BUSTING ESTATE PLANNING MYTHS AND MISCONCEPTIONS
More than Pushing a Button
We can accomplish so much these days simply by pushing a button. I just returned from a conference in Washington, DC, where I pushed many buttons using apps on my iPhone. It was simply amazing when you think about it.
I pushed buttons to check into my flight and to display my boarding pass. Another button informed me if my flight was on time, while yet another button tracked my bags onto the plane. Upon arrival at Dulles International, I pushed a button to summon an Über to take us to our hotel.
Rather than wait in a long line to check into our room, I pushed a button to check in, reading the assigned room number on my screen. We ascended in the elevator, and, after finding our room, I proceeded to punch another button to unlock our door. Once in our room we used buttons to read restaurant reviews and make a reservation.
We even pushed buttons to enroll in the conference break-out sessions, find the location of those sessions around the conference center, and communicate with the conference organizers.
There was virtually no interaction with a human being to accomplish all of these tasks. It seems that we can do a lot pushing buttons.
Even construct an estate plan.
But not a good one.
You see, unlike many transactions, a good estate plan is only developed through a meaningful interaction with a knowledgeable professional. Sure, you can access web-based estate planning programs, but those can only perform one minor function in an estate plan—that is preparing a legal document that would say who gets what in the event of your death. Even then it probably doesn’t do a thorough enough job.
Why is that? Because there is so much more thought that should go into constructing an estate plan. Consider, for example, that you have several different baskets of assets. Some carry taxable income with them (such as annuities, IRA and 401(k) accounts), while in others you might achieve a step up in tax-cost basis that eliminates capital gains to your beneficiaries. Without a thorough understanding of the complexities surrounding these issues, it’s likely that you don’t maximize your plan, and that Uncle Sam becomes a larger beneficiary than he should.
How about those in blended families? A computer program won’t provide any insight into the problems associated with economically tying your spouse who is not the parent of your children to those children through marital trust planning. Sure, the program will describe the benefits of providing income to your spouse for the rest of her life, and then how the trust will distribute principal to the children upon her death. Seems pretty straightforward.
Except it’s not.
Will that computer program reveal how to maximize family harmony when every dollar your spouse spends following your passing will result in one less dollar that the children inherit? There are strategies to consider beyond what the cold calculations that artificial intelligence can master.
How about protecting your children’s inheritance from divorce or other economic maladies? Will those computer buttons know how to give your children the greatest amount of freedom in choosing their investments, distributing the trust income and principal, and ultimately deciding who should benefit from the inheritance following their deaths? I usually have lengthy conversations with my clients about the hopes and wishes that they harbor for their loved ones. Can you do that with Siri?
No. You can’t.
Selecting your trustee in the event of your disability is usually another in-depth conversation that I engage in with my clients. There’s so much to it, in fact, that I wrote a book exclusively on that subject. If you’d like a copy of that book please visit this link. Once you receive it please read the preface where I described how shocking I found the crushing responsibility to be when my mother contracted leukemia and I became the trustee of my parents’ trusts. Reflect on the fact that I’m a board certified wills, trusts and estates attorney and a licensed CPA, and I found the responsibilities overwhelming. This is my career. Think about that for a moment.
There are so many variables to a good estate plan that every person’s plan will be unique to that individual. Sure, if you have less than $100,000 in assets and a house you probably don’t need the best estate planning attorney out there, and perhaps a computer program will suffice.
If you’ve taken the time to read this column, chances are you’ve accumulated somewhat more than that.
Yes, it’s great that we can do so much by pushing a button on our Smartphones. But do you really want to put that small amount of thought into constructing a plan to protect you and your loved ones with what took you a lifetime to accumulate?
Tax Cost Basis
With the large federal estate tax exemption, many believe that estate planning is no longer as important as it once was. Quite to the contrary, estate planning today is more important than ever. There are many non-tax reasons to ensure that your hard earned assets end up with your loved ones protected from the reaches of divorcing spouses, creditors, predators, as well as in a tax efficient manner.
While federal estate taxes don’t affect as many as it once did, income tax planning built into your estate plan can mean the difference between your spouse and other loved ones paying large amounts, or even nothing at all.
More on that in a moment.
I recently returned from my 27th year attending the country’s largest and best estate planning conference conducted by the University of Miami’s Heckerling Institute. Unlike other areas of the law, keeping up with the myriad of changes to our nation’s tax laws requires annual diligence. Since I’m board certified in wills, trusts, and estates, I also must complete more than 120 hours of high level continuing legal education in my field every reporting period.
This year, the academic lecturers stressed the importance of planning for tax cost basis. Let me explain by example. Suppose you purchased ABC Stock at $1/share. That is your “tax cost basis”. Suppose the years the value of the stock increased to $11/share. If you sold the stock at $11/share, you would report a capital gain of $10/share ($11 selling price less the $1 basis) and likely pay 20% capital gains tax.
If you were to gift that stock to your daughter during your lifetime, she takes the same tax cost basis in the stock that you would have. So if she sells the stock at $11/share, she would also report a $10/share capital gain and pay capital gains tax.
If instead of gifting the shares to your daughter during your lifetime, you left them to her in your will or revocable trust at your death, the tax cost basis of the stock increases to $11/share. If she sells the stock at that price, she reports no capital gain.
Seems pretty simple. But it’s not.
Many estate plans build in trusts for spouses, so that at the death of husband, for example, the trust continues on for wife for her lifetime. When wife dies then the trust may distribute to children. When the estate tax exemption was lower, it was important to exclude the husband’s trust benefiting wife from wife’s estate.
That strategy no longer works, largely because it does not result in a second increase in tax cost basis when wife dies, resulting in unnecessary capital gains taxes. Those taxes may be quite high depending upon the appreciation that occurs between husband’s death and wife’s death. The longer that time period, the greater likelihood that the couple’s financial and real estate portfolio increases significantly in value.
The trust for wife may be important, however, to protect the intended distribution to her and then to the children. Without it, if wife remarries, her new spouse may have rights to these assets. So it’s important to build the trust in such a way to protect the assets from this danger while achieving the intended tax planning. This isn’t always as easy as it sounds.
Consider, for example, that in order to achieve the increase in tax cost basis on the second spouse’s death, not only will the assets that increase in value be adjusted, but so will the assets that decrease in value. This is because the tax law is written to adjust the new basis to the date of death fair market value.
Let’s return to my example where husband left a trust for wife. Assume further that at wife’s death some of the stocks in the portfolio increased by $10/share while other’s decreased by $5/share at the time of wife’s death. Assume further that one of their homes increased in value by $150,000 between the time of their deaths and the other home decreased in value by $50,000.
Without sophisticated planning, not only will the increases adjust when the children inherit the assets, but the decreases will adjust as well, resulting in the potential larger capital gains taxes when those assets are sold. It is possible to draft a will or a trust instrument that would only adjust the basis to the value of the assets that increased, while leaving the decreased basis alone. How that’s done, and whether that strategy is right for a particular client is beyond the scope of this column.
This is but one tax saving strategy that can be considered when planning a client’s estate. There are dozens of others. And, as I wrote at the onset of this column, there remain many non-tax reasons to plan an estate.
I’ll be writing about other income tax saving strategies in future columns. If you haven’t revisited your estate plan in the last couple of years, now is the time to do so. The methods estate planners used to save taxes under the old law when the federal exemptions were lower may actually result in more taxes than necessary under today’s law.
Garbage In, Garbage Out
Anyone who has ever had a computer course has been taught the adage “garbage in – garbage out.” This refers to the fact that while computers do amazing things, if the programmer enters incorrect information then the result will be incorrect. Even with better and better logic based programming, a computer chip doesn’t replace the human mind.
Most clients suspect that attorneys use word processing and software programs to draft their wills, trusts and related legal documents. Certainly that’s true – at least it is in my office. We use a sophisticated document drafting platform designed specifically for estate and trust attorneys. Most other good estate planning attorneys that I know of use similar software.
So does this mean that all most attorneys do is “punch a button” when creating legal documents? While you might view my answer as self-serving, that couldn’t be further from the truth. Once the documents are drafted using the software protocol, we often have to refine the product with “post assembly changes” that are necessary to meet an individual client’s situation. Further, the programs require us to enter an enormous amount of information and answer various prompts which will be different for each individual client based upon their unique profile.
So as you might suspect, if one simply relies upon forms generated from computer programs to tackle a variety of different situations then you’ll fall into the “garbage in – garbage out” problem that belies computer programmers.
A person whose estate is comprised of valuable real estate assets should have documents that have very different provisions than someone whose estate value consists mostly of IRA and 401(k) accounts. A person who is raising minor children should have a will and trust that reads differently than another person who has adult children and grandchildren. A different type of estate plan is warranted for a married couple in their second marriage with children from prior marriages than that of a long-term first marriage with children only from that marriage.
No two estate plans are the same. Be careful when you get advice from friends and relatives, because if you don’t know everything about their own personal and financial situation, then you can’t reasonably compare your plan to theirs.
What about those computer programs such as Legalzoom that are easily found on the internet? Do they do a good job?
Again, the “garbage in and garbage out” rule applies, except here you would be the one making the decisions and answering the questions. I advise any person who asks about these web sites the same thing that I would tell someone who creates their own internet based tax return. That advice is this: In order for these programs to do an effective job, they ask a multitude of questions. Many of the questions are basic, such as those that ask your name, address and phone number. But other questions aren’t so easy to answer without some base legal or tax knowledge.
Unless you know how to properly answer all of the questions that are asked, the product of a self-created will or a self-created tax return using a software program can be dangerously inaccurate.
In order to make my point, assume that you are creating your own will and a question asks you if you want your daughter Sally to be a beneficiary of your estate. You answer “Yes”. It then asks you how much of your estate you want Sally to have.
You know that you have already made Sally a named party on your brokerage account that has $200,000 in it under a “Transfer on Death” (TOD) designation. But you want your son Allen to receive 50% of everything that you own at your death. So you tell the computer program that you want Sally to get 50% of your estate and Allen to get 50% of your estate. Consequently, the will that the program generates reads 50/50 to Sally and Allen.
Is that going to be the end result? Sadly, no.
Why? Because Sally is going to get the $200,000 brokerage account outside of the will since it has a TOD designation. Everything else would then be split 50/50. This isn’t what you wanted. You wanted the TOD account to count towards Sally’s share. You would need to add extra language inside of your will to account for that.
The computer program couldn’t pick this up since it doesn’t know how you own all of your assets. Even if the program asks you how you own your assets, unless you know the difference between a joint account and a TOD account, you will have put garbage into the system and therefore the will that comes out is garbage.
When this happens, the legal and tax costs of fixing the problems are often enormous, since it is much more difficult to undo a mistake than it is to do it right the first time.
I could go on with a multitude of other examples. There are different consequences – both estate and income tax wise – regarding the formulas that a program uses to consume your federal and state tax exemptions. One formula could result in no tax while another formula triggers a lot of tax. Legal differences exist as to how the same words in a will effect adopted children, as opposed to those that are step-children. Business owners who have Subchapter S corporations need yet other provisions to avert income tax problems at death. The list of caveats goes on and on.
While you might save money in the short run creating your own legal documents, unless you are confident that you have sufficient knowledge and expertise not to put garbage into the system, the money you save creating your own documents using internet programs might easily be outweighed by the legal and tax costs of undoing problems created later.
The Dangers of Joint Accounts
I hear this question all too often. A client will come in, thinking they have a great solution, and propose, “Should I put my bank and brokerage accounts in joint name with one or all of my children?” In almost all cases the answer is an emphatic “No!”
First and foremost, when you title an account in joint name with someone else you are actually making a gift of half of its value. So if Ethel puts her brokerage account worth $1 million into joint name with her daughter Francoise, she just made a gift of $500,000 to Francoise (half of the value of the account). Because the most anyone can gift tax free is only $15,000, titling an account worth more than $30,000 would require the filing of a federal gift tax return. In my example, Ethel would have to file a return that would either reduce her gift and estate tax exemption, or if she’s already used up her exemption she may actually have to pay gift tax.
Second, if Ethel’s daughter Francoise is experiencing any legal or financial problems, Ethel may have put her account at risk. If Francoise is going through a divorce, for example, a forensic accountant may discover the asset and it might be at jeopardy depending upon circumstances. The same holds true if Francoise has creditor or bankruptcy problems.
Third, titling the account jointly will likely thwart Ethel’s estate plan. Assume that Ethel has a will that says that upon Ethel’s death all of her assets are to be divided equally between her three children. If the account is titled jointly with rights of survivorship with Francoise, Francoise would inherit the account outright despite Ethel’s contrary intention in her will. Even if the account is held jointly as tenants in common, Francoise owns half of it and the other half would be distributed in thirds according to Ethel’s will.
Francoise might be altruistic and wish to share the account equally with her siblings. But she might have a gift tax problem herself. If she tries to divide the account that she legally owns, she is making a gift in excess of the $15,000 annual gifts that she can give tax-free.
Fourth, accounts owned jointly do not enjoy the full “step-up” in tax cost basis that would otherwise occur. Assume that Ethel owns 1000 shares of ABC Company Stock that is worth $100 share but she paid $10/share many years ago. If Ethel sold all of her shares she would recognize a $90,000 capital gain. But if Ethel dies still owning the shares, her children inherit them at the date of death value for tax cost basis purposes. So if her beneficiaries sold the shares shortly after her death for the $100,000 there would not be any capital gain and therefore no capital gain tax to pay.
But if Ethel places the account in joint name with Francoise during Ethel’s lifetime, on Ethel’s death Francoise only gets a one-half tax cost step up. In this case, Francoise would recognize a $45,000 capital gain if she sold the shares for $100,000. ($100,000 sales price less $5,000 basis in half the shares and $50,000 basis in the other half of the shares).
Hopefully you are convinced that placing assets in joint name with children isn’t a good idea. So what should you do if you want your child to be able to transact business on your accounts – particularly if you become disabled and unable to manage your own affairs?
This is where revocable living trusts really shine. Ethel can create a revocable living trust and name herself as her initial trustee but also name Francoise as her successor trustee in the event of a disability. Francoise can then transact business on all of Ethel’s accounts that the trust owns. It is not a gift to Francoise since she is acting as a fiduciary for her mother. On Ethel’s death the trust avoids probate and rightfully distributes the accounts to all of Ethel’s children (if that is her wish).
Another alternative is a durable power of attorney. Ethel can sign a durable power of attorney that would name Francoise as her attorney-in-fact to transact business on all of Ethel’s accounts. You should know that the Florida law governing durable powers of attorney changed significantly back in 2011. If you have a durable power of attorney created before that date, you should consult with your estate-planning attorney to determine if yours needs updating.
The bottom line is that you shouldn’t put accounts and assets in joint name with your adult children. There are reasonable alternatives that don’t carry all of the disadvantages associated with joint accounts.
Escaping Your Former State’s Taxing Authority
It’s fairly easy to become a Florida resident, and many do just that because Florida, unlike many other states, imposes no state income, estate or intangible personal property taxes. Becoming a Florida resident, consequently, might save you thousands of dollars annually.
At a minimum, you should spend more than half of the year here, obtain a Florida drivers license and voter registration, and list your Florida address as your primary address for credit card statements and tax returns. I’ve written a book on the subject and you can find an Appendix where I provide a checklist at floridaestateplanning.com/floridabook.
But is this enough? It may not be, especially if you come from aggressive states like New York, California, Connecticut, Massachusetts, New Jersey and Minnesota.
Why is that? State revenue departments are hungry for money. Taxpayers who haven’t properly severed their relationships with their former home state are prime targets for assessments of back taxes, interest and penalties.
Domicile was an issue at a tax and estate planning conference I recently attended hosted by the University of Miami Law School.
One of the speakers, Jonathan Blattmacher, updated us on the topic of state taxing authorities pursing those who are attempting to move to states like Florida that don’t have an income tax. He called out New York and California as two states that have aggressively pursued former residents.
“It wasn’t enough that the taxpayers reside in Florida, for example, for more than six months,” Blattmacher said. “New York pursued one taxpayer because he maintained a larger home in the state, retained his social club memberships, his estate planning documents were signed in the state, and he kept his pets there among other things.”
Flying under the radar isn’t possible in today’s technology age either. A recent CNBC article reported that New York conducted 3,000 nonresidency audits a year between 2010 and 2017, collecting more than $1 billion of revenue. More than half of those who were audited lost their cases.
What do state auditors do to make the case you haven’t left your former home state for tax purposes? I’’s not uncommon for them to review credit card bills and travel schedules, examine cell phone records, social media feeds, veterinary and dentist records.
Auditors even conducted in-home inspections to look inside taxpayer’s refrigerators. Fresh fruit and vegetables apparently can cost you a lot more than you suspect!
As the most aggressive states like New York and California succeed in pulling back former residents for tax purposes, other states are likely to follow.
Barry Horowitz, a partner at the WithumSmith+Brown accounting firm frankly stated, “If you’re a high earner in New York and you move to Florida, your chances of a residency audit are 100%. New York has always been aggressive, but it’s getting worse.”
Many clients count the number of days that they spend in their former state of residence to ensure they comply with residency rules. Conventional wisdom, for example, states that if you’re out of your former home state for 183 days, you won’t have to pay state taxes.
But the real issue is domicile. You must be able to prove that your permanent, primary home is here in Florida as opposed to New York, Ohio, New Jersey or Illinois, for example. The domicile test is becoming increasingly complicated, hence the aggressive tactics exemplified by New York which is likely to be emulated by other revenue hungry states.
For those who still have source income from their former home state, the issue is that much more complicated. If you’re a wage earner at a company located in your former home state, or if you receive distributions from a family business located there, you’re likely to have to file a state income tax return and pay taxes anyway. The issue for these individuals is whether they can escape paying taxes on their unearned income, such as investment dividends, interest, capital gains and qualified retirement account distributions.
As a board certified Florida estate planning attorney, I advise those who want to escape their former state’s taxing authority and who haven’t updated their estate plans to Florida law to do so. Despite the many differences between Florida law and other states necessitating an update, you don’t want a state tax auditor to use your outdated estate plan against you when assessing deficiencies.