Below is an outline designed to give you a basic overview of the issues involved in the estate planning process. We have included a general discussion of Powers of Attorney, Healthcare Directives, Wills, and avoiding Probate. This is not intended to be an exhaustive explanation of the process, but rather to provide an introduction.
Client Information. The first step in preparing an estate plan is to gather extensive family and asset information for your attorney. This will include a list of children, grandchildren, other descendants, parents and former spouses. The attorney will also need a list of all bank accounts, retirement plans, IRAs, business interests, real estate interests, stocks, bonds, brokerage accounts, life insurance policies and other assets. Mortgage or loan balances must also be provided. This information is necessary to analyze the tax issues and to determine how these assets will pass at the time of your death. A will does not control the disposition of all of your assets; in fact it can only control the disposition of probate property, which is property that is titled solely in your name and does not have a beneficiary designation. Non-probate property is property that passes outside of the decedent's will because of the manner in which title is held or because of some contractual arrangement. Examples of non-probate property include real estate held as joint tenants with rights of survivorship, life insurance payable to a named beneficiary, retirement plans or IRAs payable to a named beneficiary and jointly held bank or brokerage accounts ("and," "or," "and/or"). All other property that is held by a decedent at the time of his death is probate property that passes under the terms of the decedent's will. The first step in the estate planning process is to gather a detailed list of all assets and beneficiary designations.
Planning for Incapacity. To plan for incapacity, you should have a Durable Power of Attorney and a Healthcare Power of Attorney. The Durable Power of Attorney is a written instrument by which one person, as the principal, appoints another person as his agent and grants the agent the power to handle his financial and legal affairs and deal with his property. The person executing the power of attorney must have the requisite capacity to understand the nature and significance of his act at the time of the execution. The power can be drafted so that it does not become effective until the principal is incompetent, and special provisions can be included to give the agent the ability to make gifts from the principal's property, if desired. The Healthcare Power of Attorney allows an agent to make healthcare decisions for the principal, such as consenting or withholding consent to healthcare. The Healthcare Power of Attorney allows an agent broader discretion than a Living Will. A Living Will is a direction from the principal to his doctors specifying that life sustaining treatment and artificial nutrition and hydration either be or not be provided, but only applies in two limited circumstances, (1) if the principal is terminal and is likely to die in a relatively short period of time, or (2) if the principal is in a permanent coma.
Estate and Gift Tax Planning.
- General Rules. At the time of your death, the Internal Revenue Service and the South Carolina Department of Revenue are interested in the fair market value of all of your assets (including life insurance and retirement plans). Transfers at death to charitable organizations or the surviving spouse are usually deductible (provided the spouse is a citizen of the United States). In addition, deductions are allowed for administration expenses, funeral expenses and debts of the decedent.
- The Estate Tax Exemption. In addition to the deductions for marital and charitable transfers, there is an exemption for other transfers. This exemption must be used during your lifetime to cover gifts that exceed your annual gift tax exclusion ($13,000 - discussed below). To the extent that is not used for lifetime transfers, the exemption is available at your death to shelter transfers to beneficiaries that do not qualify for the charitable or marital deduction. The exemption had been at a level that would cover $600,000 of taxable transfers for many years. The Tax Relief & Job Creation Act of 2010 increased the estate tax exemption to $5,000,000 per person (indexed for inflation after 2011.) It provides for the possible transfer of the $5,000,000 exemption amount to a surviving spouse, so married couples can potentially shield up to $10,000,000 of their assets from taxes. In the language of tax professionals, the estate tax exemption is now "portable." In order for the surviving spouse to be able to increase his or her exemption by the amount of the deceased spouse's unused exemption amount, the personal representative of the deceased spouse's estate must make an election on a timely filed estate tax return on which the amount of the unused exemption is computed. This requirement is a potential trap for the unwary, because often the estate of the first spouse to die will be less than the amount required to file an estate tax return.
- The Gift Tax Exemption. The Gift Tax Exemption that is available to shelter lifetime transfers in excess of $13,000 per year increased to $5,000,000 in 2011.
- Tax Rates. The top estate tax bracket is 35% for assets in excess of $5,000,000.
- The Credit Shelter Trust. If a family's total estate is less than $5,000,000 this year and is not expected to exceed that amount, there may be no need for tax planning. However, if the family's total estate is larger than the exemption, a "simple will" may result in unnecessary estate taxes on the second death. A credit shelter trust is an irrevocable trust that segregates assets at the first death and allows a married couple to use both of their exemptions to shelter $10,000,000 this year from estate taxes. A simple will only uses one spouse's exemption, and the other spouse's exemption is wasted if portability is not elected. There are several reasons a couple may wish to continue to use a Credit Shelter Trust in their estate plan: (1) it is uncertain whether the portability provisions will continue after 2012; (2) accumulated income and future appreciation within a Credit Shelter Trust will be excluded from the gross estate upon the death of the second spouse; (3) the generation-skipping tax exemption (discussed below) is not portable; therefore, it is the only way to take advantage of the generation-skipping tax exemption of the first spouse to die; and (4) a Credit Shelter Trust provides asset protection and management structure for trust assets.
- Equalize the Estates. Under current federal law, a husband and wife can together pass $10,000,000 to beneficiaries tax-free ($5,000,000 exemption for each spouse) using a credit shelter trust or electing portability. In a world without portability, however, if the husband owns all of the property and the wife dies first, her exemption is wasted. To remedy this, the estates should be equalized so that each spouse owns an equal amount of assets. Interspousal gifts can be made free of gift tax if the spouse receiving the gift is a U.S. citizen.
- Reduce the Estate with Annual Gifts. A person can make gifts of up to $13,000 to another each year free of gift tax. He can make $13,000 gifts to as many people as he chooses, and those people do not have to be related to him. Together, a husband and wife could make up to $26,000 in gifts each year to each donee. Each year, a husband and wife could transfer up to $26,000 to each child and grandchild thus avoiding both estate and gift taxes on these transfers. Gifts in excess of these amounts will use up a portion of the estate tax exemption. In making gifts, it is important to consider the cost basis of the asset that you give away. Suppose that you have $13,000 of IBM stock that you originally purchased for $3,000. If you give this stock to your grandson, he will take your $3,000 cost basis in the stock. If your grandson sells the stock for $13,000, he will have to pay a capital gains tax on the $10,000 gain. On the other hand, if you keep this stock until your death and leave it to your grandson by your will, he will take a new cost basis equal to the fair makret value on the date of your death. If the stock is worth $13,000 at your death, your grandson could sell it for $13,000 without incurring a capital gains tax. Try to choose assets to give away that do not have a large amount of built-in appreciation (fair market value greater than cost basis).
- Irrevocable Life Insurance Trust. For estates in excess of $10,000,000, the use of a credit shelter trust outlined above can deter estate taxes until the death of the last surviving spouse. Upon the death of death last surviving spouse, an estate tax will be assessed. One method of providing a fund for the payment of this estate tax is with a life insurance policy that is owned by an irrevocable insurance trust. This generally works as follows: The husband and wife establish an irrevocable insurance trust with a third party as the trustee. Husband and wife make annual gifts to the trust, and the Trustee uses the annual gifts to purchase a life insurance policy insuring the husband and wife. Upon the death of the husband and wife, the trust is funded with the life insurance proceeds and these funds are available to pay the estate taxes. Because the policy was not owned be the husband or wife or payable to thier estates, the value of the insurance is not included in either estate for estate tax purpoes.
- Generation-Skipping Planning. Normally, a parent dies and leaves assets directly to children. If the parent has a large estate, there will be a tax due at the parent's death. When the children die years later, these inherited assets will be taxed again as a part of the children's estates. in some situations, it is a good idea to establish a generation-skipping trust to maintain assets for your children. For example, a parent could provide that at death, a trust is established for her children for life and upon the death of the last child, the assets of the trust would pass to the grandchildren. This would give the children the benefit of the trust (income and principal) for life, but the trust assets would not be included in the children's estates for tax purposes. This technique does not save any estate taxes at the parent's death; however, it can result in substantial estate tax savings at the death of the children because the assets will not be subject to a second estate tax. This type of trust also provides additional protection from claims against children's assets by spouses in the event of a divorce and from creditors.
- Other Planning Opportunities. We have tried to include some of the more common types of estate tax planning tools in this outline. There are numerous other planning opportunities available, including Charitable Trusts, Grantor Retained Annuity Trusts, Grantor Retained Unitrusts, Conservation Easements, Family Limited Liability Companies, and Qualified Personal Residence Trusts.
Avoiding Probate. At the time of your death, your will must be admitted to probate in the county where you reside at the time of your death. As outlined above, probate assets are assets that pass pursuant to the terms of the will. Under South Carolina law, the probate court is entitled to a fee of 1/4 of 1% of the fair market value of all probate assets ($2,500 for every $1 million of probate assets). In addition, the terms of your will are available for the public to review and an accounting must be filed with the court to detail the income and distributions of your probate assets. Your estate must also be administered in every county in which your own real property, which is called ancillary probate. In order to avoid probate, we normally use revocable living trusts together with a pourover will as our primary estate planning documents. Generally, the Revocable Living Trust is a trust created during a person's lifetime. The creator of the trust is called the Grantor. Any assets that have been transferred to the trust prior to the Grantor's death are not subject to probate.