Board Certified, Estate Planning and Probate Law - Texas Board of Legal Specialization
Av Preeminent rated, Martindale Hubbell
Considerations for Practitioners
in Solo and Small Practice:
Planning Your Own Estate
Planning Your Own Estate
Walter Wm. Hofheinz
Table of Contents
- I. Purpose
and Scope
- II. Initial Considerations
- A. Realize client’s dispositive desires
- B. Minimal inconvenience
- C. Minimal expense
- D. Over the entire planning life cycle
- B. Minimal inconvenience
- III. Lifetime Planning
- IV. Dispositive Planning
- A. Complete Disposition in All Events
- B. Co-ordinate Non-probate Assets
- C. Protect Minor or Disabled Beneficiaries
- B. Co-ordinate Non-probate Assets
- V. Transfer Tax Planning Essentials
- A. Estate and Gift Tax
- B. Generation Skipping Transfer Taxes
- C. Planning Techniques
- D. Planning patterns
- E. Preserving flexibility
- B. Generation Skipping Transfer Taxes
- VI. Special Problems
- VII. Conclusion and summary
- II. Initial Considerations
Considerations for Practitioners
in Solo and Small Practice:
Planning Your Own Estate
Walter Wm. Hofheinz
I. Purpose and Scope
This outline provides an overview of basic estate planning substantive law, and a practical discussion of the strategies, tools, and techniques appropriate to solving both typical and special estate planning problems sometimes encountered by lawyers in solo and small practice environments planning their own estate.
II. Initial Considerations
Initially it is important to define the task to be accomplished, since, as one poster put it, "If you don’t know where you’re going, you’re likely to end up somewhere else."
A working definition of estate planning which includes the considerations appropriate to the full scope of such representation is the following: "Estate planning is the process through which the client’s dispositive desires are realized with minimal inconvenience and minimal expense, each throughout the entire planning life cycle." As will become apparent in the following discussion, each of the components of this definition are inter-related, and often place conflicting demands upon the client and lawyer.
A. Realize client’s dispositive desires
Throughout the planning process, it is imperative that the focus be on what the client wants to have happen to his property as it is transferred to his or her beneficiaries, whether during life or at death.
1. Compromises arising from extrinsic constraints
A second problem which often arises is that of assisting the client in his or her decision regarding the costs and benefits of deviation from primary dispositive desires in order to meet extrinsic constraints, primarily in the context of transfer tax planning. For example, many of my clients, in the absence of extrinsic considerations, would prefer a dispositive plan which left all their property to the surviving spouse outright; on the other hand, I have yet to have a client spontaneously describe to me a primary dispositive plan which even approximates a marital deduction bypass trust. Most of those in need of transfer tax planning, however, once they understand the costs and benefits, will compromise their primary dispositive desires in order to obtain the available tax benefits. Such compromises are the client’s prerogative, however, and the lawyer should not impose them without informed decision-making by the client.
2. Benefits, control, and ownership
In exploring the dispositive desires of the client, it may be helpful to discuss the objectives of the desired disposition in terms of benefit and control, rather than ownership. Often clients simply have no idea that beneficial interest and control can be separated from each other and dealt with independently in order to accomplish a particular objective.
B. Minimal inconvenience
It is my experience that, for most clients, the inconvenience of determining and implementing an estate plan falls into one of two categories: the inconvenience of change itself, and the difficulty of requirements for implementing the plan chosen.
1. Change
Change is unavoidable, but manageable. Appraisal of the extent and timing of change required by contemplated alternatives is an essential component in the cost benefit analysis performed by the client, whether acknowledged by the client or not. Many obstacles arising from the client’s understanding of the process (discussed in detail below) which are related to this component of the client’s evaluation can be avoided if the requirements imposed by a plan in this area are explicitly recognized and addressed by the lawyer.
2. Implementation requirements
The more obvious inconveniences related to the estate planning and transfer process are those related to the details of implementation, whether they are restyling account and beneficiary designations, creating and maintaining ownership entities, or transferring property during life or during the estate settlement process. Awareness should be maintained that it is often the timing of a required action, rather than the action itself, which imposes significant inconvenience on the client. For example, complete funding of an intervivos management trust is for most purposes the equivalent of transfer of property during an estate settlement. In the first instance, however, the client assumes the inconvenience of the process, in the second, the executor does.
The other less obvious inconveniences typically relate to the change in substantive position by the client implementing the planning: the change in relationship as a management trust is created, funded, and control is surrendered to a trusted child; the change in perceived economic security by the parent who, during life, transfers substantial assets to lower generation beneficiaries for tax planning purposes; or the transfer of equity interests to lower generation beneficiaries which creates a continuing fiduciary relationship on the part of the transferor.
C. Minimal expense
As we are all aware, expense is often the single component of the evaluation factors most apparent to the client. In evaluating this factor, however, the client is often unaware of the trade-off between current and future expenditures, and between expense and the convenience of the planning implemented. Expense items fall into several categories:
1. Out-of-pocket expenses
The first and most obvious type to consider is out-of-pocket expense such as legal fees, accounting costs, transfer costs, and other implementation costs.
2. Transfer taxes
The next expense item of which most clients are generally aware is the potential income and transfer tax cost. Often clients are confused, however, about the distinctions between and interplay of the income and transfer tax systems. Other clients may be concerned about paying taxes when they, in fact, have non-taxable estates.
3. Lost opportunity costs
Few clients seem to be aware of, or consider seriously, the potential lost opportunity cost (or actual possibility of out-of-pocket losses) which may arise from inflexibility, inappropriate ownership or transfer structure, or failure to design and implement a comprehensive plan.
D. Over the entire planning life cycle
This, the final element of the definition, is, in my experience, the one most often ignored by both practitioners and clients alike. For disposition, the timing concerns are typically apparent. Often, however, clients do not fully appreciate the timing questions involved in reaching an optimal balance of inconvenience and expense.
As might be expected, these timing questions assume increasing importance, become more complex, and affect the balance of the different elements of the definition as the time frame for the contemplated planning expands. For example, in the context of a simple single-generation non-tax plan, timing is important to the extent that the inconvenience can be avoided entirely by the client, if not the executors and beneficiaries, and the expense of transfer can be delayed until death with minimal (if any, under Texas probate law) additional cost. On the other hand, in a complex multi-generation tax plan, timing questions may be of critical importance in determining not only the desirability, but feasibility, of potential alternatives.
The life cycle of a typical estate plan includes the following stages: initial implementation, maintenance, inter-generational transfer, and final termination and distribution. In long-term plans, the maintenance and transfer phases may alternate, as a number of generations may pass before the rule against perpetuities forces termination and distribution.
Whether the expected duration of the life cycle of a plan is only a year or two, as when planning for a terminally ill client, or whether final distribution is not expected for more than one hundred years, as is often the case with a multi-generation whole-family tax plan, a thoughtful and appropriate analysis of the way in which implementation timing affects the feasibility and convenience of the plan throughout its expected life is essential.
III. Lifetime Planning
A. Management of Property
1. Durable Power of Attorney
A durable power of attorney provides a mechanism for management of property by an agent during periods of incapacity or absence. It may be general or limited, although most clients choose the flexibility of a general power. If a limited power is used, it is often coupled with creation of a revocable management trust to be funded through exercise of the power of attorney at the time of incapacity. Although a statutory form has been promulgated, Texas Probate Code §481 et. seq., I have provided a form which I prefer since it is shorter and I believe more comprehensible to clients.
2. Revocable Management Trust
Where an extended period of incapacity is expected, a trust is preferable since it provides a more structured management vehicle, and can provide for disposition of the managed property at death of the principal beneficiary or beneficiaries.
3. Designation of Guardian
§679 of the Texas Probate Code provides a mechanism for designation of a Guardian before the need arises. Since in a properly planned estate it is unlikely that a guardian will be needed, except perhaps of the person, the ability to designate a guardian is not of great import. What is extremely useful about this section, however, is the ability to absolutely disqualify named persons a guardian. This is especially important since appointment of a guardian revokes any durable power of attorney made by the principal/ward. Thus those who might be dissatisfied with the designated attorney in fact can be precluded from bringing a guardianship action to remove that persons power to act.
B. Health Care Decisions
1. Health Care Power of Attorney
Texas Civil Practice & Remedies Code §135.001 et. seq. prescribes the requirements and provides a statutory form for a health care power of attorney. Execution of a disclosure statement is a substantive predicate to effectiveness of the health care power of attorney, thus should be attached to the power of attorney.
2. Directive to Physicians
§672.004 of the Texas Health and Safety Code, revised by the 1997 legislature, provides a statutory form of "Living Will" for those who do not wish their life to be artificially prolonged if they are terminally ill. I have attached a copy of the form.
IV. Dispositive Planning
While the disposition of property is the centerpiece and primary purpose of the estate planning process, three potential problem areas are of most relevance.
A. Complete Disposition in All Events
Frequently the disposition implemented, whether through a Will or Trust, makes assumptions about the facts which will exist at the time of transfer which might cause the plan to fail to achieve its intended purposes and convey its intended benefits. Carefully review the disposition made to assure that the primary beneficiaries are as intended, that there are secondary beneficiaries who will take if a primary beneficiary has died if a natural person or is not in existence if a trust. If the secondary beneficiaries are designated by class, assure that the class description is unambiguous. Finally, provide for a contingent devise to occur if all primary and secondary are not available to take.
B. Co-ordinate Non-probate Assets
Co-ordination of non-probate assets has two aspects. First, it is essential that non-probate assets be integrated into the dispositive planning implemented, both for the protection of beneficiaries, and to assure that such assets are available to fund tax motivated trusts or other ownership entities. Second, simplicity in administration of the dispositive plan chosen will enhance the probability of its preservation during the maintenance phase and effective implementation at the time of death. As discussed in conjunction with asset protection concerns below, however, non-probate assets not subject to the claims of creditors should not be co-ordinated in such as way as to cause those assets to be available for payment of claims.
C. Protect Minor or Disabled Beneficiaries
All wills and trusts (except those having only charitable beneficiaries) should have a contingent protective trust for the protection and management of the property of minor and disabled beneficiaries. I have attached sample language.
V. Transfer Tax Planning Essentials
The following is intended to be a non-technical overview of the principle relevant features of the transfer tax laws.
A. Estate and Gift Tax
1. Imposition of Tax
The federal estate and gift tax system imposes an excise tax on gratuitous transfers, whether made during life or at death. I.R.C. §2001, I.R.C. §2501.
Certain gifts are excluded from taxation. The annual gift tax exclusion is available for transfers of up to $10,000 per donor per donee per year. It is restricted to gifts of a "present interest." (The use of a "Crummey" power causes some types of gifts in trust to qualify for the exclusion.) Excludable gifts are never taxed, thus substantial amounts of property may be transferred to beneficiaries without tax cost through appropriate use of the exclusion. Certain direct transfers for the payment tuition and medical expenses are also excluded. I.R.C. §2503.
2. Property Subject to Tax
a. General Rule
All property in which an individual has an interest is subject to the tax. I.R.C. §2031, §2033.
b. Property Subject to Control of Transferor
Where an individual has a general power of appointment, during life the lapse of the power will be subject to tax as a gift of value of the property subject to the power (with a de minimis exception of the greater of $5,000 or 5% of the value of the property subject to the power), and at death possession of the power will cause the value of the property to be subject to tax in the estate of the power holder. A general power of appointment is a power which permits the power holder to appoint the property to himself or herself, his or her estate, his or her creditors, or the creditors of his or her estate. I.R.C. §2041.
One type of property about which there is much confusion is life insurance. While life insurance proceeds are not subject to income taxes by virtue of the definition of income found in the Internal Revenue Code, they are properly includable in a decedent’s gross estate and are subject to estate taxes if at the time of death the decedent owned "incidents of ownership" in the policy, i.e., had the right to say who was to receive the proceeds or how they were to be paid. The amount includable is the full value of the policy proceeds. I.R.C. §2042. When an includable interest in life insurance has been transferred within three years preceding death, that interest will be treated as being held at the time of death causing inclusion of the proceeds.
c. Transfers with a Retained Interest
Certain property transferred during life without receipt of consideration in money or money’s worth, but in which the transferor has retained an interest or power, is also includable in the gross estate even though subject to the gift tax at the time of transfer. One non-technical way in which to determine if property is properly includable in the gross estate is to ask "Did the transferor retain at the time of the transfer the right to spend it (e.g. a revocable trust), to receive income from it (e.g. a retained life estate, whether legal or in trust), determine without restriction who will receive it (e.g. a revocable trust), or affect the timing or manner in which a received it (a special power of appointment, power to amend, discretionary distribution right as trustee)?" If the answer to any one of these elements is yes, the property will be includable. I.R.C. §2036, §2037, §2038. When such an interest has been released or transferred within three years preceding death, that interest will be treated as being held at the time of death causing inclusion of the value of the property as if no transfer had been made. I.R.C. §2035.
d. Valuation
The tax is imposed on the fair market value, not book value or income tax basis, of the property at the time of transfer (completion of the gift or death).
3. Deductions Allowable
Three deductions are most significant: the deduction for administration expenses and debts of a decedent; the marital deduction, and the charitable deduction.
a. Martial Deduction
The marital deduction is allowed for property passing to a surviving spouse in a "qualifying manner." I.R.C. §2056. Essentially, if property will be included and subject to taxation in the estate of the surviving spouse, it will be eligible for the marital deduction. An outright gift qualifies, as do certain special gifts in trust which meet the requirements of Qualified Terminable Interest Property (a "QTIP" gift). The effect of use of the marital deduction is to defer payment of taxes until the death of the second spouse to die, but, if the total amount owned by the married couple exceeds the amount of a single exemption equivalent (now "applicable exclusion amount") and appropriate planning is not implemented (as with a "simple" all-to-spouse Will), it may actually increase the total amount of tax payable.
Note also that significant additional restrictions for qualification for the marital deduction are placed on gifts to a spouse who is not a U.S. citizen. I.R.C. §2056A.
b. Charitable Deduction
The charitable deduction is allowed for property passing to a qualifying charity in a "qualifying manner." Essentially, property may be given outright, or in statutorily prescribed trust arrangements (Remainder or Lead, Annuity or Unitrust, or Pooled Income Fund). I.R.C. §2055. A significant change made by the Taxpayer Relief Act of 1997 is the imposition of the requirement that the actuarial value of the remainder be at least 10% of the value of the gift in order to qualify for the charitable deduction.
c. Effect of Deductions
Deductions are subtracted from the gross estate, and gifts during life not within the annual exclusion are added to the resulting subtotal, yielding the "taxable estate." The taxable estate is then multiplied by the applicable tax rate, which ranges from 18% to 55%, to determine the tentative federal estate and gift tax.
4. Unified Credit
Each individual is given a "unified credit" against the federal estate and gift tax. The amount of this credit at present is $192,800—the exact amount of tentative tax resulting from a taxable estate of $600,000. Thus a taxable estate of $600,000 results in no out-of-pocket dollars being payable and is referred to as the "exemption equivalent." (Why didn’t they just give everyone a true $600,000 exemption? We won’t go into that here!)
The Taxpayer Relief Act of 1997 gradually increases the effective exemption on the following schedule:
1998 $625,000 1999 $650,000 2000 $675,000 2001 $675,000 2002 $700,000 2003 $700,000 2004 $850,000 2005 $950,000 2006 $1,000,000
Now comes the tricky part—the unified credit is a non-transferable personal right. If a person does not use the credit either through taxable gifts during life or by disposing of property in a taxabl transfer at death, it vanishes! Thus the potential effect of a simple all-to-spouse disposition actually to increase taxes if the total marital estate exceeds $600,000: gross estate, minus marital deduction, equals zero taxable estate. With no tax imposed the decedent’s unified credit is gone, but the property will be includable and taxed in the survivor’s estate, with only the survivor’s exemption equivalent available. A secondary effect of this structure is that the effective lowest tax rate when taxes must be actually paid is 39%. This results in the estate of the survivor paying a minimum of 39¢ (and possibly as much as 55¢) for each dollar of unified credit wasted.
B. Generation Skipping Transfer Taxes
Federal estate and gift taxes apply to all gratuitous transfers. Certain types of transfers are also subject to an additional transfer tax—the generation skipping transfer tax. This tax is imposed when property is transferred in such a way that no estate or gift tax will be paid in each generation between the generation of the transferor and that of the transferee. Generation skipping transfers may be direct or in trust. For example, a gift directly to a grandchild is a generation skipping transfer. Why? Because the property will never be owned by child’s generation in a way that subjects it to the estate or gift tax. In trust, such a transaction may take the form of providing benefits to child for life in a way which will not cause the property be included in the child’s gross estate, with the balance left at the child’s death going to grandchildren. Obviously, avoiding a 55% (or even 39%) estate tax over several generations can be enormously beneficial.
The generation skipping transfer tax is intended to limit the benefit available to the very rich. By doing so, however, the law provides significant planning opportunities for those with substantial assets. Each individual is allowed an exemption from the generation skipping transfer tax of $1,000,000. Thus a married couple can shelter up to $2,000,000 from estate taxation for a number of generations to come. (The period for which such a plan can be carried out is dependent upon the Rule Against Perpetuities, which limits the duration to "lives in being, plus twenty-one years." By careful drafting, this period can be made likely to exceed 100 years.) The taxes on generation skipping transfers in excess of the exemption are confiscatory (the maximum estate tax rate in addition to the estate tax), so as a general rule such transfers should be strictly avoided.
C. Planning Techniques
Techniques used to minimize transfer taxes basically fall into four categories:
1. Maximize the value of available credits and exemptions.
One example of this is use of a "credit shelter" or "bypass" trust to both fully utilize an available unified credit, while preserving the benefit of and access to the property for the surviving spouse. Another is the use of long term trusts to fully utilize the generation skipping transfer tax exemption.
2. Defer payment of taxes.
Use of the marital deduction is illustrative of this principal. Although the property passing to the surviving spouse will be taxed eventually, you have preserved the full benefit of the property during the life of the survivor.
3. Don’t own it.
Property can be consumed or given away. Unfortunately (or perhaps fortunately, depending on your perspective), in a substantial estate it is often difficult to consume enough to make a significant difference in potential transfer taxes, since the consumption must not involve the purchase of assets. Gifts, of course, provide an effective mechanism for shifting value to beneficiaries, but require giving up the property (at least when in their most straightforward form). Gifts generally have the added advantage that future appreciation of property transferred is removed from the estate of the transferor, which may have enormous benefits. Life insurance, for example, appreciates extremely rapidly at the moment of death—from its surrender value to its face value.
Obviously, the third technique has the disadvantage that if you don’t own it, you don’t control it or have the benefit of it. This circumstance creates the need to use ownership entities which legally separate ownership of equity (and therefore value) from management rights, such as limited partnerships.
4. Utilize valuation rules to the maximum permissible benefit.
This technique relies upon the rules which generally look to the individual’s perspective in determining fair market value, not the larger group of which that individual may be a part. In addition, application of this rule encourages transfer of the property at the earliest, lowest value time, avoiding (or deferring) payment of transfer taxes on the appreciation of property.
D. Planning patterns
Developing explicit patterns for planning assists in the accurate and appropriate analysis of the optimal way to meet the needs of a particular client.
1. Categories for analysis
The circumstances of clients generally fall into categories based upon whether single or multiple generation planning is appropriate, and whether tax avoidance is an appropriate goal or not.
a. Simple Single generation dispositive planning
For by far the vast majority of the population, this is the appropriate category of planning. By this category I mean an outright disposition (at some appropriate age) to the beneficiaries of the client. Typically this type of plan will utilize a Will as the primary dispositive device, with testamentary protective trusts for minors or disabled beneficiaries, and with final outright distribution. In cases in which the client owns real property outside of Texas, it may be advisable to utilize a revocable trust as an ancillary tool, or the primary dispositive tool with a pour-over Will for other assets. In addition, the typical client will require lifetime planning documents such as a Durable General Power of Attorney, a Health Care Power of Attorney, a Directive to Physicians, and sometimes a Designation of Guardian.
Threshold tests and some additional considerations included:
1. Gross estate, asset composition, and spending habits
If the estimated gross estate of the client and the client’s spouse is substantially less than $600,000, transfer tax avoidance is not needed. As the gross estate approaches that amount, however, the composition of the assets included in the estate or the spending (or should I say saving?) habits of the client may indicate that tax avoidance should appropriately be considered.
Assets which should trigger at least a discussion of the possible need for transfer tax planning, whether basic or advanced, typically have significant appreciation potential. Often the small business of a young couple can reasonably be expected to grow in value in the future, or real property valued at fair market value in a depressed market might suddenly appreciate in favorable economic times.
Even in the absence of such assets, the spending or saving habits of the clients may indicate that in the normal course of events their estate will increase to a taxable level—or will not.
In either such instance, the possibility of appropriate tax planning should be discussed, since the client may determine that, on the balance, the expense of proceeding with the more complex planning may be outweighed by the benefit of minimizing later expense and inconvenience.
2. Recipients
The characteristics of the recipients of the property may also suggest that multi-generation tax or protective planning is appropriate. Traditionally protective planning has been thought of as a way of protecting minors, those without capacity, and those without good sense from their misfortune. Increasingly, however, protective planning on the part of the older generation has the purpose of protecting property transferred to the beneficiary from external threats: spousal claims, creditors’ claims, and professional tort claims. Thus where the beneficiary falls into a high risk group (for example, is a doctor or a lawyer), or is on their third marriage, substantial consideration should be given to whether protective planning is in order.
b. Multiple generation dispositive and protective planning
The first branch of more advanced planning is appropriate where no tax avoidance is required at the client generation, but one or more factors indicate that creation of ownership entities lasting more than one generation would achieve the planning goals of the clients and their beneficiaries. Note especially the change in perspective at this point—the focus is on the evolution of the plan over a much longer life cycle, that of at least two generations younger than that of the client (or if the client is in the middle generation, at least one generation older than the client and one generation younger than the client), and the incorporation of the additional generations’ planning goals into the estate plan for the client.
Typically, in addition to the tools used in single generation planning, one or more irrevocable generation skipping trusts will be established, usually inter vivos, sometimes as testamentary trusts. The disposition of all older generations is poured into these generation skipping trusts, which then become the primary ownership entities through which benefits are passed to the younger generations. Such trusts usually have a duration limited only by the rule against perpetuities.
Factors which may make consideration of this planning approach appropriate are both non-economic and economic.
1. Non-economic factors
Non-economic factors which argue in favor of implementing multiple generation planning include achieving special management goals. These emphasize distribution timing objectives, but may also touch on management concerns for one or more members of the lower generation. Each of these considerations is independent. For example, a lower generation family member may agree that benefits should be passed to his or her children, but feel that he or she is the best manager of the property prior to distribution, in which case the lower generation family member may serve as Trustee. Alternatively, there may be a desire to benefit the child, but only to the extent benefits are really needed, with any balance passing to other descendants, in which case an independent Trustee may be appropriate.
2. Economic factors
Economic factors which often argue strongly for multiple generation planning include asset protection and tax planning for lower generation family members. Where such considerations are the primary motivators, it is often appropriate for the beneficiary to also serve as Trustee, and to have beneficial interests as broad as possible yet not interfering with the intended objective.
(1) Asset protection
As discussed above, where a beneficiary has significant potential liability problems, the client can establish a spendthrift trust which nearly completely shelters the transferred property from the misfortunes of the beneficiary, whatever they may be. Indicators include the inclusion of a beneficiary in a high risk group for tort liability, high risk business activities, multiple marriages, or a pre-existing bankruptcy.
(2) Lower-generation tax planning
As noted above, the second reason for multiple generation planning is to eliminate or minimize taxes in lower generations, even where the planning client does not have a taxable estate in excess of the exemption equivalent of $600,000. Frequently this planning opportunity occurs when a middle generation member seeks advice, and realizes that if an expected gift from a parent is received, their estate will immediately increase to a level at which tax planning will be essential. Through appropriate planning at the parent generation, the child may entirely avoid, or at the very least limit, the need for transfer tax planning in their generation.
a. Basic transfer tax planning
Basic transfer tax planning becomes appropriate as the value of the gross estate of the married couple exceeds the $600,000 exemption equivalent; nearly all clients agree that it is necessary by the time the gross estate exceeds around $800,000 to $900,000. Techniques typically implemented in addition to those above are the basics of transfer tax planning: full utilization of each decedent’s unified credit through use of a "bypass" or "credit shelter" trust (usually testamentary); deferral of taxes on any amount in excess of the exemption equivalent through use of the marital deduction (I.R.C. §2056); use of lifetime gifts within the annual present interest exclusion ($10,000 per donee per donor per year, I.R.C. §2503); and removing the value of life insurance from the client’s estate through use of irrevocable trusts, sometimes containing "Crummey" provisions, so as to qualify gifts for the present interest exclusion.
b. Values and asset composition
Up to a value of approximately $1,200,000 for the gross estate of a married couple, all transfer taxes may be completely avoided simply by implementation of marital deduction bypass planning. As the value of the gross estate exceeds that amount, the asset composition will determine whether basic or advanced tax planning is appropriate to the clients’ situation. (Note that for a single client, more advanced techniques become appropriate as the gross estate exceeds $600,000, depending on asset composition.) In almost all cases, only the value of "real" assets, those which the client can use, consume, invest should be used to determine the type of planning which is appropriate, with escalation to advanced techniques only when such "real" assets exceed an amount somewhere between $1.3 and $1.6 million, depending on the tolerance of the client for paying taxes. Life insurance, usually of little value to the insured client while still alive, can be easily removed from the gross estate of the client by transfer to or purchase within an irrevocable life insurance trust, with minimal inconvenience and expense to the client.
As the asset value reaches the upper part of the range appropriate for this type of planning, often clients begin to feel more comfortable about making gifts. This willingness enhances the effectiveness of the annual exclusion as planning tool. For example, a married couple could transfer to 3 children and 5 grandchildren a total of $160,000 each year at no tax cost. A gift giving program, fully implemented, can keep an estate in the range in which basic planning is appropriate.
c. Single or multiple generation
Considerations similar to those discussed above under non-tax multiple generation planning pertain also to those situations in which the older generation has implemented basic tax planning. As might be expected, as the estate size increases, arguments favoring multiple generation planning strengthen.
In particular, one should seriously consider a multiple generation plan if the gross estate divided by the number of next generation beneficiaries exceeds the exemption equivalent. For example, if married clients with a $1.4 million estate leave that estate to two children, each of the children will immediately have a taxable estate upon the death of the parents. Through use of multiple generation planning, transfer taxes in the children’s generation (and younger) can be completely avoided at no additional tax cost in the parent’s generation (up to $2 million in such a transfer).
d. Advanced transfer tax planning
Advanced transfer tax planning becomes appropriate when the gross estate exceeds a value of between $1.3 and $1.6 million. Such planning fully utilizes the principles described above. In addition, actions based upon two additional principle are typically employed: first, fully leveraging the exemption equivalent by making transfers prior to appreciation rather than after; second, exploiting the valuation anomaly created by the existing interpretation of "fair market value." Where the asset composition permits, substantial taxable gifts may minimize the total amount of tax payable. Charitable giving may in some cases provide a net benefit to primary beneficiaries while also providing a substantial gift to a charity in which the client is interested.
The amount passing in a multiple generation form is limited to the $2 million available to the couple, with the balance passing in a fashion which will not incur the generation skipping transfer tax.
Typically, advanced planning adds to the repetoir described above techniques developed to split management from equity (currently primarily in the form of limited partnerships), overlay ownership entities on operating entities to facilitate early equity transfer, and the creation of contractual rights and obligations. In addition it is frequently desirable to restructure operating entities as well as ownership entities.
E. Preserving flexibility
Although trite, the saying that "Change is the only constant" is all too true in the area of estate planning. Change arises from many sources—new legislation, economic changes, changes in personal circumstances of those involved with the plan. As plan life cycles become longer, this fact becomes inescapable. To the extent possible, the lawyer should create an environment within the implementation of the plan that allows adaptation as things change.
Formula clauses, flexible distribution standards, broad non-general (traditionally called limited or special) powers of appointment, and flexible trust termination provisions are all methods used to achieve this end. In addition, I would suggest that the following principles enhance the ability of those involved in plan implementation to maximize the benefit of the plan:
• Allow decisions by those with the best information
• Consolidate control in each generation in those who would "normally" receive property outright
• Plan for orderly transitions in control in both ordinary and extraordinary circumstances
VI. Special Problems
Three areas present special problems for lawyers engaged in planning their own estate. Of course, other more generally shared problem areas in such as planning for the orderly disposition of non-law-practice business interests and special family circumstances may also be present.
A. Asset Protection
Appropriate asset protection planning can be an integral part of the estate planning process. While the threat posed by potential malpractice claims is frequently overstated due to the difficulty of successfully prosecuting a malpractice claim, it is real. In addition, other investments and business activities can put accumulated assets at risk. Simple steps which only minimally add to planning inconvenience and expense can reduce risk while accomplishing dispositive and tax planning goals.
1. During Life
As substantial assets are accumulated, it is advisable to transfer equity to younger generation beneficiaries to avoid taxation of appreciation of assets. One effective manner of doing so is through a family limited partnership, which allows continued management control by the donor through a general partnership interest, while transferring a non-control equity interest to beneficiaries. Typically the limited partnership interests are transferred to trusts established as ownership entities.
Limited partnerships have offer the advantage of separation of management and equity interests, protection of equity interests by limiting the availability of the underlying assets to creditors of limited partners, and stability due to their routine use as ordinary business entities. In addition, they have few adverse income tax consequences. Principle disadvantages include increased accounting, accountability to limited partners, and the expense of establishing the partnership.
Any gifts from older generation family members should be structured so that the beneficiary is granted management and use rights, but in a spendthrift trust.
2. At Death
To protect assets at death, no non-probate assets, such as life insurance proceeds and retirement benefits, should be paid into the probate estate. Although the disposition can be co-ordinated through either a will or trust, the assets should be segregated into a separate dispositive trust specifically not made subject to the claims of creditors. I have attached sample language creating a special disposition trust for insurance.
B. Planning for Windfalls
Appropriate planning for windfalls complements asset protection planning and can lead to substantial tax savings.
1. Gifts (During Life or at Death)
Where the beneficiary is to receive a gift, and has the potential of having a taxable estate, it is appropriate to avoid an outright gift to the extent possible to do so (essentially the total generation skipping transfer tax exemption available to the transferor). Thus all such transfers should be in trust in a manner designed to avoid inclusion in the beneficiary’s estate. Typically such a trust is designed as a generation skipping trust that will continue for the period permitted by the rule against perpetuities. As in the case of marital deduction bypass planning, the beneficiary may be the trustee, may manage the property, and through special powers of appointment may control the disposition of the property.
2. "The Big Case"
If involved in litigation involving a property interest of some sort, consideration should be given to structuring compensation for representation so that at an early stage of the case when the value of the interest is very low the fee is satisfied with an actual property interest which is then transferred into a generation skipping trust for the benefit of desired beneficiaries. Access to some portion of the proceeds can be retained by a compensation agreement with the recipient trust, or through creation of a special power of appointment in a third party in favor of the transferor.
C. Disposition of Practice
Disposition of a functioning law practice presents two problems. First is the lawyer’s obligation to the client. The intrinsic difficulties resulting from disruption of the representation should be minimized, and the client assisted in obtaining other counsel. Second, if the practice has some on-going value, the only way survivors will realize any benefit is if arrangements have be made during the planning process.
1. Solo: Identifying Those Who Can Assist Survivors
Often fiduciaries selected will have little knowledge of the professional relationships of the lawyer, the status of on-going cases, and the appropriate disposition of pending matters and closed files. Clear identification should be made by the solo practitioner of one or more lawyers who can assist in the closing of the practice, whether on a compensated or complementary basis. Where pending files have value is excess of the actual services remaining to be rendered (such as partially complete contingent fee cases), it may be possible to reach an agreement with appropriate counsel, subject to the client’s approval, to complete the representation with some consideration being paid to the survivors or the deceased lawyer. It may also be useful to provide insurance proceeds to fund a closing down period of the office, including staff salaries for secretaries and legal assistants who can perform the actual closing work under the supervision of the lawyer assisting.
2. Small Firm: Formalizing Practice Agreements
Similar planning should occur in the small firm setting, particularly where the "firm" is actually an expense sharing arrangement. Families and fiduciaries may not understand the relationship of the firm members, their expectations, and the residual value, if any, of the practice of the deceased firm member. Thus agreements on the issues outlined for solos should be at least informally memorialized, or incorporated in the individual practitioner’s planning. Consideration should be given to funding the value of the "buy out" of the each practitioner’s interest through life insurance.
VII. Conclusion and summary
Estate planning for the lawyer engaged in solo or small firm practice presents both common and special problems. Through careful attention to dispositive planning, tax planning, asset protection planning, and practical issues associated with the termination of a law practice, dispositive goals can be accomplished with minimal inconvenience and expense throughout the planning life cycle.
