INTRODUCTION
Proper estate planning is critical for all families, whether the family has grown children or children in nursery school. Proper planning can enhance a family's financial security 5, 20, or 30 years later. Basic estate planning can also improve the chances of avoiding disputes between children once a parent passes away, thereby saving time and improving the likelihood of peace among family members. Unfortunately, many families do not give planning matters serious consideration until after the occurrence of an accident, a stroke, or a debilitating illness.
A basic estate plan is important even when taxation is not a significant consideration in a family's affairs. Taxation is generally not an issue for the vast majority of families because federal tax law allows for an unlimited marital deduction. Federal estate taxes are also generally not an issue for estates smaller than $650,000 in 1999 ($675,000 in 2000). Similarly, state inheritance and estate taxes can often be eliminated or minimized for most estates based on various statutory exemptions or adjustments.
For larger estates, such as a combined husband-wife estate of $1,500,000, there could be a federal estate tax due of over $ 100,000 on the estate of the surviving spouse. This is an example of an scenario where the tax burden might have been minimized if gifts had been made to children, grandchildren, or to a charitable organization.
THE NEED FOR A WILL
Essential to a proper estate plan is for both parents to have a will. In many ways, a will is the central component of the estate planning process. By executing a will a person is able to develop a plan that addresses his wishes or objectives, meets the needs of his family, and minimizes the burden of taxation. Without a will, the law of intestacy generally applies to the distribution of one's estate. For example, under the Maryland laws of intestacy, the assets of an estate are generally distributed = to the living spouse and = to the minor children.
Through a will, a person can ensure that the living spouse receives a larger portion of the estate than is otherwise authorized under the law of intestacy. Also, one can utilize a will to make special bequests to individuals or charities. Other significant aspects of a will include the ability to provide for special funeral arrangements and of special powers for the administration of the estate itself.
Maryland requires the will to be in writing, signed by the person making the will, and witnessed by two individuals in the person's presence. Family members should be aware of the location of the will once it is executed. Obviously, if the will cannot be found, the instrument has no effect.
A surviving spouse has the right under Maryland law to "elect" against what he or she considers to be an unfavorable will. Under these circumstances, the surviving spouse may generally elect to take a one-third share if there are surviving children or grandchildren; or a one half share otherwise. This election must generally be made within 7 months form the date of the appointment of a personal representative.
THE PROBATE PROCESS
In general, the terms of a person's will should be kept confidential. Once the person has passed away, the individual with possession of the will may inform "interested persons" as to the provisions of the will. Once admitted to probate, the will becomes a matter of public record. Also, Maryland law imposes a duty on the custodian of the will to deliver it to the Register of Wills office.
The routine matters involved with administering an estate are generally handled through the Register of Wills office. The jurisdiction of the Orphans' Court involves issues relating to the conduct of the personal representative, judicial probate, and various extraordinary matters that may arise with respect to estate administration. In general, judicial probate does not arise unless there is a contested issue under the will, such as a problem relating to the appointment of the personal representative or an allegation that the will has been lost or destroyed.
The personal representative has the right and duty to take, protect, and preserve the assets of the estate. One of the first duties of the personal representative is to ascertain the type and value of the property in the estate within the first three months of administration. Bank accounts, certificates of deposit, and stocks may generally be valued by the personal representative. However, it will be necessary to hire a qualified appraiser to value such assets as real estate and the stock of a closely-held business. He or she has the fiduciary responsibilities to invest in and sell property, employ investment advisors, and conduct various other activities.
While funeral expenses are considered a high priority as an expense payable out of the estate, Maryland law generally places a $3,500 limit on the amount of funeral expenses payable from an estate. Nevertheless, the Orphans' Court may issue an order authorizing the personal representative to pay funeral expenses in excess of $3,500. The will itself may authorize the payment of funeral expenses in excess of this statutory limit.
LIFE PLANNING CONSIDERATIONS
As stated above, the first essential step in estate planning is a will. A will can provide for how a person wants the assets of his or her estate divided, guardianship of minor children, and mitigation of estate tax burdens. However, an individual should also consider planning for ways to manage his or her assets during lifetime, taking into account potential situations of physical or mental incapacity. The various methods of managing one's assets during lifetime include the use of powers of attorney, trusts, and joint tenancies.
In most instances, a well drafted power of attorney ("power") can be one of the most efficient and inexpensive ways to manage the affairs of the "infirm" individual. A power of attorney is a document in which one party appoints another to act as his or her agent. The power of attorney provides the agent with the power to carry out certain specified acts.
Many parents may find themselves reluctant to give a power of attorney to their children to deal with life contingencies and future issues of incapacity. The first thing for parents to seriously consider is for each spouse to grant the other spouse a power to act on behalf of the other. A power can be made effective prior to a person's infirmity or problem. Another type of power that should be given serious consideration, called a springing power of attorney, does not become effective until the time when an individual's incapacity occurs.
As a practical matter, if one wants to "create" a power of attorney, he should execute the power in writing and have it notarized. Financial institutions have been known to show great reluctance to honor a power of attorney. A possible way around this dilemma, if feasible, is for the parties to utilize the power of attorney from the financial institution where they bank. Also, with respect to transactions dealing with the Internal Revenue Service, the federal government has created its own version of a power of attorney for taxpayers -- Form 2848.
Realizing certain inherent limitations in the use of a power of attorney, many people have turned to trusts as a way to manage an individual's or family's assets. For the same reasons a person may decide to execute a power of attorney, he or she may decide to set up a trust -such as to mitigate the possibilities of costly guardianship proceedings. A trust is generally more "expensive" to setup than a power of attorney because it is a more complex instrument requiring the services of an attorney or other professional. The trust may be essential to the preservation of a portion of a family's assets for the benefit of a person with a disability. A trust may also be setup as a "charitable trust" in which the trust income is designated to flow to certain specified beneficiaries during lifetime and to a charitable organization.
Although a trust may offer important federal and estate gift tax planning considerations, a trust does not offer any practical income tax planning benefits. Also, a trust may not be practical for carrying out basic transactional arrangements for a person with an incapacity.
Examples of these basic transactional matters include the handling of social security payments, the filing of tax returns, and annuity payments. These types of transactions are likely to be best handled through a power of attorney.
Probably the most popular form of addressing the need to manage the assets of another is through a "joint tenancy." A joint tenancy may be most likely found with respect to a husband and wife's bank account. The clear advantage of a joint tenancy over a trust is the ease with which it takes to set one up -- particularly in the case of a bank account. Although not likely to become a problem for the vast majority of families, a joint tenancy might be fraught later with estate tax or creditor problems for the surviving co-tenant.
REVOCABLE (LIVING) TRUSTS
A revocable trust,.sometimes referred to as a living trust, is often used as a substitute for a will. Under a revocable trust, the grantor transfers property into a trust during his or her lifetime. The grantor retains the power to revoke the trust at any time during his or her lifetime. Also, the trust becomes irrevocable at the time of the grantor's death and is not subject to probate. However, the trust assets become part of the decedent's (i.e., grantor's) estate and thus, subject to federal estate taxes.
A living trust can be used by a grantor to settle his or her estate before death. It can help to reduce the chances of a "will contest" based on arguments of incompetency, fraud, or undue influence. To the extent the grantor was "operating" the trust for a number of years (i.e., during a period when the grantor was clearly competent and of sound mind), potential heirs are likely to find it difficult to challenge the trust's provisions years later. These potential heirs would be hard pressed at that point to argue that the trust's provisions were not consistent with the grantor's wishes.
The grantor can use the revocable trust to take care of his or her needs should the individual become incapacitated or disabled. The trust is also a good financial planning tool when the trust beneficiary may not have the expertise to manage the money.
CHARITABLE TRUSTS
There are generally two types of charitable trusts used by individuals. First, there is what is called a charitable lead trust. This trust is used to pay benefits to a charity for the duration of one or more lives, or for a specified term with the remainder interest passing to noncharitable beneficiaries. If a qualified charitable lead trust is established under a will, a charitable contribution deduction is available for federal estate tax purposes. The lead interest transferred to the charity must be either a guaranteed annuity or a fixed percentage of the fair market value of the property, which will be distributed on a yearly basis. The larger the guaranteed annuity or fixed percentage, the greater will be the amount of the charitable contribution deduction.
The second type is called a charitable remainder trust. This trust must satisfy specific statutory criteria in order for it to qualify for an estate tax charitable deduction. There are two choices for such a trust: a charitable remainder annuity trust and a charitable remainder unitrust. Under either of these trusts, a designated trustee has control over the funds during the spouse's life -- with the remainder interest to be received by the charity.
BASIC TAX PLANNING IDEAS
Each spouse can transfer up to $650,000 of property during his or her lifetime or at death, free of taxes. This amounts to $1.3 million for a couple. In addition to this $650,000 gift/estate transfer exemption, a taxpayer is permitted to make yearly gifts of up to $ 10,000 ($20,000 for a couple) to as many individuals as he or she chooses. Also, the payment of tuition or medical expenses is not considered a taxable gift, nor are gifts to political parties or a charity.
Parents often wonder as to what types of property are best for making gifts to their children, including whether to use appreciated property. In reality, the best property to use for making gifts is cash. A donee takes as the tax basis for the gift property the basis for that property in the hands of the donor. Consequently, the usual advice is to transfer high basis assets by gift, unless the property will be sold soon, at which time the gain will be recognized to a donee who might be in a lower marginal income tax bracket. If lower basis property is retained until death, its basis will be stepped-up at that time, with the tax potential on the appreciation then disappearing from the income tax base.
Ordinarily, it is not advisable to transfer depreciated property by gift. If the donee subsequently sells the property, for purposes of determining loss, his basis will only be the fair market value of the property at the time of the gift, not the higher tax basis. The reason for this rule is to preclude the transfer of tax losses to a related taxpayer.
The better approach with loss property, therefore, is for the donor to sell the property, take the loss and then transfer the cash proceeds. Nevertheless, this may not always be appropriate where a donor feels that the property will significantly appreciate, or should be kept in the family for sentimental reasons.