Frequently Asked Estate Planning Questions
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As legal advice must be tailored to the specific circumstances of each case, the information contained here on this FAQ page does not constitute legal advice, and should not be used as a substitute for the advice of competent counsel. Additionally, any U.S. federal or state tax advice contained herein is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal or state tax penalties that may be imposed. Each person should seek advice from his/her tax advisor based on his/her particular circumstances.
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Each of us has several different “Estates” for Estate Planning purposes.The first is your “taxable Estate,” which consists of the assets to which an estate tax will be applied at your death. This “Estate” includes all the things that you own or over which you have control at the time of your death. Your “taxable Estate” will include all of your clothing, furniture, jewelry, collectibles, antiques, bank accounts, investments, real estate, retirement accounts, life insurance policies – in short, everything. If there is any question in your mind regarding whether or not something will be includable in your taxable Estate, it is safe to resolve your doubt in favor of inclusion. Since the estate tax is a tax on the transfer of assets, the value of the assets owned by the decedent is the amount that is subject to the tax. That is why a life insurance policy is includable at its death benefit value, not on its cash or surrender value.
The other kind of Estate is your “Probate Estate.” Your Probate Estate consists of all of the things that you personally own at the time of your death. Your Probate Estate does not include joint tenancy or tenancy by the entirety assets, nor assets such as life insurance, retirement assets, annuities, etc., which are controlled by beneficiary designation. Joint tenancy and tenancy by the entirety assets carry with them an automatic right of survivorship, so they pass by operation of law to the surviving joint tenant or tenant by the entirety. A beneficiary designation supersedes the disposition provisions of a Will, Trust or the laws of intestacy, so they are not subject to those documents or laws but simply pass to the person you name as beneficiary on an appropriate beneficiary designation form. Everything in your Probate Estate is also a part of your taxable Estate, but not necessarily the other way around.
There is no single definition of an Estate Plan. An Estate Plan may consist of any number of planning documents. Some basic documents that, in Illinois, are included in most Estate Plans are Living Trusts, Wills, Powers of Attorney for Property, Powers of Attorney for Health Care, Living Wills, HIPAA Authorizations and, in appropriate cases, Appointments of Agent to Control Disposition of Remains. Any documents that control the disposition of assets at death or the handling of your affairs during incapacity are “Estate Planning” documents.Your failure to plan your Estate results in the state in which you are resident at the time of your death planning it for you. There are default rules that control the disposition of your assets at death, and other rules that govern what happens in the event of your incapacity. Unfortunately, those rules do not take your individual circumstances into consideration, and their implementation tends to be time-consuming and, therefore, more expensive than planning your own Estate. The default rules also fail to take estate and income tax consequences into consideration.
A well-drafted Estate Plan may address any of the following issues:
- Appointing a Guardian to take care of your minor children upon your death;
- Appointing Agents to make financial and/or health care decisions in the event you are not able to do so;
- Appointing a Trustee to handle your assets upon your incapacity;
- Directing the disposition of your assets upon your death in a responsible manner, taking into consideration the ability of your beneficiaries to manage wealth;
- Providing asset protection for the assets you leave to others at death;
- Avoiding the probate of your estate at your death;
- Minimizing, and often avoiding, the payment of federal and/or state death taxes;
- Providing for the tax-efficient distribution of your retirement assets;
- Providing for the care of a child with special needs;
- Authorizing those individuals of your choosing to view medical records and speak with medical professionals with respect to your health care;
- Expressing your feelings with respect to death-delaying and life-sustaining procedures; and
- Appointing an Agent to control the disposition of your remains.
The most important thing to keep in mind is that having an Estate Plan means that you control your destiny, rather than leaving major decisions to the default rules imposed by the government.
There are several factors that you should consider in choosing an Estate Planning attorney:
- Expertise: Estate Planning is one of the most complex areas of the law. Even worse, it changes almost daily. Obviously, you would not hire a real estate lawyer to handle your divorce; nor would you seek a heart specialist for a broken ankle. The same concept applies when it comes to your Estate Plan. The Estate Planning arena is extraordinarily complex when compared to many other areas of law, and the attorney must be well-versed in the areas of federal and state estate taxes, applicable income tax rules and state and federal laws as they relate to Estate Planning.
- Integrity: Estate Planning is highly personal. You will be sharing the intimate details of your personal and financial life with this professional. Competence is not enough; it is critical that your attorney be highly ethical and above reproach.
- Compatibility: Estate Planning is a process, and not an event. Ideally, the relationship with your Estate Planning attorney will be a long-term, if not life long, relationship. Compatibility is a critical component of any effective relationship, especially one of long duration.
It is advisable to review your plan on an annual basis. Estate Planning should be viewed as a process not an event.The one constant in life is change. Your personal and financial circumstances are in a constant state of flux. In the same way, and usually unbeknownst to you, the laws that control the effectiveness of your plan are also constantly changing. Federal and state tax laws, and IRS decisions and rulings change almost daily. Finally, statutory and case law, both on the federal and state level, are constantly under review and being changed. Because of all these changes, and their interaction with each other, the estate planning process is continuous. Just as you maintain your car or have regular physical checkups, it is important to maintain your Estate Plan to insure it is keeping up with changing circumstances. The FAMILY LEGACY PLAN™ established by Huck Bouma PC for its clients is designed to keep estate plans current regardless of legislative or political changes, or changes in a client’s personal or financial situations.
The following are examples of specific personal circumstances that necessitate a plan review:
- A birth or death in the family;
- A divorce;
- A change in your desire for the distribution of assets;
- A change in your financial circumstances; or
- A change in one of your fiduciaries, such as your Executor, Trustee, or Agent under a Durable Power of Attorney.
If you are already married, there are limited options available to protect “marital” assets from a divorcing spouse. However, if you are not yet married, there are a number of methods that can be employed to protect your assets, including the use of a Pre-Marital or Antenuptial Agreement, appropriately drafted Trust, and asset ownership options. All of these issues should be discussed with an attorney as far in advance of a marriage as possible.There are also effective planning options available to protect your assets from your children’s spouses after your death.
Joint tenancy is the most common form of ownership among married couples with smaller estates. It is often used in an attempt to avoid probate at death. Joint tenancy is rarely, however, an optimal solution, and often leads to unintended consequences.Joint tenancy ownership, by definition, means that, upon the death of one joint tenant, the surviving joint tenant becomes the sole owner of the asset by operation of law. This is a convenient and inexpensive way to avoid Probate and would appear to be a desirable way of passing property to a spouse, child or grandchild since title can pass without court action.
However, there are several possible pitfalls of joint tenancy ownership that most people do not consider. For example, at the time the joint tenancy is created, the person putting the property into joint tenancy may be deemed to have made a gift to the other joint tenant. Although this is not a problem between a husband and wife, it can be disastrous with children and others. By creating a joint ownership interest in someone like a child, creditors of your child may seek to collect a debt owed by your child by attachment or forced sale of the joint tenancy property. If the child becomes mentally or physically incapacitated, the joint tenancy property may be subject to the control of his or her guardian or conservator. The spouse of a child may be able to claim an interest in such property in the event of an unforeseen divorce. A common problem arises when a parent places assets in joint tenancy with one child, and then dies. The surviving joint tenant child becomes the sole owner of the joint tenancy assets, usually to the detriment of the other children, who are left with no legal interest in the parent’s estate.
Even for a married couple, a joint tenancy may cause disastrous consequences. For those couples that have an estate subject to either state or federal estate tax, a joint tenancy may create an estate tax trap. Though successfully avoiding probate of the joint tenancy asset, a far more detrimental consequence is often the result.
In most situations, a more sophisticated estate plan than simple joint tenancy should be used
An Executor is the individual or entity named in a Will to oversee the administration of assets passing under the Will. If Probate is required, the Court will officially appoint an Executor, and issue “Letters of Office” to the Executor. Letters of Office give the Executor authority to handle the assets involved, called “probate assets.”A Trustee, on the other hand, is the individual or entity named in a Trust to oversee the administration of assets held in the name of the Trust.
Finally, whereas the Executor is discharged when the estate is closed, the Trustee may have ongoing responsibilities pursuant to the terms of the Trust.
Any candidate for Executor is usually also a good choice for Trustee, and vice versa. The Executor controls all non-trust assets at death. The Executor is charged with the duty of notifying heirs of estate proceedings, taking an inventory of the estate assets, giving notice to creditors, evaluating and paying claims against the decedent, filing income and estate tax returns as needed, managing the properties of the Estate within the limitations established by the decedent’s will and the probate laws, paying all professional fees and expenses, and eventually distributing the assets of the Estate to heirs and legatees. These same duties fall to a Trustee for all trust assets.A good candidate for Trustee, whether an individual or corporate fiduciary, should possess certain fundamental characteristics. First, and above all, the candidate must be knowledgeable about what a Trustee is and does. A Trustee must be trustworthy, reasonable, well-organized, and responsible, and must possess good listening skills. A Trustee should also have either direct experience with investments, tax laws, legal issues and accounting, or have access to those professionals who provide such expertise. Last but not least, the candidate must be able to get along with the beneficiaries of the Trust and work effectively with them. In choosing a Trustee, keep in mind that a Trustee’s duties may last over a long period of time if Trusts of longer duration are established.
The individual Trustee.
An individual Trustee must be a person of good reputation, have personal integrity and be impartial and free of potential conflicts of interest. If you would like to name a family member as Trustee, you should realistically assess whether the family circumstances are such that the proposed Trustee could be effective in administering the Trust. Family harmony is sometimes very difficult to maintain when one child is given power as Trustee to determine when or whether a sibling will receive discretionary distributions from the Trust. Second marriage situations may present a potential conflict of interest when either the surviving spouse or a child from the first marriage is named to act as Trustee. Where the Trust will hold stock in a family business, naming a child as Trustee who is also a principal in the business may give rise to conflict with beneficiaries who are not employed by the business. An individual serving as Trustee should also be familiar with your philosophy and be capable of implementing that philosophy within parameters of appropriate Trust administration and according to the terms of your Trust. A major reason for naming an individual Trustee is to have a Trustee who matches well with beneficiaries: someone who is understanding, yet not controlling or controllable. Serving as Trustee is serious, time-consuming work. Therefore, it is highly important that you realistically assess whether the personal circumstances of a particular individual will allow him or her to perform the duties of a Trustee. As a practical matter, an otherwise well-qualified individual may be unable to accept appointment for reasons ranging from existing personal and professional responsibilities to poor health.
The corporate Trustee.
If you are considering a Bank or Trust Company as Trustee, you should meet with a representative of the institution to obtain answers to these fundamental questions:
- Experience: How long has this Bank or Trust Company been in the personal Trust business?
- Personnel: What personnel does the Bank or Trust Company assign to a personal Trust account? How often are statements distributed? Ask to see a sample statement. Does
- the person who markets and develops the initial relationship stay in the picture once the Trust is accepted? When seriously considering a particular institution, the client should ask to meet the officer team that would be assigned to the account. Ask how many accounts are assigned to each administrator and investment officer and about the process used for considering requests for discretionary distributions. Inquire about officer turnover; continuity in relationships is essential for establishing Trust and confidence in the institution.
- Asset management: What is the asset base being managed in personal trust accounts? Does the institution have a clear investment management philosophy? Is the institution willing to accept “special assets” such as real estate or stock in a closely held business? Who does the Trust department’s investment research: outside services or in-house research staff? What is the frequency of portfolio review? How have the institution’s investments performed in the last 10 years? Five years? One year? Last quarter? Last month?
- Fees: Ask for a copy of the fee schedule and for an example of how fees are calculated in a sample account. Inquire into the circumstances, if any, in which the institution charges “extraordinary” fees. Does the institution customarily assess a fee on termination or resignation? Are any other charges assessed in addition to the scheduled fee? What are the costs of trading securities in the Trust account? Fees are frequently an issue in choosing whether to name an individual or a corporate Trustee. Sometimes a family member or a friend is named as Trustee on the assumption that the individual will not charge a fee. There are several reasons why such an assumption may be misplaced. An individual with expertise may choose to be compensated for acting as Trustee. An individual without expertise may charge a lesser Trustee’s fee, but will need to pay for the services of a range of other professionals, such as an investment manager, attorney, accountant and/or tax advisor, who perform services that are incorporated in the corporate fiduciary’s fee. In addition, the individual Trustee will most likely have to pay higher investment transaction costs. It is therefore best to compare these costs with those of a corporate Trustee before concluding that it “saves” to name individuals.
The “inappropriate” Trustee.
The word “appropriate” implies that some choices may in fact be “inappropriate.” There are times when the selection of either an individual or a corporate fiduciary may be inappropriate for a particular Trust. For example, an individual may be selected on an other-than-rational basis:
- “His feelings will be hurt if I don’t pick him to be Trustee.”
- “I’ve got to choose her because she’s the oldest.”
- “I can’t play favorites; let them all be Trustees.”
Estate Planning is one of those times when individuals are brought face to face with things they do not like to think about: disability, death and taxes. But it is also one of the few times when a person cannot avoid confronting potential or actual conflicts that may exist within family relationships. Where the relationship between a Trustee and a particular beneficiary or group of beneficiaries is not good, trouble is likely to follow. An individual may find it difficult to serve as Trustee of a Trust specifically established for another family member who has had behavioral or financial “problems” in the past. Similarly, a child may not be able to act impartially when serving as Trustee of a Trust established for the benefit of a stepfather he or she has long resented.
There are also times when the selection of a corporate Trustee may be inappropriate. For example, the selected corporation may not be authorized to administer trusts in a jurisdiction where the Trust holds real estate. Corporate Trustees are also increasingly reluctant to accept appointments as Trustees of irrevocable life insurance trusts (ILITs) prior to the death of the insureds. A corporate Trustee may also be an inappropriate choice for a small trust where the fees charged may not be proportionate to the size of the account. Some corporate Trustees set limits on the size of trust that they will accept.
A Trust is an agreement between the Grantor (creator or creators of the Trust), and the Trustee (the person appointed to manage trust assets). The Trustee agrees to manage the Grantor’s property for the benefit of a third person, the Beneficiary.The most common example is a Revocable Living Trust where an individual, John Smith, signs a Trust Agreement (for example, “The John Smith Living Trust”) and then transfers his assets to the Trust. Typically, he would act as Trustee during his life. He is also primary Beneficiary during his life. He then designates a successor Trustee to take over management of his trust assets at his incapacity or at his death, and also creates the rules for distribution of the trust assets at his death.
Revocable Living Trusts have been used for many years as a means of avoiding Probate and providing for management of assets in the event of incapacity. The Grantor of a Living Trust generally names himself or herself as initial Trustee, thus creating a Self-Declaratory Trust.The Grantor of the Trust specifies the terms under which the Trustee manages and distributes the property held in trust. It is a “Living Trust” because it comes into existence during the Grantor’s lifetime. It is not a testamentary Trust, which comes into existence as the result of the probate of a Will. A Revocable Living Trust does not require Probate proceedings to validate its provisions.
For individuals choosing to use a Living Trust in their Estate Plan, the Trust becomes the basic instrument of the Estate Plan. All of the property transferred to the Trust is generally held for the benefit of the Grantor during his or her lifetime, and may be held thereafter for the benefit of the Grantor’s surviving spouse. Subsequently, the trust assets are either distributed or held for the benefit of children or others, all according to the directions contained in the Trust Agreement.
In the case of a Self-Declaratory Trust, the Grantor is the original Trustee of the Trust, either alone or with another and, as such, retains control over management of the assets transferred to the Trust. The Grantor will generally remain as Trustee until his or her resignation or until he or she becomes unable to act because of disability or death. Upon the occurrence of any of these events, the successor Trustee designated in the Trust document will take over as Trustee. If the Trust is not self-declaratory, the Grantor names a third party or institution (Trust Company or trust department of a Bank) to act as Trustee. Such a Trustee can, and often does, continue to act even after the Grantor’s incapacity or death.
A Living Trust is created and goes into effect upon its execution and funding (assets transferred to the Trust). The Grantor may revoke or amend the Trust at any time as long as he or she is alive and competent. The Trust becomes irrevocable only upon the death or mental incapacity of the Grantor.
There are numerous Estate Planning objectives that cannot be accomplished other than by creating a Trust and then transferring assets to the Trust. Such transfers can provide important benefits, many of them beyond the potential tax planning that can be accomplished. These non-tax advantages of Trusts should be carefully considered in designing and implementing any Estate Plan:
- Elimination of probate costs and reduction of other estate administration costs: Fully funded Trusts are generally effective in eliminating the time and expense of a Probate proceeding. Though even fully funded Trusts are subject to administration proceedings upon death, they avoid the delays inherent in a Probate proceeding as well as the court costs involved in such a judicial action. The attorneys’ fees in a Trust Administration are generally substantially less than those incurred in a Probate proceeding. Even when a Trust is not fully funded, and a Probate proceeding is required, the Trustee can continue to manage and dispose of trust property after the Grantor’s death separate and apart from the Probate and Administration proceedings relating to the Grantor’s estate.
- Placing management of property in hands of Trustee: Frequently a Beneficiary, such as a minor or disabled child, is unable to properly manage and care for the transferred property. A Trust places the duty and responsibility of such management and care in the hands of a Trustee who acts for the benefit of the Trust Beneficiaries. The trust assets can then be distributed to the Beneficiary upon the happening of certain events or the attainment of certain ages, when the disability no longer exists, or the child has attained a level of maturity so that he or she can adequately manage his or her own affairs.
- Providing flexibility of income and principal distributions over a future period: Often an individual knows the Beneficiaries to whom he or she wishes to transfer property, but is not sure of just how to distribute the property among those Beneficiaries. A Trust permits the Grantor to provide the Trustee with discretion to make appropriate distributions in light of the circumstances prevailing in the future. The Grantor, in drafting the Trust, can insert guidelines for the Trustee to follow in exercising discretionary powers of distribution.
- Freeing property from the claims of the Beneficiary’s creditor’s (“Spendthrift Trusts”): Trusts are often used to insulate transferred property from the claims of the Beneficiary’s creditors or from the claims of a spouse in the even of a future divorce. The extent to which trusts may be used to successfully serve this purpose depends on state law. For example, a “spendthrift” Trust under the laws of some states will generally protect the trust property from claims of creditors of the
Trust beneficiary, except to the extent of claims based on items of support furnished to the Beneficiary.
- Protection of Beneficiary from the Beneficiary’s own imprudence or incapacity: A Trust can also be effective in protecting a Beneficiary from him or herself in that the Trustee, not the Beneficiary, determines the distributions to be made from the Trust for the Beneficiary. A Beneficiary may be unable to conserve his or her estate because of a proclivity for excessive spending, embarking on risky ventures, or similar imprudent actions. A Trust can be useful in preventing dissipation of the Beneficiary’s assets resulting from such unwise actions. Similarly, a Beneficiary, though now competent to manage and care for his or her assets, may in the future suffer an incapacity because of advancing age, illness, drug dependence, alcoholism, etc. A Trust can serve to manage and conserve the Beneficiary’s assets during such a period of incapacity and then, after the death of the Beneficiary, dispose of the Beneficiary’s property in accordance with a plan of disposition arrived at while the Beneficiary was fully competent.
- Controlling disposition of assets under the law of a particular jurisdiction: The disposition of an individual’s Estate through a Will is generally subject to the law of the state or other jurisdiction in which that person was domiciled at the time of death. In some Estate Planning situations, it may be desirable to have the law of another state control the management or disposition of assets. A Trust may permit application of the more favorable law of a state other than the state of the individual’s residence to the disposition of assets.
- Ability to provide for estate tax savings, generation skipping transfers, and other planning options: Trusts provide the flexibility to include provisions required to implement most Estate Plans. Credit shelter provisions allowing the married Grantor to take advantage of the estate exemption at each spouse’s death, generation skipping transfer tax provisions, and other estate and gift tax provisions can be included in the Trust to reduce, or even eliminate, estate and gift taxes.
What is the difference between a Will and a Living Trust?A Will is what Estate Planners typically refer to as a “testamentary instrument.” That means that a will takes effect only upon death. A Living Trust, on the other hand, takes effect as soon as it is signed and funded (assets are transferred to it).Both a Will and a Living Trust are, at their core, a set of instructions for the administration and disposition of assets and payment of administration expenses and taxes at death. A Living Trust, however, also directs the management of assets during life. As a result, if you have a properly funded Living Trust, your incapacity will not require a Guardianship proceeding; your successor Trustee can simply continue to manage the assets in your Trust without court intervention or supervision. Likewise, if you have a Living Trust to which all your assets have been transferred, your Estate will avoid Probate at your death. All of your assets will simply pass according to the instructions you left in your Living Trust and, although an Administration process is still necessary, it is usually accomplished outside the courtroom with the help of your attorney at a lower cost and over a shorter time period than a Probate proceeding.
Even if you have a properly funded Living Trust, you must still have a Will, though it will be companion Will to your Living Trust, often called a Pour-Over Will.
The rules regarding distributions from retirement plans (Traditional IRAs, Roth IRAs, 401(k) plans, Profit Sharing plans, 403(b) plans etc.) are extremely complex and should be discussed with an estate planning professional before any distributions from the retirement plan are made. The answer depends on a number of factors, and is beyond the scope of this forum.For example, if you are the spouse of the owner of the retirement plan, the distribution rules are different than if you are a non-spouse. In either event, you will have a number of options that should be fully explored before a final distribution decision is made. There are also special rules that apply to Trusts and Estates as beneficiaries of retirement assets. Your choice of Beneficiary of a retirement asset will have substantial and serious income and estate tax consequences, so discussion of your options with an estate planning professional is critical.
The area of retirement plan distributions is one of the most difficult and complex in Estate Planning. The fact that retirement plans may comprise a substantial portion of your Estate makes these decisions especially important.The choice of Beneficiary will depend upon your individual circumstances. The following issues are some you may want to consider when naming a Beneficiary:
- Do you want your Beneficiary to be able to “stretch” distributions over his or her lifetime?
- Do you want trust protection for your Beneficiary?
- Is your Beneficiary your spouse? A child? Another individual? A trust? A charity?
- Do you want to include trust planning among your retirement distribution options?
These factors, among others, will determine the proper designation of Beneficiary of your retirement assets. Your choice of Beneficiary of a retirement asset will have substantial and serious income and estate tax consequences, so discussion of your options with an estate planning professional is critical.
A Durable Power of Attorney for Property is a written document giving authority to an individual (an Agent or “Attorney-in-Fact”) to handle someone’s (the Principal) financial affairs, generally limited to circumstances in which an individual is disabled or incapacitated.This is a very powerful document and should be created with great care. It is also an essential document for everyone over the age of 18.
A Durable Power of Attorney for Property ensures that if, for any reason, you are incapable of handling your own financial affairs due to accident, illness, or unavailability, the person you name (your Agent) can step in and handle these matters for you. The Power of Attorney for Property allows your Agent to manage those assets which you own in your own name, or in which you have a joint tenancy or tenancy in common interest with others. It does not generally give authority to deal with assets in a Trust. Only the Trustee has authority over those assets.
The power is “durable” because it will be effective even if you are disabled or incompetent. This is important because it is at these times that the power is most needed. A properly drafted Durable Power of Attorney for Property can avoid court proceedings (Guardianship) in the event of your incapacity.
It is very important that the person you name as Agent is trustworthy and reliable. You should also name successor Agents to act in the event that your first choice is unable to do so. Under the Illinois Durable Power of Attorney Act, you cannot name co-agents, but only agents to act in succession.
It is also important to understand that the Power of Attorney for Property is void at your death. It cannot be used, for example, to transact business or avoid Probate upon your death. Therefore, the need for a Revocable Living Trust should be carefully considered.
The Durable Power of Attorney for Property does not authorize the Agent to make medical and other health care decisions. Only an Agent under a Durable Power of Attorney for Health Care can make those types of decisions.
A Durable Power of Attorney for Health Care is an available form in Illinois and in most other states. This is the more important of the two advance medical directives in Illinois, the other of which is a Living Will. By signing this document, you entrust your Agent with the legal authority to make medical decisions for you if you are unable to do so or if you are unable to communicate your decisions. As with a Power of Attorney for Property, Agents may not be named to act in concert, but only in succession.The Power of Attorney for Health Care includes the right to make medical decisions, to withdraw life support, and to authorize the donation of vital organs. This document transfers the responsibility of withdrawing life support systems from the attending physician to the person designated as Agent. It lifts from the shoulders of the physician the potential liability for withdrawing life support.
As with Powers of Attorney for Property, a non-durable power of attorney ends when the Principal becomes incompetent while a “durable” Power of Attorney does not. All Powers of Attorney end automatically upon death. If the Principal (you) becomes incompetent, the Durable Power of Attorney for Health Care continues to be valid. You may revoke this Power of Attorney at any time.
A federal law, called the Health Insurance Portability and Accountability Act (HIPAA) was enacted, in part, to safeguard an individual’s medical information. It requires that written authorization be obtained before health care or medical information can be given to anyone, including members of your family.A HIPAA Authorization is a written document that lists the names and addresses of those people to whom you want to give authority to access your medical information and with whom you direct your physicians to cooperate to make sure that they get the necessary information to direct your care.
Without appropriate authorization, physicians and other health care providers cannot, and will not, release your medical information to anyone, potentially including your spouse, children, and others.
An important aspect of Estate Planning is the ability to control the management of assets and the medical care to be provided in the event of physical or mental incapacity. It is an unfortunate fact that many individuals will become unable to take care of their own affairs because of physical or mental incapacity.The traditional method for dealing with incapacity has been for the local Probate Court to appoint a Guardian or a Conservator to be responsible for the personal or financial management, or both, of the individual who is deemed to be incapacitated.
Like Probate, this process is expensive and time-consuming. An attorney, and usually an accountant, must be employed, and reports which will detail the financial affairs of the incompetent person, must be submitted to the Court. Annual accountings to the Court are required to be made by the Guardian, and the Guardian is usually required to post a bond. In most cases, the financial status of the protected person becomes a public record, available to anyone who goes to the courthouse and inquires.
Creation of a Revocable Living Trust, along with a transfer of assets to such a Trust, avoids the need for appointment of a Guardian in the event of incapacity. The successor Trustee named in the Trust will automatically become the acting Trustee of the Living Trust upon incapacity and will have the power to manage and distribute trust assets for the benefit of the Grantor without court intervention. A Durable Power of Attorney for Health Care and a Durable Power of Attorney for Property, properly prepared and executed, can also work to reduce the expenses of a Guardianship proceeding in most situations, and may even avoid the necessity of filing such a Guardianship proceeding.
A Living Trust provides for the successor Trustee to take over as Trustee upon the death of the initial Trustee. It is recommended that the Executor and Trustee consult with an attorney and an accountant upon the death of a Grantor in order to make sure the administration of the trust assets is handled properly and to assure that the non-trust estate is appropriately administered. The attorney can then advise the Trustee with regard to the following:
Consider Using Qualified Disclaimer(s):
Qualified disclaimers are among the most powerful and effective post-mortem tax and Estate Planning tools. A “qualified disclaimer” is the timely filed written irrevocable and unqualified refusal to accept an interest in property, from which no benefits have been accepted. As a result of such refusal, the interest passes, without any direction by the disclaimant, as though the disclaimant had predeceased the person who gave the interest in the property. A “qualified disclaimer” must be made prior to acceptance of any benefit of the property by the disclaimant. It is imperative the successor Trustee(s), particularly a surviving spouse, review the Estate Plan of the decedent with an attorney prior to accepting the benefits of any property passing from the decedent.
Location and Verification of Documents:
The Executor or the Trustee must first obtain the decedent’s original Trust and Will, and determine if there have been any Amendments or Codicils. Under Illinois law, the Will must be filed with the Clerk of Circuit Court of the county in which the decedent was a resident at the time of his or her death. If there are non-trust assets of sufficient value, a Probate proceeding will be required and an Executor will be appointed. Finally, a sufficient number of death certificates should be obtained to assist in the re-registration of assets and collection of benefits.
Inventory of Assets:
All assets must be located, valued and preserved. A complete and accurate inventory of all such assets must then be prepared for the following reasons:
- To determine whether a Probate proceeding is required;
- To determine whether a federal or state estate return tax must be filed and whether any estate tax is due;
- To identify sources of liquid assets and cash;
- To divide assets between or among such contingent Trusts as may have been created in the Will or Living Trust;
- To gather necessary information in preparation for a possible appraisal;
- To determine whether any liabilities are associated with any of the assets in the Trust; and
- Generally to assist the surviving spouse, heirs, Executor or Trustee.
- Collection of Benefits: The Trustee should see to the collection of any benefits owed to the decedent and the decedent’s survivors. These benefits may include:
- Final salary, wages or other compensation, accrued vacation or sick pay;
- State or federal disability payments, retirement or disability income, either from federal social security or as a fringe benefit from an employer;
- Funeral and death benefits from Social Security, the Veteran’s Administration, or as the result of employment agreements;
- Medical expense reimbursement from health or Medicare supplemental insurance; group or association life and disability income benefits; and worker’s compensation claims;
- Paid-up life insurance policies for which premiums are not currently being paid; fraternal association or financial institution policies, credit life policies on home, autos and credit cards; term riders on regular policies; accidental death riders on regular life or disability policies; and accidental death policies such as travel insurance, or policies provided when travel tickets are purchased with credit cards;
- Death benefits due from policies owned by Irrevocable Trusts, or from business insurance such as buy-sell agreements; and
- Social Security death benefit for surviving spouse or minor children, if applicable.
A Probate proceeding may sometimes be appropriate, even if not required, for any of the following reasons:
- Probate allows the Estate to take advantage of the state creditor notice statutes and shortens the period during which claims against the Estate may be filed. Assets in the Probate Estate will then be primarily liable for decedent’s debts, although Trust assets may be used to pay creditors if probate assets are insufficient for that purpose;
- A Probate Estate creates a separate tax entity for tax planning purposes;
- A Probate Estate allows for trapping distributions; and
- Probate may be necessary under state law if disclaimers are used
The assets of the Trust or Estate may have to be appraised by a reputable appraiser. This is important whether or not an estate tax return is required:
- If a Probate proceeding is filed, an appraisal may be required for the accounting necessary in that proceeding;
- An appraisal may be necessary to value assets for estate tax purposes and to determine whether estate taxes are due; Treasury Regulations provide detailed instructions for the appraisal of various estate assets (Treas. Reg §2031). For example:
- Personal property such as jewelry, silverware, art, or similar items valued in excess of $3,000 require a professional appraisal (Treas. Reg. §2031-6);
- Professional appraisals are always needed for real estate;
- Publicly traded stocks, bonds or mutual funds are valued based upon the mean between the highest and lowest quoted selling prices on the valuation date (Treas. Reg. §2031-2); and
- A formal appraisal is required for closely held stock and unincorporated business interests (Treas. Reg. §§2031-2 and 2031-3).
- Appraisals will help establish the current market value for the Trust assets;
- Appraisals will be needed in order to establish the new income tax “basis” in the Trust assets under Code §1014; and
- An appraisal may be needed if assets must be divided among contingent Trusts created in the controlling Trust document.
- If a business or partnership is an asset of the Trust immediate steps must be taken to preserve and protect the enterprise. The Trustee should do the following:
- Determine whether to continue or liquidate the enterprise and take the appropriate steps after this determination is made;
- Review corporate or partnership documents and interview partners/shareholders to determine the existence of buy-sell obligations or if business insurance exists; and
- Contact the accountant for the enterprise for accounting and tax planning advice.
Title to Trust Assets and Probate Assets:
The Decedent’s name should be removed from all assets either through Probate or by the Trustee. A death certificate should be recorded in any county where real estate was owned. The distribution provisions of the Will or Trust must be followed, which may require preparation of deeds or other documents of title. Any deed distributing real estate must be recorded. All non real-estate assets must be re-registered or re-titled to the Beneficiaries’ names.
- The estate tax return, if it is required to be filed, is due nine months following the date of death; a state inheritance tax or estate tax return may also have to be filed. It is advisable to retain an attorney or an accountant experience in preparing estate tax returns;
- A Revocable Trust becomes irrevocable upon death of the Grantor. Its “grantor trust” status is also terminated;
- An Irrevocable Trust is required to have an EIN (employer identification number), so appropriate steps must be taken to obtain a tax ID number from the IRS;
- An Irrevocable Trust must file an annual 1041 tax return;
- Living Trusts often dictate a division of assets upon the first spouse’s death to minimize the estate tax due on the total Estate. This is generally accomplished by using a Marital Trust and a Credit Shelter Trust. Funding of such separate Trusts cannot be finalized until the valuation of all assets is completed. Valuation of assets is not fixed until such valuation is final for estate tax purposes. This process includes selecting a valuation date. The valuation date is the date of death by default, unless the alternate valuation date (six months after the date of death) is elected. Such an election can only be made if it will decrease the value of the gross Estate and decrease the estate tax. The federal estate tax return (Form 706) is due nine months from the date of death. Asset valuation is generally fixed upon receipt of the estate tax closing letter, but is not finally fixed until the statute of limitations on the estate tax return (three years after the Form 706 is due and has been filed) has expired.
- Miscellaneous tax matters:
- The Decedent’s final income tax return is due on April 15 of the year after death;
- If the Decedent made estimated income tax payments, the payment due after the date of death should be made when due;
- Real estate taxes on any property owned by the Trust or by the Decedent should be paid when due;
- Application should be made for tax identification numbers for all Trusts which became irrevocable upon the death of the Decedent;
- A determination should be made of the amount of cash necessary to pay all liabilities, including estate taxes;
- Any tax elections available to the Trustee should be made; and
- A determination should be made of all issues which may affect the Estate’s or the Trust’s income or estate tax liability, such as charitable bequests, unused capital losses, bankruptcy losses and the availability of carry-overs and carry-backs.
Income Tax Returns:
A final income tax return must be filed on behalf of the Grantor. In addition, a Trust may need to apply for an Employer Identification Number (EIN) and income tax returns may need to be filed on behalf of the Trust. Similarly, if a Probate Estate is opened, the Estate must apply for an EIN and may also have to file income tax returns.
With the help and under the guidance of the Estate Administration attorney, the Trustee should inventory all the trust assets, pay the debts as required in the Trust to the extent the Executor named in the Will is unable to pay those debts, and transfer the remaining assets of the Trust to the Beneficiaries named in the Trust agreement.
Once the taxes and debts have been paid, the Trustee should distribute the trust assets to the Beneficiaries. At that point, the Trust terminates, unless other provisions are contained in the Trust agreement which provide for continuing Trusts for a surviving spouse or children. In that case, the Trust continues pursuant to the provisions set out in the Trust agreement until all Trusts terminate.
The traditional method of passing property in an Estate is through the Probate process. This is true whether the decedent had a Will, and therefore died “testate,” or had no Will, and therefore died “intestate.” In either case, a petition is filed with the Probate Court upon death, and a judicial Probate proceeding is required to administer and settle the Decedent’s Estate. In Illinois, Probate is required for all Estates where the total value of “probate” assets owned by the Decedent is in excess of $100,000 in value. The term “probate assets” refers to those assets individually owned (as opposed to ownership in joint tenancy with a right of survivorship), for which no beneficiary designation or other “pay upon death” designation has been made.The Executor must first file the Will. The Executor is appointed in the Will of the Decedent. After filing the Probate proceeding, the Executor (or Administrator) is officially “appointed” by the Court, which issues “Letters of Office,” giving the Executor or Administrator legal authority to act. The Executor is charged with the duty of notifying heirs of Estate proceedings, taking an inventory of the Estate, giving notice to creditors, evaluating and paying claims against the Decedent, filing income and estate tax returns as needed, managing the assets of the Estate within the limitations established by the Decedent’s Will and the Probate laws, and eventually distributing the Estate that remains after payment of attorneys’ fees, Executor’s fees, estate and income taxes, and other costs of administration.
If the Decedent died without a Will (“intestate estate”), the Estate will be managed and distributed according to the laws of the state in which the Decedent resided at the time of his or her death and any others in which he or she owned real estate.For a Decedent who dies without a Will, instead of being able to select beneficiaries and the terms under which the Estate will be passed to them, the state legislature, speaking through the Probate laws, will dictate the distribution of the Estate, which may or may not conform to the Decedent’s desires. The Decedent’s wishes and any special needs of loved ones will certainly not be considered.
Probate of an intestate Estate is also usually more expensive because the Court has no direction from the Decedent regarding choice of Executor, surety on the bond of the fiduciary hasn’t been waived, and other important issues. A surety bond must therefore be posted by the Administrator in order for the Administrator to act. The Administrator is usually appointed by the Court based on an order of priority set forth in the state Probate laws.
By far the best way to avoid Probate is through the use of a properly funded Revocable Living Trust. A Trust is defined in more detail elsewhere on our site. However, a Living Trust is basically a document that contains your wishes for the administration of your assets, both during your life and after your death. Your assets must be transferred to your Trust during your life if the Trust is to accomplish Probate avoidance. If you choose, you can be your own initial Trustee (Self-Declaration of Trust) and thereby control your Trust assets yourself. At your disability or death, the successor Trustee named in your Trust will administer your trust assets as you instruct. Because the assets are not in your name (they are in the Trust’s name), they avoid Probate.It is important to understand that Probate and federal estate taxes have nothing to do with one another. In 2012, for example, each individual is allowed to pass assets valued at $5,120,000 with no federal estate tax. This does not mean that these assets will not be subject to Probate. Probate is the administration of your estate, and estate tax is the transfer tax on all of the assets you own at your death (probate and non-probate).
In most situations, there will be some “administration expenses” when you die. These can be minimized through the use of a well-designed and properly drafted Estate Plan, but they can generally not be avoided altogether. Expenses may include:
- Executor’s fees;
- Trustee’s fees;
- Income taxes;
- Estate taxes;
- Legal fees;
- Accounting fees;
- Appraisal fees;
- Expenses of a last illness; and
- Court costs, if Probate is required.
All assets in which you have any ownership interest at the time of your death are subject to estate taxes. These include life insurance proceeds payable at death, interest in joint tenancy assets, retirement funds, homes – everything.However, the law provides you with some relief. All assets passing to a surviving spouse generally pass free from estate tax regardless of value. This is the result of the unlimited marital deduction, which provides that assets transferred to a surviving spouse at death are not subject to taxation. As the term indicates, this deduction is unlimited.
Additionally, we are each given an exemption against federal estate taxes for assets passing to a non-spouse beneficiary. Pursuant to the Tax Cuts and Jobs Act of 2018, that exemption is permanently set at $10 million, adjusted for inflation ($11,200,000 in 2018). This simply means that if the value of your total estate, net of bills and expenses is $11,200,000 or less, there will be no federal estate tax due. If your estate exceeds the exemption amount, the effective tax rate is 40% of the amount over the exemption.
In addition to the federal estate tax, Illinois has an estate tax. The state of Illinois does not tax estates of $4,000,000 or less. If the estate exceeds $4 million in total value, Illinois will tax the estate in its entirety, at rates ranging from 5.6% to 16%.
Most Americans are no longer subject to the federal estate tax because of the high exclusion ($11,200,000 in 2018). However, it remains potentially the largest tax that most people who are subject to it will ever confront, with a flat rate of 40%. It is, however, also the one tax that can most easily be minimized. Substantial estate tax savings opportunities are available by applying conventional Estate Planning techniques to a given individual’s estate. In order to understand estate tax planning opportunities, an explanation, and a short history, of the federal estate tax is in order.When portability was made permanent by President Obama in the American Taxpayer Relief Act of 2012, it basically meant that married couples had the opportunity to double the exclusion amount from $11,200,000 to $22,400,000.
Reunification and Applicable Exclusion Amount.
Under the Tax Cuts and Jobs Act of 2018, gift and estate taxes remain unified, minimizing the effect of the choice to make a gift during life or at death. The “applicable exclusion amount” under IRC §2010 is set at $10,000,000 and this amount is indexed for inflation in multiples of $10,000 beginning in 2012 by IRC §2505, with the result that beginning January 1, 2018, the so-called “unified credit” for gift and estate taxes is $11,200,000.
Estate tax rates.
Estate tax rates are simply truncated by the Act at the top marginal rate of 40%.
One of the most important and significant features of the federal estate tax is that a Decedent is entitled to a deduction from his or her gross estate for any amount left to a surviving spouse. This deduction is known as the “unlimited marital deduction.” In order to be deductible under this provision, the gift to a surviving spouse must be of a non-terminable interest (except as set forth below) and must “qualify” for the marital deduction. The purpose of the requirement of qualification for the marital deduction is to insure that the amount left to a spouse be left in such a fashion that it will eventually be included in the surviving spouse’s taxable estate. A direct gift, with no strings attached, automatically qualifies. In order for a trust to qualify for the marital deduction it must provide that the spouse (1) have at least a right to all of the income from the trust payable at least as frequently as annually; and (2) have a general power of appointment over the corpus of the trust that can be exercised in his or her will. A general power of appointment means that the spouse is free to decide who gets the corpus of the trust at his or her death and in what proportions. The federal estate tax provides for a statutory exception to the requirement that a gift to a surviving spouse be non-terminable; this exception is for “Qualified Terminable Interest Property” (QTIP). The Decedent can create a QTIP Marital Trust which restricts the surviving spouse’s access to and control over the Marital Trust corpus during his or her life and at death, so that the Decedent can control the ultimate disposition of the QTIP Marital Trust corpus at the surviving spouse’s death (to assure that the property in the trust passes to the Decedent’s children, for example). The Executor must elect to accept this requirement at the decedent’s death. Ordinarily this is not an issue, since making the QTIP election means that the trust is larger during the surviving spouse’s lifetime by the amount of federal estate tax that is saved by making the election than it would be if the Executor refused it. Thus, the surviving spouse will enjoy a significantly higher amount of income from the QTIP trust than if the Executor had not made the election. The requirement that all income be paid to the surviving spouse during his or her life is also a requirement of QTIP Marital Trusts.
Since the marital deduction is “unlimited,” it would seem to make sense for a married individual to rely completely upon the marital deduction to shelter his Estate from estate tax upon death. This leads, however, simply to a postponement of estate tax, rather than to complete avoidance. Upon the death of the first spouse to die, if all property passes to the surviving spouse, no tax will be payable when the first spouse dies; the tax will simply be deferred until the death of the surviving spouse, when all property previously transferred to that spouse will be included in the surviving spouse’s estate, subject only to available credits in that estate or portability of the unused exclusion in the predeceased spouse’s estate (see below). In an ultimate sense, therefore, no tax savings have been accomplished since the unified credit available to the first spouse to die was not used. That is the case in most situations where a married couple holds the majority of its assets in joint tenancy and each names the other as Beneficiary of all life insurance, IRAs and qualified retirement benefits: all such property qualifies for the marital deduction and none of it for the applicable exclusion amount. An Estate Plan utilizing a “credit shelter trust” can maximize each person’s available exclusion amount and shelter up to $10,860,000 ($5,430,000 in the estate of each spouse) from federal estate tax. Additional tax savings can be accomplished through the use of a gifting program to reduce overall Estate size (see below), or by incorporating more sophisticated planning vehicles into the Estate Plan. Each individual should discuss these, and other, options with his or her Estate Planning professional.
“Portability” of the Applicable Exclusion.
Portability is the ability for a surviving spouse to use any applicable exclusion amount left unused by his or her predeceased spouse. Thus, for example, if Spouse A dies using only $2,000,000 of his $11,200,000 applicable exclusion amount, then upon the subsequent death of Spouse B, she may use her $11,200,000 plus his unused $9,200,000, for a total of $20,400,000. To prevent serial credit collection, the law allows the portability of the unused applicable exclusion amount of only the last spouse to die. It is important to note, however, that a portability election must be made on an estate tax return filed in the Estate of the first spouse to die in order to preserve it in the Estate of the surviving spouse. Thus, if the surviving spouse wishes to preserve her predeceased spouse’s exclusion amount, an estate tax return will need to be filed at the death of the predeceased spouse, whether or not that estate is a taxable estate or not. In the absence of such a filing, portability of the unused estate tax exclusion amount from the predeceased spouse’s Estate to the surviving spouse’s Estate cannot be accomplished. For many reasons, portability should be viewed as an adjunct to proactive estate tax planning, rather than a substitute for it.
Generation–skipping transfer tax.
The so-called GST exemption is equal to the applicable exclusion amount, now $11,200,000, as imported by reference by IRC §2631(c).
It is often appropriate to make gifts during life to intended beneficiaries. Gifts accomplish a number of important objectives, including the reduction of the size of an Estate (and thus the estate tax consequences upon death), and being able to participate in the Beneficiary’s enjoyment of the property gifted. In 2018, each person may give up to $15,000 ($30,000 per married couple) each year to any number of different individuals without any gift tax consequences, as long as the gift is of a present, nonterminable, interest. Such gifts are known as “annual per donee exclusion gifts.” There are a number of technical requirements for qualification of such gifts for the annual exclusion; before making such gifts, an estate planning professional should be consulted. These annual exclusion amounts are indexed for inflation, so the actual amount of the exclusion will change slightly over time. There is also a lifetime gift tax exclusion of $11.2 million in 2018.
Gifts in excess of $15,000 ($30,000 per married couple) per year per donee can be made, but there will likely be gift tax consequences to making such gifts. In appropriate situations, a gifting program can have a substantial impact upon gift and estate tax liabilities, and such a program should be explored in all cases where an estate tax is likely to be due at death.
A gift can be made directly to an individual, or it can be made to a properly drafted Trust for the benefit of one or more individuals. In any event, a gift should only be made if the donor will not, under any reasonably foreseeable circumstance, have need of the property and if the cash needs of the donor are certain to be sufficient for all his or her needs. Property given directly to the donee is no longer available to the donor. If the donor attempts to keep control of the gifted property, problems, including litigation, can and do arise and the amount of the “gift” may remain in the donor’s taxable Estate for federal estate tax purposes.
An exception to the gifting rules described above is the direct payment of tuition and medical expenses on behalf of an individual. The payment of tuition directly to an educational institution on behalf of a donee or the payment of medical expenses directly to the provider of the medical treatment do not constitute taxable gifts, no matter the amount of those payments.
The federal estate tax is a tax on all transfers of assets made at death. An individual’s taxable Estate consists, therefore, of all assets owned outright by the Decedent at the time of his or her death, but also includes assets in which the Decedent was deemed to have sufficient incidents of ownership and/or control to cause those assets to be included in the taxable Estate. The federal estate tax will also reach assets that were given away in contemplation of death, life insurance policies in which the Decedent had an incident of ownership, Trusts created by the Decedent over which he or she retained administrative control or power, joint tenancies or other joint interests in which the Decedent had an interest, property given away with a retained life interest, and other arrangements that are the substantial equivalents of these enumerated items.
Illinois State Estate Tax.
The State of Illinois has an estate tax, decoupled from the federal estate tax, with a threshold of $4 million dollars in 2018. The $4 million threshold is not an exclusion, per se, since it “disappears” for any Estate of over $4 million. Thus, for Estates below $4 million, there is no tax, but for estates over $4 million, there is a tax on the entire Estate, with no exclusion from the tax.
Illinois also brought back the state QTIP election, thereby allowing decedents to plan for both the federal and state marital deductions. With proper planning, this permits a married couple to postpone taxation, regardless of Estate size, of both the federal and state estate tax until the death of the last spouse to die.
For many people, the minimization or elimination of estate taxes becomes the primary focus of their Estate Planning. Though tax considerations are certainly important, they should not drive the Estate Plan design; in other words, the tax tail should not wag the planning dog. The primary objective of any Estate Plan should be the disposition of assets to the Beneficiaries you intend, in a manner consistent with your wishes, taking into consideration the age and aptitude of those Beneficiaries, and the protection of minors and those not able to manage their assets themselves. In other words, responsible wealth transfer is far more important than simple tax avoidance. In most circumstances, the two objectives are not mutually exclusive. Asset protection may also be an overriding concern, one that trumps estate tax planning.Having said that, however, there are a number of things that can be done, within the planning process, to minimize, or even eliminate, in some cases, the estate tax. Since the size of your Estate determines the amount of tax that will be owed, the extent to which you can reduce the size of your Estate will correspondingly reduce the amount of tax that will be owed at your death. There are several ways that this can be accomplished: (i) if you are married, taking advantage of the applicable exclusion amount for both spouses; (ii) making lifetime gifts that remove assets from your estate; (iii) charitable planning; (iv) valuation discount planning; (v) other sophisticated planning.
Gifts fall into a number of different categories. Charitable gifts give you a dollar-for-dollar credit against estate taxes. Gifts to charitable trusts can provide you with an ongoing stream of income and provide you with an income tax deduction, and reduce your Estate at the same time. Gifts to individuals can be present interest gifts, or future interest gifts, such as gifts to Trusts for the benefit of a child, where the child benefits in the future. An effective use of gifting is to give away something that has little value during life, but a substantially higher value at death, such as a life insurance policy. Imagine being able to reduce your taxable estate by several hundred thousand dollars simply by transferring a life insurance policy to a Trust, rather than owning it yourself.
You can also leverage your gifting, by using vehicles such as Grantor Retained Annuity Trusts or Family Limited Partnerships. A discussion of such methods of estate tax reduction is beyond the scope of this brief explanation.
Making gifts is often a very effective way to reduce the size of your Estate. Although all gifts are taxable, there are several gift tax exclusions of which you can take advantage. The first is the annual exclusion (also called the annual per donee exclusion), which exempts annual present interest gifts of $15,000 (indexed for inflation) per “donee.” Simply put, each individual can make present interest gifts of $15,000 per year to an unlimited number of people. Thus, if you have 3 children, you can make a gift of $15,000 to each of them this year, and then again each year thereafter. Each of those gifts qualifies for the annual exclusion. If you are married, each spouse can make such gifts, resulting in total gifts of $90,000, without gift tax consequences in the example above. Assuming that each of those 3 children is married and has 2 children of their own, a married couple can now make gifts each year to the 3 children, their spouses, and their children, thus effectively reducing the couple’s taxable Estate by $360,000 (12 donees times 2 donors times $15,000) each year with no adverse gift tax consequences. You also have a lifetime gift tax exemption of $11.2 million in 2018. So, in addition to the annual exclusion gifts mentioned above, you may make gifts using your lifetime gift tax exemption. To the extent that the lifetime exemption is used during life, it will not then be available for transfers at death. From a tax perspective, however, lifetime gifts are almost always more advantageous than gifts at death, because (i) gifts are tax exclusive while bequests are tax inclusive, (ii) as the money you give away grows in value, that value is also outside your taxable Estate, and (iii) any income earned by the gifted funds is income to the recipient, rather than being income to you.Before engaging in a gifting strategy, we highly recommend discussing that strategy with an Estate Planning professional. How a gift made today will be treated when, and if, the law changes, is still an open question, and you should understand the risks and consequences of making any lifetime gifts.
An effective use of your annual gift tax exclusions and your lifetime exemption is to give away assets that have a low value while you are alive and a much higher value at death (in making lifetime gifts, you should also consider the effects of carry-over income tax basis of the assets being gifted). The prototypical asset that falls within this category is a policy of life insurance. During your life, a life insurance policy has a relatively low value, but at your death, the full death benefit will be subject to the estate tax. Making gifts to irrevocable Trusts, such as a Grantor Retained Annuity Trust, can also effectively leverage your gift tax exemption by allowing you to give away more than the actual value of the gift.
A gift can be made directly to an individual, or it can be made to a properly drafted Trust for the benefit of one or more individuals. In any event, a gift should only be made if the donor will not, under any reasonably foreseeable circumstance, have need of the property and if the cash needs of the donor are certain to be sufficient for all his or her needs. Property given directly to the donee is no longer available to the donor. If the donor attempts to keep control of the gifted property, problems, including litigation, can and do arise and the amount of the “gift” may remain in the donor’s taxable estate for federal estate tax purposes.
An exception to the gifting rules described above is the direct payment of tuition and medical expenses on behalf of an individual. The payment of tuition directly to an educational institution on behalf of a donee or the payment of medical expenses directly to the provider of the medical treatment do not constitute taxable gifts, no matter the amount of those payments.