FAQ - ESTATE PLANNING
THE BASICS OF ESTATE PLANNING AND LIVING TRUSTS
The way in which you plan your estate may be the greatest gift you can give to your heirs. A well planned estate avoids aggravations, expenses and delays which may mar the fond memories which could have been preserved. There have been many changes in tax laws within the past few years which, if taken advantage of, can reduce the expenses and hassles of managing an estate. Everyone should have their estate plan reviewed on a regular basis to insure that it is taking best advantage of the most current tax laws.
There are several terms which immediately come to mind in estate planning, such as "probate," "estate taxes," and "inheritance taxes." We no longer need to worry about state inheritance tax. This tax was eliminated in 1982. However, we still need to concern ourselves with probate and estate taxes.
PROBATE
Probate is a complex way of proving a will and transferring title. It requires publication of the will and expenses, which then become public record. Because of the use of the court system and statutory waiting periods, probate can take an extended period of time. It is triggered when property or bank accounts are held in the name of a person who has passed away.
Joint Tenancy
Probate can be avoided by placing two persons' names on title in joint tenancy with the hope that the second person will survive the original owner. Upon the first person's death, the property automatically becomes the property of the surviving person on title. We do not recommend joint tenancy because, although it will avoid probate on the first person's death, probate will be triggered on the second person's death.
A further problem can develop when people try to avoid probate on the surviving spouse's death by putting a child's name on title to the property as a joint tenant. This can be a dangerous move. If that child were involved in an accident, lawsuit, indebtedness, or in any other way became liable for payments, half of the property could be deemed to be that child's, and the creditors may force a sale of the property. Joint tenancy may also disrupt the distribution of the estate.
With Joint Tenancy bank accounts, any joint tenant can unilaterally remove all of the funds from the account at any time.
Property held in joint tenancy with one child will pass directly to that child to the exclusion of any other children or heirs, regardless of what is stated in the will.
If the property is passed by way of joint tenancy, it may not receive a full "step up in basis". This means that if someone receives the property by way of joint tenancy, when that person sells the property, he or she may have a capital gain, which is taxable, even though there are laws which would have allowed the sale to be tax free.
Revocable Living Trust
The best way to avoid probate is through the use of a Revocable Living Trust. It is referred to as a "Living Trust" because the trust is established during the person's lifetime, rather than established in his will and activated by his death (a testamentary trust). It is called revocable because it can be changed or revoked at any time by the person setting up the trust.
The property held in the trust passes to the heirs without having to go through the probate process. One of the many benefits of a trust is that probate is avoided but the "step up in basis" is still achieved. This means that when the recipient of the property sells the property, there will be little or no capital gain recognized, because the basis of the property to the recipient will be the same as the fair market value of the property as of the date of death.
By placing the property in a trust, there are no restraints on control of the property or use of the property. Because the trust is revocable, an additional tax return does not need to be filed and property taxes under Proposition 13 will not be reassessed.
ESTATE TAXES
A person may give all of his or her property to the surviving spouse upon that person's death without incurring any estate taxes. However, this places all of the property in the surviving spouse's estate. If the estate is over $1,500,000 there will be estate taxes due upon the death of the surviving spouse. By use of an "A/B" or "split" Trust, estate taxes can be avoided or substantially reduced.
In addition to being able to leave everything to the surviving spouse without incurring estate taxes, the law provides a Applicable Credit Amount (ACA) which allows a person to leave $1,500,000 to his or her heirs without any estate taxes. To maximize the use of the ACA, thereby reducing estate taxes, the property can be placed in a trust which splits into two trusts upon the death of one spouse. One of the trusts contains property with a combined value of approximately $1,500,000, the ACA amount. This property may be used by the surviving spouse during his or her lifetime but upon his or her death, it must go to the heirs designated by the first spouse to die. The remainder of the property is placed in a trust which is the sole property of the surviving spouse. In this way, the amount in the surviving spouse's estate subject to tax review upon his or her death is reduced.
If the estate is under $3.0 million there will be no estate taxes by using the split trust. If the estate is over $3.0 million taxes will only be paid on the amount which exceeds $3.0 million rather than the amount which exceeds $1.5 million. Use of the "split" trust can avoid probate and estate taxes in most instances.
WHAT IS A TRUST?
A trust can be likened to a clear bowl. The property (including improved and/or unimproved real property, boats, bank accounts, stocks, bonds, securities, etc.) is placed in this bowl. The hands holding the bowl are those of the trustee. The persons allowed to use the contents of the bowl are called the beneficiaries.
During the lifetime of a married couple, the trustees, or the hands holding the bowl, could be the husband and wife. Upon the passing of one of the spouses, the surviving spouse could remain as the trustee. When the surviving spouse passes away, the children, bank, accountant, attorney, stock broker or any other person may be named as a successor trustee. The successor trustee in turn holds the bowl. The trust may be established to continue for a period of time, or the trustee may be instructed to distribute the property and dissolve the trust upon the passing of the surviving spouse.
The option of maintaining the trust for the benefit of the children, or another beneficiary over a length of time may be beneficial. A percentage of the trust could be distributed to the beneficiary at different times. In this way, it may allow a child to mature or learn to handle money as he or she receives only part of the inheritance with a sufficient span of time to learn how to handle the funds before the entire inheritance is distributed. If property is to be distributed to a minor, the trust may hold these funds until the minor has reached majority. In this way, the hassle and expense of a guardianship for the funds of the minor can be avoided.
A trust may also be used to avoid the expense, embarrassment and inconvenience of a conservatorship. A conservatorship may need to be established when someone becomes incapacitated and is no longer able to manage his or her property. A friend or family member after seeing an attorney, must go to court to establish the conservatorship. At this proceeding, the judge must determine that the person is no longer competent. After the conservatorship is established, an accounting must be filed with the court after the first year and every two years thereafter. The expense of establishing the conservatorship and the biennial attorney and accountant fees can be avoided by establishing a trust. If the person were to be unable to manage his or her own estate, the successor trustee would be appointed to manage the estate without court intervention.
Dollar Savings with a Trust
With the use of a trust, not only can probate fees be avoided but also some or all estate taxes. Probate fees are approximately five percent (5%) of the estate. Two and one-half percent (2-1/2%) are paid to the executor and two and one-half percent (2-1/2%) are paid to the attorney. This is mandated by statute. With an estate consisting of approximately $200,000, by avoiding probate you can save over $10,000. With an estate consisting of approximately $1.25 million, with the utilization of an "A/B" or "split" Trust, there may be a savings in excess of $280,000 consisting of probate fees and estate taxes.
A trust does not hinder the use nor the transferability of the assets. It merely places title in an entity which will not trigger probate and avoids a conservatorship. There is no transfer tax, gift tax, Proposition 13 real estate tax reassessment or income tax problems associated with establishing a revocable living trust, nor does it require the filing of any additional income tax returns while both husband and wife are living. Of course, the trust may be changed or revoked at any time.
By avoiding probate you not only avoid its inconveniences, hassles, delays and expenses, but you maintain privacy. In probate the will, assets and expenses of the decedent are made public. With the creation of a trust, the assets, expenditures and gifts of the decedent remain private; also the expense, inconvenience and embarrassment of a conservatorship or guardianship can be avoided.
A trust is beneficial for single individuals, widows and widowers as well as married couples. Currently the best way of planning an estate to avoid delays and expenses and to maintain privacy includes the use of a Revocable Living Trust.
