probate, the trustee was appointed executor as he wished, and the trust was created with funds of $250,000.

Elizabeth died in 1986 in California, but nobody told the trustee, who administered the trust funds until 1995, when it learned Elizabeth had died. By then, the trust funds totaled over $500,000. The trustee also learned that the Maywood Lodge had been disbanded in 1982 and merged into another Masonic lodge, Pleiades Lodge No. 478.

The trustee’s duty was to fulfill George’s testamentary objectives, but because George did not say how to distribute the trust funds if the Maywood Lodge ceased to exist, the trust could be interpreted in different ways. If George meant to benefit any Masonic lodge into which the Maywood Lodge merged, the trust funds should go to the Pleiades Lodge. If George meant to benefit “only” the Maywood Lodge, his bequest lapsed when the Maywood Lodge was dissolved, and the trust funds should be distributed under the law of intestacy.

To resolve this issue, the trustee filed a complaint for construction of the trust in court, asking for directions on how to distribute the trust funds. A genealogical search found two paternal cousins of George in California, and the trustee named them and the Masonic lodges as defendants to the suit. George’s cousins and the Pleiades Lodge each asserted exclusive rights to the trust funds. There were no surviving witnesses who might have had insight as to George’s testamentary intent. The court was left to decide which legal doctrine to apply in the circumstances.

The court might have chosen the doctrine of deviation, which applies when a situation arises that is not covered by a trust’s specific provisions and was not anticipated by the settlor or testator. Under this doctrine, the court must gauge the overall purpose of the trust and fulfill the settlor’s intent by authorizing deviation from the trust’s terms, ascertaining as best it can what the settlor most likely would have done in circumstances that he or she did not contemplate. There are similar doctrines for charitable trusts, but those did not apply because George’s will did not contain an expression of charitable intent.

Alternatively, the court might have chosen the clear language rule, which holds that the court’s primary goal is to ascertain the settlor’s intentions, initially by looking to the trust language. If the words of the trust instrument are clear, the court must presume that they express the settlor’s intention and apply the language verbatim, without resorting to evidence of intent existing outside the trust instrument.

The court would have had a hard time making a decision. George plainly did not want his property distributed to strangers and had not anticipated that the Maywood Lodge would cease to exist before Elizabeth died. These circumstances would have occasioned application of the doctrine of deviation. But the language of the instrument was also unambiguous: the trustee was to distribute the trust property “only” to the Maywood Lodge, thereby excluding the Pleiades Lodge and leaving the trustee no choice but to distribute the trust funds under the law of intestacy. Either way, the court would at best have been approximating George’s intent.

In the end, the court did not need to resolve the controversy. The putative claimants settled the case, dividing the trust funds evenly. But the situation need not have arisen. Had George even occasionally consulted with a lawyer knowledgeable in estate planning, he could easily have updated his will and testamentary trust to include viable contingent beneficiaries if the Maywood Lodge ceased to exist before the time came to distribute his trust funds, and to include a residuary clause to distribute any remainder.

The case shows why clients should cultivate an ongoing relationship with lawyers who are well versed in estate planning, keep abreast of developments in the law, and will serve as a continuing resource as circumstances and needs change.

© 2012 Much Shelist, P.C.

Why Your Qualified Plan – Isn’t

Recently The National Law Review published an article by Ben F. Wells and William M. Freedman of Dinsmore & Shohl LLP regarding Qualified Plans:

There are many generous tax benefits that come from having a “qualified” retirement plan (such as a section 401(k) plan). For example, as an employer, you can deduct your plan contributions, but participating employees don’t have to recognize the contributions as income until they receive a distribution; usually many years later. However, those tax benefits disappear if your plan loses its qualified status.

What can cause a plan to lose its qualified status?

Several things, but there are three types of problems that frequently arise:

  • Failure to adopt required plan amendments in a timely fashion. The IRS issues reams of guidance that require plan amendments. Fail to adopt even one on time, and your plan is technically disqualified.
  • Failure to administer the plan in accordance with its terms. Your plan document probably contains hundreds of pages of fine print and technical jargon. Most employers have never read it, at least not all the way through. But you are required to follow it to the letter. Slip up one time and your plan can be considered disqualified.
  • Failure to satisfy the Internal Revenue Code’s various tests. The Code contains a number of mathematical tests which specify who must benefit from the plan and what benefits must be provided. These tests also prohibit “discrimination” in favor of highly compensated employees and others. Many of those tests are extremely complex and easy to violate. Fail one of them, and fail to correct it within the allowable time periods, and your plan will be disqualified.

How to correct qualification failures

Luckily the IRS has provided ways to correct most qualification failures. For example, their “Employee Plans Compliance Resolution System” or “EPCRS” allows plan sponsors to correct qualification failures through a variety of methods, such as employer contributions, retroactive amendments and corrective distributions. Generally those corrections are designed to put the plan in a position as if the qualification error had not occurred. But these require experienced and knowledgeable advisors to navigate.

Conclusion

To help avoid disqualification, make sure that:

  • Your advisors are monitoring your plan to help eliminate potential causes of disqualification.
  • Your plan document is up to date, and matches the way you actually administer your plan. Don’t make a change to your plan without telling your document provider and third party administrator.
  • Someone in your organization is reviewing your plan’s discrimination testing and dealing with violations.

If you see a problem, correct it as soon as possible – before the IRS audits you. This way you can keep your qualified plan “qualified.”

© 2012 Dinsmore & Shohl LLP

Is the $5 Million Gift Tax Exempt Amount About to End?

Recently posted in the National Law Review an article by Elyse G. Kirschner and Carlyn S. McCaffrey  of McDermott Will & Emery regarding the The Tax Relief Act of 2010 made significant changes to the gift, estate and generation-skipping, however, not permanent:

 

 

 

The Tax Relief Act of 2010 made significant changes to the gift, estate and generation-skipping transfer tax regimes by increasing the amount each individual can give without incurring tax from $1 million to $5 million.  The increase was not permanent however, and rumor has it that it may be in jeopardy.  To avoid any risk, those who have decided to use their full exemptions should do so no later than December 31, 2011, and, if feasible, November 22.

The Rumors

The Tax Relief Act of 2010 made significant beneficial changes to the gift, estate and generation-skipping transfer tax regimes.  Most important, it increased the amount each individual can give without incurring gift tax and generation-skipping transfer tax to $5 million from $1 million.  For married individuals, the combined exemptions can be as high as $10 million.  The 2010 increase was not a permanent one.  Congress scheduled the exemption to return to $1 million after the end of 2012.

Rumors circulating recently within the financial and estate-planning communities have suggested the $5 million exemptions may be in immediate jeopardy.  Democratic staff on the U.S. House Committee on Ways and Means recently proposed decreasing the $5 million gift, generation-skipping transfer tax and estate tax exemptions to $3.5 million, effective January 1, 2012.  There also are rumors the Joint Select Committee on Deficit Reduction (the Super Committee) may recommend a drop down in the gift tax exemption to $1 million, effective at year end, or possibly as early as November 23, 2011, when its recommendations are scheduled to be released, though there is no confirmation this rumor is true.

What Should You Do?

Although it seems unlikely that Congress will focus on changes to the transfer tax system before year end, congressional action in the transfer tax area has been notoriously difficult to predict.  Congress’ decision in December 2010 to reinstate the estate tax retroactively, to permit the estates of 2010 decedents to opt out of paying estate tax and to reduce the generation-skipping transfer tax rate to zero, was a noteworthy example of congressional action that took the entire estate-planning community by surprise.  A congressional decision to reverse the 2010 transfer tax reductions would be more surprising because it would immediately strip from taxpayers a benefit that was clearly agreed to last December.  However, Congress is unpredictable.

In view of the uncertain availability of the $5 million exemption, those who have decided to use their full exemptions may want to do so quickly, rather than run the risk of losing them.  To avoid any risk, your deadline should be no later than December 31, 2011, and, if feasible, November 22.  The choices to be made include identifying the property to be transferred, selecting the individual recipients and determining the manner in which the recipients should receive their gifts.

Selection of Assets to Give

Assets to be transferred to the trust should be those that are likely to appreciate over time.  The transfer of appreciating assets will help leverage the initial gift.  Investments that are temporarily depressed as a result of recent market conditions, for example, could prove to be successful gifts. Remainder interests in residences in today’s depressed housing markets may also be attractive gifts.  Marketable securities, interests in hedge funds or other investment partnerships and real estate are all good possibilities.  High-basis assets typically are a good choice, but assets that are valued today at less than their basis are not usually the best choice.

If non-marketable assets are given, an appraisal of those assets is needed to properly value and report the gift, but the appraisal can be completed after the gift is made.  In most instances, a formal appraisal of non-marketable assets will take into account certain valuation discounts (for example, lack of marketability and minority interest discounts).  The effect of these valuation discounts will be to further leverage the gift tax credit.

Selecting Recipients

The logical recipients of gifts will be those family members who will receive the estate.  Because tax-free gifts can be made to a spouse and charity, gifts to them do not need to be accelerated to take advantage of the gift tax exemption.  In some cases, clients may plan to use their increased exemptions to forgive debts previously made to friends and family members with financial needs, or to meet the living expenses of adult children.

Making Gifts in Trust

Outright gifts are a simple way to use the gift and generation-skipping transfer tax exemptions, but gifts in trust offer many more advantages.  For example, transferring assets to a trust for the benefit of children can protect those assets from the claims of their creditors or spouses.  In addition, with a trust the trustees of the trust can control the timing and manner of distributions to children.

Furthermore, if portions of the remaining $5 million generation-skipping transfer tax exemption are allocated to the trust, future distributions to grandchildren and more remote issue can be made free of the generation-skipping transfer tax.  Finally, if the trust that is established is a so-called “grantor trust” for income tax purposes, you, and not the trust, will pay the income tax on the income generated inside the trust.  When the gift-giver pays the income tax on the income of the trust, the size of the estate is reduced without having to make additional taxable gifts to the trust.

An Existing Trust or a New Trust?

Once the decision is made to make a gift in trust, the next question is whether to make the gift to an existing trust or to a new one.  Whether an existing trust or a new trust is selected is a function of a number of considerations, such as whether the trusts that are already created have the appropriate beneficiaries, whether a spouse also plans to make a gift in trust and whether certain provisions should be in the trust to address uncertainties at this time.

© 2011 McDermott Will & Emery

The Illinois Civil Union Law and Its Impact on Estate Planning

Recently posted in the National Law Review an article by Gregg M. Simon of Much Shelist Denenberg Ament & Rubenstein P.C. on Civil Unions and Estate Planning:

On June 1, 2011, the Illinois Religious Freedom Protection and Civil Union Act went into effect. The new law provides a legal procedure for the certification and recognition of civil unions between same-sex and opposite-sex individuals. This new Illinois law has numerous real and potential effects on many areas of the law, including estate planning—effects that may not be limited to the parties in a civil union. Much Shelist spoke to Gregg M. Simon, Chair of the firm’s Wealth Transfer & Succession Planning practice, about some of the estate planning issues being raised by the new law.

Much Shelist: Can you give us a brief overview of the Illinois civil union law?

Gregg Simon: For a number of years, advocates of the legal recognition of same-sex couples in Illinois had been working with the state legislature to pass some form of civil union or marriage law. On the other side, certain religious and other groups had expressed concerns about the scope of such legislation and how it might be applied or enforced. Eventually, compromise language was worked out that, while not fully addressing all concerns of all parties, contained provisions that enabled passage of the legislation in the Illinois House and Senate on December 1, 2010. In February 2011, Governor Pat Quinn signed the law, which went into effect on June 1, 2011.

As written, the law is fairly short and direct. It provides procedures for the certification, registration and dissolution of a civil union and entitles parties entering into a civil union the same legal obligations, responsibilities, protections and benefits that are afforded to married spouses. In essence, where “spouse” appears in existing and future Illinois statutes, administrative rules, common law, or other sources of civil or criminal law, the word now also refers to a party in a civil union. These “default” rights and obligations can include the right to make health care decisions (unless, as with married couples, a guardian for the disabled partner has been appointed or an agent under a health care power of attorney has been named), the right to dispose of the remains of a deceased partner, various inheritance and property rights, creditor protections, and so on.

Civil unions in Illinois are not just for same-sex couples. Opposite-sex couples can also enter into a civil union, although they should carefully weigh the known and potential advantages and disadvantages of a civil union versus marriage. Likewise, the rules prohibiting certain civil unions are generally similar to those that prohibit marriage between specific individuals. For example, an individual is not allowed to enter into a civil union if he or she is in an existing civil union or marriage, and closely related individuals cannot enter into a civil union.

MS: From an estate planning perspective, what should couples be aware of?

GS: With respect to the Illinois civil union law, there are three broad concepts relating to estate planning that people should keep in mind. First, it should be understood that the law could affect almost anyone, not just the parties in a civil union. For example, let’s assume that a parent has drawn up a will prior to the effective date of the Illinois civil union law that designates his or her child and that child’s “spouse” as beneficiaries. Now let’s imagine that at some point in time the child enters into a civil union with his or her same-sex partner. Under a strict reading of the law, that same-sex partner would be treated as a spouse and would therefore qualify for the beneficial interest designated in the will. That might be the intent of the parent whose assets are to be distributed—or it might not.

Second, the civil union law raises almost as many issues as it resolves, many of which will be the subject of legal disputes until a clear body of case law and precedent has been established. Using the same example, let’s imagine that the parent was perfectly happy with his or her child’s same-sex partner receiving a beneficial interest, but failed to clarify in the will that its terms applied equally to a spouse and a party to a civil union (particularly if the parent died before the civil union legislation was enacted). Let’s now imagine that the child’s siblings do not want the same-sex partner to receive a portion of the assets. Since the will only used the word “spouse,” the siblings could take legal action to try to deny the same-sex partner his or her portion of the beneficial interest, claiming that the use of the word “spouse” (and failure to change the language of the will after June 1, 2011) meant that the parent intended only for an opposite-sex, married partner of the child to be eligible to receive any assets.

These examples are not so farfetched. After Illinois law was changed in the early 20th century so that adopted children were treated the same as natural-born children, almost 100 years of related litigation ensued. These cases focused on whether an adopted child was included when a testator used the terms “children” or “issue,” particularly when the document was executed before the law was changed (i.e., at a time when an adopted child would not have been included within those terms).

The takeaway is that clarity is paramount when it comes to estate planning. In order to ensure that your wishes are carried out as you intend, you should review all applicable documents with experienced legal counsel and ensure that any potentially ambiguous language or terms are clarified and reflect current legal realities.

A third important concept is that the federal Defense of Marriage Act (DOMA) and federal tax laws do not recognize same-sex civil unions or marriages, even those that are recognized by the various states. This raises a whole host of issues regarding estate and gift taxation, Social Security benefits and other federal-level treatment of individuals in civil unions. Many of these issues are being litigated right now.

MS: What are some of the key conflicts between state and federal marriage and tax laws?

GS: DOMA defines “marriage” as a legal union between one man and one woman, and defines “spouse” as a person of the opposite sex who is a husband or wife in a marriage. DOMA further says that no state can be required to honor the law of another state regarding legal relationships that are treated as a marriage between persons of the same sex. In essence, DOMA denies same-sex couples all of the federal benefits of marriage, even if the couple was married or entered into a civil union in a state that recognizes such relationships.

From the perspective of estate and tax planning, this means that same-sex couples are denied the following, among other benefits: the estate tax marital deduction for assets passing outright to a spouse, or to certain qualifying marital deduction trusts and qualified domestic trusts; portability of exemption amounts; the gift tax marital deduction; gift splitting, or the right to treat gifts made by either spouse as made equally by both spouses; and, for the generation-skipping transfer tax, treatment of the same-sex parties as being in the same generation. Opposite-sex couples in a civil union may also face some, if not all, of these issues, particularly in states that do not recognize common-law marriage.

On the other hand, there are some transfer rules that apply to married, opposite-sex couples that, by not applying to same-sex couples, might produce favorable results. These include (1) the option of setting up a grantor retained income trust, which typically does not work for married couples, and (2) adding certain provisions to a qualified personal residence trust that are not permissible for married same-sex couples. Sales of remainder interests can similarly work for domestic partners.

Additional issues arise when a same-sex couple moves to another state. How will that jurisdiction interpret the civil union law of Illinois, particularly in those states with laws that specifically recognize legal relationships only between one man and one woman?

MS: Will legal challenges to DOMA and other laws help clarify this picture?

GS: In the long run, the answer is yes. There are a number of court cases, perhaps the best known of which is Edith Schlain Windsor v. United States, that are challenging the legality of DOMA and its application on a variety of issues. The Obama administration and the Office of the U.S. Attorney General, which are charged with enforcing the law, have stated that they do not believe DOMA is constitutional as applied to the cases that have challenged its constitutionality and have declined to defend it in these cases. Whether or not DOMA or any of its component parts are upheld as constitutional, the decisions in these cases are bound to add clarity to the situation.

However, “clear” does not always mean less complex. Whether or not DOMA is overturned, the decisions made by the courts will add new twists in the area of estate planning. For example, an older, opposite-sex couple in Illinois may choose to enter into a civil union rather than a marriage, in order to continue receiving Social Security benefits that derive from prior marriages. If DOMA falls, and their civil union is then treated as a federally recognized marriage, they could stand to lose a significant portion of their Social Security benefits.

Given all of the uncertainties, individuals who are considering a civil union should work closely with their attorneys to review their current estate planning documentation. Ambiguous language should be revised and clarified, and new or different tools (trusts, etc.) may be advisable in light of the new legal and tax landscape. Estate plans are “living” things, if you will; as the environment changes, they should be reviewed regularly and adjusted accordingly.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.