ESTATE PLANNING: WILLS AND TRUSTS AND BUY AND SELL AGREEMENTS
The legal process by which property is passed
from a person who has died to his or her heirs is called "probate"
and the usual method for determining who shall inherit the various
assets entails the Court enforcing the instructions in a written
document designating heirs called a "will".
Recently, in an effort to avoid some of the costs
of probate, it has become popular to create a legal document called
a "trust" in which instructions for distributions after death
are contained and which, if properly prepared, transfers assets
after one's death without court involvement (and formal probate)
but which achieves intended post death distribution as effectively
as a will.
If one dies without a will or a trust already
written the Court will apply statutory rules as to who will inherit
what assets. While the rules become quite complex, and while who
inherits what depends on the nature of ownership of the property,
usually the spouse will inherit all community property and separate
property of the deceased person will be divided between the spouse
and the living children. Dying without an effective will or trust
is termed dying intestate. The process of analyzing the assets
and family needs of a person and drafting appropriate wills, trusts
and related documents is called estate planning.
While the law will allocate who will inherit
from you even if there is no will or trust with that governmentally
dictated transfer along set statutory guidelines, most people
wish to create their own plan as to what will happen to their
property and family upon their death. Yet, studies throughout
the United States have long indicated that many people delay or
avoid creating wills and that over ninety percent of people who
actually go to the time and expense of creating a will never return
to the attorney office to actually sign it.
This odd fact seems inexplicable until one realizes
that planning for one's own death is a most unpleasant activity,
one easily delayed if one wishes. After all, it is the surviving
family that ends up paying the cost of poor estate planning. However,
the cost of poor estate planning can be very high, both in terms
of not providing structures to most effectively care for children
or the elderly surviving spouse and in having to pay large estate
taxes that perhaps could have been minimized with correct estate
2. Can One Draft One's Own Estate Plan?
The estate planning process involves both family,
financial and tax planning which can become quite complex. It
also involves integrating into the plan the use of wills, trusts,
powers of attorney, living wills, charitable gifts, life time
gifts, and decisions regarding means to hold title to property
(such as community property or separate property, joint tenancy
or tenancy in common, etc.) While bookstores and software stores
abound in preformed trusts and wills, and while many good books
are written for the layperson so as to allow the creation of one's
own estate plan, for any sizable estate or if one has minor children
or elderly persons depending on the proceeds of the estate, it
is extremely risky to create one's own plan.
The reason for the need for professional help
is not just the complexity of the documents and the knowledge
required to understand how to integrate into a single plan the
numerous legal and structural tools available, but also the drastic
damage to a person's assets that estate taxes can wreck if careful
planning is not achieved. Estate taxes can easily take fifty percent
of a person's estate, due nine months from date of death. Once
death occurs, it is usually too late to engage in the type of
planning that can avoid many of these taxes. And such planning
requires an extensive range of knowledge.
An example will perhaps illustrate how subtle
the planning must be:
Joint tenancy is a form of mutual ownership of
property in which two or more persons own an undivided common
interest in property and if one dies, title immediately and automatically
transfers entirely to the surviving joint tenant. If one owns
property in joint tenancy with one's spouse one can bypass probate
entirely upon death since the property will automatically transfer
to the surviving joint tenant and one need not go to the expense
of a full probate. One can save perhaps several thousand dollars
in executor and attorney's fees by holding property in joint tenancy
and no probate will be needed for that property. it seems like
a very good move to hold all your property with your spouse in
joint tenancy, right? Wrong. Income tax would greatly punish such
For example, assume a married couple owns some
rental property together. Assume the husband dies. If they had
decided to own the property as community property rather than
joint tenancy the wife would have received a stepped up basis
for income tax purposes on the entire value of the property. That
means that for purposes of computing income tax, the basis of
the property is revalued NOT at what the couple bought it for
but the value of the property as of date of death. The appreciation
of the property between the initial purchase and the date of death
is never subject to income tax!
However, if they had owed the property in joint
tenancy, the surviving spouse would only get a stepped up basis
on one half of the property owned under current tax law.
Let us put in some numbers. Assume a husband
and wife own an apartment house they rent out. If the property
they owned was purchased for one hundred thousand dollars and
right after death of the husband the wife sold it for three hundred
thousand dollars, the two hundred thousand dollar gain is income
tax free (if held in community property). However, if that same
property was held in joint tenancy, income tax capital gains tax
is applied to one half of the gain (but only if held in joint
There would no tax on the two hundred thousand
dollar gain if held in community property and tax at perhaps twenty
percent on one half of the two hundred thousand dollar gain if
held as joint tenancy. That is a twenty thousand dollar tax bill
that was incurred to save perhaps a thousand dollars in probate
There are other aspects to the above transaction
worth noting. There is a community property set aside procedure
that could have minimized the cost of probate if the property
was held in community property. Further, while holding the property
in joint tenancy might be thought to reduce estate taxes (since
the wife already owned one half of the property) in reality there
is no estate tax for transfers between husband and wife thus the
above transfer effectively wasted eighteen or nineteen thousand
The above example is one of the simpler errors
often made by persons creating their own estate plan. In maneuvering
in the complex laws regarding probate, trusts, income tax and
estate tax, one needs expert advice from experienced financial
planners, insurance brokers, CPAs and attorneys and to "save"
money by creating with help one's own estate plan can be the most
expensive mistake a person with assets can make.
The cost of estate planning in terms of attorney
fees varies widely but most simple wills will cost less than one
thousand dollars while a very complex estate plan involving millions
of dollars may cost over ten thousand dollars. Nevertheless, it
is seldom that good estate planning will cost more than a fraction
of the taxes that can be saved once a good plan is implemented.
3. What Is a Will and How are They Made?
A will is simply a written document that provides
for the transfer of assets upon death of the person drafting it.
Normally, it is witnessed by two persons, appoints someone to
probate the estate (the executor) lists who the heirs are,
and apportions the assets among them. If one wishes to disinherit
a relative who otherwise would receive by statue a portion of
your estate (such as children or a spouse) one also so provides
in the Will. Wills can be as short as a page or two or over thirty
pages long. Quite often Wills provide for trusts to be created
upon the death of a person (testamentary trusts) appointing
assets into the trust for a particular person or purpose. A typical
testamentary trust provides for minor children, apportioning a
part of the estate to the children, instructing the person in
charge of the trust (trustee) as to how to invest the funds
and when to distribute them (for college or upon marriage, for
One can write one's own will so long as one is
of sound mind and has testamentary intent. That is , one is aware
of what one owns and intends by the document to transfer the property
upon one's death.
Wills may be altered until the moment of death
(and often are) and are rigorously enforced by the probate courts
who adhere to the doctrine that a person should be free to determine
what happens to one's assets upon death.
Wills can be attacked by any interested party
(will contest) and the most common attacks are unsound
mind of the deceased (did not know what he or she was doing)
and undue influence (the mind of the deceased was overcome
by the improper pressure of a third party.) Novels and movies
to the contrary, it is extremely difficult to overturn a will
based on the above doctrines with the attacking party having a
very heavy burden of proof.
4. Intervivos Trusts and Their Primary Uses
A trust created to be effective during the lifetime
of the person creating the trust is a "living trust" or,
in Latin, an Intervivos trust. (A trust contained in your
Will becomes operative only upon your death and is a Testamentary
A trust is just a unique form of contract in
which a person with assets (the trustor) enters into an agreement
with a trustworthy person (the trustee) to hold specified assets
for the benefit of a person or group of persons (the beneficiary).
This American invention, however, is quite useful when one wants
to protect a person who for whatever reason is unable in your
opinion to have total control of an asset, but to still have the
person receive the benefit of the asset.
The most common trusts are for children. A person
will appoint a relative or trusted friend to hold assets in trust
for minor children until they reach a certain age. Another common
trust is to hold assets for an elderly relative no longer able
to take care of him or herself.
A trustee has a fiduciary duty to the beneficiaries,
the highest duty known to law (equivalent to a spouse to his or
her spouse, a lawyer to a client, etc.). If the trustee breaches
that duty by taking the assets or ignoring the instructions in
the trust document, the trustee is personally liable to the beneficiaries
or the trustor...or both. A suit for breach of that duty can begin
decades after the act is done since only when the beneficiaries
are of legal age and when reasonable care would have discovered
the wrongdoing does the statute of limitations begin to run.
Indeed, this office engaged in prolonged litigation
in the 1980s concerning wrongdoing that occurred in the 1950s
involving a trust created in the 1940s and an estate created in
the 1920s in which the wrongdoing was only discovered in the 1980s
long after the death of the embezzling trustee. A judgement was
eventually entered against persons who had received the embezzled
assets from the wrongdoing trustee twenty years after she died.
It is therefore critical to note that the trustee
undertakes a tremendous responsibility when assuming the role
of trustee. While simple errors of judgment will not necessarily
result in legal action against the trustee, negligence or wrongdoing
can cause action decades after the act.
It is also critical to note that Trusts often
last decades, and can last a hundred years or more theoretically.
When drafting a trust which can eventually pay sums to your grandchild,
it is common to have a clause that if a beneficiary dies before
inheriting, his or her bequest goes to his or her children. In
reality, you are creating a plan that will affect your great grandchildren
and attempting to plan for a life that will not begin for perhaps
sixty years. Consider that the trustees may be making decisions
having to do with the education of your great grandchildren in
universities situated on the Moon and involving science not dreamed
of today and with beneficiaries whose lifetimes may exceed one
hundred and fifty years. You are making plans for people who will
live in a world as alien to you as yours would be to a soldier
in the Spanish American War. Clearly, your instructions must be
drafted with precision yet with enough flexibility to work in
a world you can only vaguely imagine. Perhaps no other legal decision
you make will have such widespread effects for so many people
for so long as the creation of a trust.
Most trustees receive fees based on a small percentage
of what is in the trust and for extraordinary effort, may receive
more fees. Fees are normally set in the trust for Intervivos trusts
and by court for testamentary trusts. While many trustees are
family members or friends willing to waive fees, it must be remembered
that the tasks of a trustee-to make wise investments and carry
out your instructions at the risk of personal liability-are significant
and that some compensation is certainly warranted.
INTERVIVOS TRUSTS AND AVOIDING PROBATE
The cost of probate involves fees paid
to the executor and the attorney which is normally a small percentage
of what is in the estate and is set by statue though may be voluntarily
negotiated by the parties. Depending on the size of the estate
and the type of inheritance, those fees can be substantial. (Community
property going to a spouse is normally not expensive with specially
reduced rates, etc.) In a million dollar estate going to the next
generation, the attorney fees and the executor fees could easily
exceed thirty five thousand dollars, depending on the complexity
of the estate and the manner of holding the property. Quite often
the executor is the surviving spouse or relative who waives their
fees but regardless the fees are not nominal.
Additionally, probate is a public forum in which
all assets are listed in a public document. If one wants to avoid
public disclosure of one's assets, trusts are again a valuable
tool. Lastly, a probate normally lasts at least a year and often
more than two years. While preliminary distributions can be made,
the need for complete accountings filed with the Court and the
backlog of the courts make a probate that closes before a year
has passed quite unusual.
The above detriments of probate have led more
and more people to create a trust during their lives in which
they place their assets, making themselves the Trustors, Trustees
and beneficiaries. They can withdraw or add assets during their
lives at any time (thus the Intervivos trust is "revocable") but
upon death the trust becomes permanent ("irrevocable") and the
instructions to the surviving trustor are to distribute the assets
as directed in the trust, usually for life to the surviving trust,
then outright outside of the trust to the children or grandchildren.
For those assets in the Trust, no probate is needed since the
trust already provides for distribution and probate does not affect
assets distributed in the trust.
It is critical to understand that for most purposes
an revocable trust does NOT save any sums in taxes. Since it may
be revoked at anytime until death, the government has treated
the trusts as, effectively, nonexistent for tax purposes. It is
only in the savings of the fees and costs and probate, and the
private nature of the transfer, that the Intervivos trust may
save money for the family.
Depending on the complexity of the trust, the
cost of creating such Intervivos trusts can range from about five
hundred dollars to several thousand dollars. It is critical to
note that the assets transferred into the trust must be legally
held by the trust. A common mistake is to list the property in
the trust...but not to change title on the property thereby rendering
the trust useless. For example, if you are putting a piece of
real estate in the trust, a title deed from you to the trust should
be created...and recorded.
Irrevocable Trusts are living trusts which
cannot be revoked by the Trustor...they are completed gifts and
no different than transferring an asset to any other person. A
gift tax may be due and the asset can not be retrieved absent
consent of the beneficiary and trustee...and could result in another
gift tax being levied upon the return of the asset previously transferred.
Irrevocable trusts are not tax neutral. A gift tax may be paid
when created and the trust, itself, becomes a separate taxable
entity. Thus an income producing asset, previously taxed to the
trustor, is now taxed to the trust or, if distributed to the beneficiary,
is taxed to the beneficiary.
The danger of an irrevocable trust is simple-it
is an irretrievable gift and one no longer has access to the asset
if one changes one's mind. The benefit is tax transfer but this
should only be considered if the trustor is in a high tax bracket
or there are other tax advantages available due to the nature
of the asset.
5. Life Insurance and Estate Planning
Life insurance can play an important role in
estate planning, especially to fund estate taxes (in large estates)
or to provide for the raising of a family after the death of a
income producer (in small estates.) There are numerous complex
ways to own life insurance in trusts that allow one to control
the use of the proceeds but to avoid having the life insurance
included in one's estate for estate tax purposes. Most of the
time, life insurance can be owned in such a manner that the proceeds
are NOT counted as part of your estate when computing estate taxes
and this is a tremendous advantage. Once again, recall that estate
tax, after the initial six hundred and fifty thousand dollars
of gifting (increasing annually to over one million in the next five
years) quickly rises in rates to fifty five percent.
Life insurance as an alternative investment to
stocks, bonds or real estate is more problematical, despite the
claims of the various aggressive insurance companies who create
increasingly complex methods of computing cash value and the like
so that after a period of time the insurance becomes quite valuable.
The problem, of course, is that the only way the insurance company
could pay you a return on your insurance premium and also provide
you the benefit of insurance is by having a return significantly
lower than the prevailing market. This obvious fact is often hidden
in remarkably complex and confusing insurance plans and policies
which would make even a lawyer blush.
But when combined with a valid use, such as providing
for minors or providing for liquidity for business or estate tax
purposes upon the death of a income provider, insurance can be
6. Durable Powers of Attorneys: Living Wills: Nomination of
When one becomes incapable of handling one's
own assets or health decisions, it is critical to have a competent
and honest person take over those responsibilities. Assuming you
have done no planning, the usual procedure is for a relative to
petition the court to appoint a conservator who is required
to collect all your assets, account for them, and take care of
you for a fee approved by the court.
Of all the proceedings destined to destroy a
family and its relationships, a petition to appoint a conservator
ranks highest. Put bluntly, if contested, it is a proceeding in
which the family member is trying to prove to the satisfaction
of the Court that a person, usually a parent or spouse, is incompetent.
Testimony of witnesses and experts is heard at remarkable expense
while your mother or father, wife or husband sits there and listens
to you and your family describe their more embarrassing actions
or hear experts explain how childlike or foolish they have become.
Win or lose, the hearing will forever disrupt the relationship
within the family.
Often our clients in such situations elect to
risk loss of critical assets rather subject the family to such
a destructive proceeding. The pain of having to make such a decision
is hard to imagine unless one faces the dilemma of either watching
the hard won assets of a life time wasted by a mother or father
who thinks they are doing the best they can...but are no more
capable of making informed financial decisions than a child or,
instead, forcing that parent to face a humiliating public experience
There is a alternative choice and it is one that
each person should elect to take. By executing a durable power
of attorney for assets while competent, a person may avoid
the entire court battle and simply provide that if two doctors
declare one incompetent, the power of attorney appoints someone
else to take over control of assets or, if a durable power
of attorney for medical care is also executed, for medical
decisions. Assuming two doctors declare that competency returns,
the durable power is immediately retracted and one assumes sole
control of assets or medical care once again. In the powers of
attorney one may specify in detail precisely what medical care
is to be used and how the assets are to be held. Most importantly,
one selects the persons to occupy the role of care giver or asset
protector, and the durable power will be enforced by the Court.
The form for the power of attorney for medical
care is set by statute and is a "fill in form" that anyone can
complete. The form for the power of attorney for assets is more
complex and requires legal advice. Both forms are easily completed
and will cost less than a few hundred dollars at most. The typical
conservatorship hearing costs well in excess of ten thousand dollars.
Another short form is the Directive to Physicians
often called the Living Will. It is a form that directs
the doctor not to use life preserving medical care if one is "brain
dead" or if further medical treatment has no chance of doing other
than prolonging life. Euthanasia (mercy killing) is illegal
in this State. The living will does not allow it...it simply directs
the physician to limit medical care if there is no chance for
recovery and to allow the patient to die naturally. Quite
often the Living Will is combined with the Durable Power
of Attorney for Medical Care.
NOMINATION OF GUARDIANS FOR MINORS
Another short form nominates those you feel should
care for your children should you and your spouse become incapacitated.
While the Court will be guided by your nomination, the Court maintains
the right to always act in the best interest of the child...and
will almost always ignore a nomination which interfers with those
who have an existing right to custody, such as a spouse.
7. BUY AND SELL AGREEMENTS IN CLOSE CORPORATIONS
OR OTHER BUSINESS ENTITIES
One who owns a small business quickly realizes
that, upon death, the value of the business may plummet to zero
if there is no one there to run it or buy it and that a company
worth millions one day may be worth zero upon the death of its
managing owner. Thus an asset which is often the most valuable
asset for a family is suddenly gutted and the family left with
Equally galling is the result when a key employee
who owns a small percentage of a business and assumes greater
and greater responsibility as the years pass, suddenly has the
majority stockholder die and the untutored spouse or child of
the stockholder suddenly come into the company with effective
control and often little knowledge of the business. A common result
is the employee leaving in a rage and starting a competing business.
The usual scenario in both cases is the disruption
or destruction of an asset worth a great deal with both the estate
of the decedent and the minority owners dismayed and injured by
Again, advance planning easily alters the scenario
to the benefit of all. The usual method is that the owners agree
ahead of time that in the event of the death of either, the remaining
shareholders or owners will buy out the estate's interest in the
business at a preset formula, usually allowing a twenty percent
down payment and ten years to buy out the remaining price at prime
plus two or three percent. This allows the estate to convert the
business interest to cash by selling to the only people interested
in buying...the existing owners. It allows the existing owners
to know that they will ultimately own the business at a fair price
with time to buy it out. Life insurance can even be used to pay
for te ddown payment or even the entire purchase price.
These types of arrangements are called "Buy
and Sell Agreements" and are integrated into the entire estate
plan. Often a client who has no other owners of the business will
bonus a small amount of interest to a promising employee on the
condition that the employee will sign the Buy and Sell, thus assuring
continuity and benefit to the family of the existing owner while
giving the employee the knowledge that ultimately he may be the
owner of the business.
A successful business client put it well: "The
most important decisions one makes in life are made without forethought
or the type of logical analysis one uses in buying the most inexpensive
trinket...be it choice of college, choice of spouse or choice
of careers, most of us base it on emotion or have the choice imposed
upon us by forces or influences we do not always even recognize."
What that client did not mention is that perhaps the most important
choice for the economic future of the family is also often not
made with care and forethought-namely estate planning. Death and
incompetence are things most of us pretend will not occur and
are dark shadows always on the horizon, best ignored if one is
to enjoy life.
The price for such self indulgent blindness is
often paid by the spouse or the next generation. If one has a
sense of duty to family, it is hard to conceive of a greater obligation
than to make the plans for your own demise since if you do not,
who will? Your spouse? Your children? In reality, it is the government
itself who will take over that responsibility, electing who shall
inherit what and taxing the family to the maximum. Your choice
thus is quite simple: either you or the government will determine
how best to protect your family in the event of your death.
you not owe it to them to take that burden on yourself? That requires
intelligent estate planning since most of the decisions should
come from the person whose estate it will be. Once fully established,
an estate plan need only be reviewed upon unusual events such
as the death or marriage of a close relative or a radical alteration
in assets or the tax laws.
Estate planning requires the calm consideration
of death and disease, of incompetence and disability, all subjects
one might consider wise to avoid. However, the opposite is actually
the case; Jean de la Fontaine in 1676 put it quite well: "Death
never takes the wise man by surprise; he is always ready to go."
These Articles are to give the reader a general description of certain areas of the law. Legal advice is necessary to apply these legal concepts to your particular situation. The Reader should obtain competent legal advice before relying on the Articles.
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