ESTATE PLANNING IS NOT JUST FOR THE WEALTHY

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1 Summer 2013 Editor: Julius Giarmarco, J.D., LL.M. Tenth Floor Columbia Center 101 West Big Beaver Road Troy, Michigan (248) Fax (248) Assistant Editor: Salvatore J. LaMendola, Esq. ESTATE PLANNING IS NOT JUST FOR THE WEALTHY By Julius Giarmarco, J.D., LL.M. An estate plan is the process of planning for the orderly administration and disposition of property in the event of the owner s death or incapacity, while minimizing or eliminating estate taxes. But, as a result of the American Taxpayer Relief Act of 2012, estate planning is no longer about estate taxes for nearly 99.8% of Americans. The reason is the $5.25 million gift and estate tax exemption, which is indexed for inflation. However, persons with nontaxable estates still need an estate plan (i.e., Will, Revocable Living Trust, General Power of Attorney, and Health Care Power of Attorney) to address a host of other significant issues. The non-tax goals of estate planning include the following: Avoid Intestacy Laws. Every state has laws that direct what happens to property (in the decedent s name alone) when someone dies without a Will (called dying intestate ). Not surprisingly, only spouses, children, and blood relatives inherit under intestacy laws. These default Wills may not work well, particularly for unmarried persons who are without children or who are charitably inclined. A complete estate plan will avoid any surprises under the intestacy laws. Avoid Probate. Probate is a lawsuit that you file against yourself and then lose. There is no reason to go through probate. A married couple faces four probates one at each spouse s death, and one in the event of each spouse s incapacity. It s only the assets in the deceased or incapacitated spouse s name alone that have to go through probate. But, even property held in joint name (or payable by beneficiary designation) must go through probate upon the surviving joint tenant s (or beneficiary s) death or incapacity. The court costs, legal fees, publicity, and delays associated with probate can be easily avoided by having all assets titled in the name of a Living Trust. Set Forth Dispositive Wishes. Only with a complete and up-to-date estate plan can you be assured that what you have goes to whom you want, when you want, and how you want. This is particularly true for persons in second marriages who have children from a prior marriage they wish to protect. And parents with special needs children who are receiving government assistance must be careful to implement an estate plan that does not result in the loss of those benefits. (More below under Special Needs Trusts.) Appoint Guardians. If you have minor children, then the most important decision that you will have to make in preparing an estate plan is deciding who will take care of your minor children in the event of your death. It is often not an easy thing to consider, but you should name one Guardian and one alternate (in case your first choice cannot serve). Protect Heirs. A comprehensive estate plan will protect your heirs from their inability, their disability, their creditors, and their predators (including ex-spouses). Some spouses are uncomfortable with or incapable of handling financial matters. Most parents want their children to receive their inheritance when they are old enough and experienced enough to properly manage the assets. Thus, holding the assets in trust for the spouse s or child s health, education, maintenance and support with lump-sum distributions for children at stated ages (e.g., 25, 30 and 35) is usually a good idea. A capable trustee (e.g., an accountant, lawyer, bank, or trust company) should be INSIDE ESTATE PLANNING IS NOT JUST FOR THE WEALTHY BRAVE NEW WORLD: TAX PLANNING FOR MARRIED SAME-SEX COUPLES TRUSTS OR CORPORATIONS: WHICH WORK BETTER AS FOUNDATIONS? COPYRIGHT 2013 JULIUS GIARMARCO, ESQ.

2 2 appointed to manage the assets and distribute them to the beneficiaries per the terms of the trust. Make Medical Decisions. Everyone remembers Terri Schiavo, who was in a persistent vegetative state for 15 years before her artificial hydration and nutrition were stopped. A dispute between her husband and her parents produced one of the most hotly-contested, protracted, and well-publicized end-of-life cases in history. You can avoid a similar situation for your family by executing a Health Care Power of Attorney. With a Health Care Power, you can decide the extent, if any, which you want heroic measures to be used to sustain your life and who will make those decisions if you cannot. The financial aspects of long-term care are also important. Do you have sufficient funds to provide for your medical care? Should you purchase long-term care insurance? Will you qualify for Medicaid? Neglecting these issues can put a heavy burden on a spouse and other family members. Prepare for Incapacity. Estate planning is not only about handling your affairs in the event of your death. It also involves handling your affairs if you become incapacitated. In that case, who will manage your assets, pay your bills, file your tax returns, care for your pets, enter you into an assisted living center or nursing home, communicate with your health care providers, etc.? With a General Power of Attorney and a Living Trust, these matters (and numerous others) can be handled by fiduciaries you select. Otherwise, such matters may end up under the local probate court s supervision. Plan for Elder Care. You are likely to live much longer than your parents did. But what happens if you are not healthy and are incurring insurmountable health care costs? Your assets could be wiped out by a lengthy illness, hospital and/or nursing home stay, leaving your spouse and family with nothing. An elder care attorney can help guide you through the complex maze of Medicaid and veteran benefit laws; explain the options available to pay for home health care, assisted living and nursing home costs; assist you in qualifying for benefits; and implement a plan to protect your assets from nursing home costs. Avoid Disputes. Children will not fight over dividing a bank account equally. However, deciding who receives a piece of jewelry or artwork can cause a tremendous rift between siblings. Many parents leave it to their children to work out the equal division of personal property. The better approach is to divide the personal property among the children as part of a personal property list incorporated into a Will or Living Trust. Select Fiduciaries. Oftentimes, the most difficult decisions you face in the estate planning process are selecting your first and second choices for fiduciaries. There are up to five roles to be filled: (1) the Personal Representative under your Will; (2) the successor Trustee under your Living Trust (if you are no longer able to act as Trustee); (3) the Attorney-in-Fact under your General Power of Attorney; (4) the Patient Advocate under your Health Care Power of Attorney; and (5) Guardians for any minor children. Typically, a trusted family member, adviser, or bank or trust company will fill these roles. Oftentimes, the roles of the Personal Representative, successor Trustee, and Attorney-in-Fact will be held by the same person or persons. For a married couple, the first fiduciary is oftentimes the spouse. Consider Life Insurance. Consider the many uses of income tax-free life insurance in a non-taxable estate. Life insurance provides immediate cash for payments of debts, funeral expenses, and administration costs. It can provide security for loved ones in the event of a breadwinner s premature death. Life insurance can create an inheritance and provide for dependents with special needs. It can also be used as an equalizer for those inactive children not receiving a family business. Finally, life insurance can be used to enhance charitable giving. Plan for Retirement. It s just as important to plan to care for yourself during your retirement as it is to plan for your beneficiaries after your death. This is where estate planning overlaps with retirement planning. Social Security benefits alone may not provide enough income for your retirement. Consider saving for retirement by establishing an IRA or other taxdeferred vehicles. Consider Charity. Giving to charity is not only personally rewarding, the federal government allows certain tax deductions for donations made to qualified charities. Thus, charitable giving can be smart estate planning. There are numerous options for making charitable gifts, whether during lifetime or at death. From simple outright gifts to charitable trusts, an experienced estate planning attorney can help you choose the technique that s most appropriate for you and your family. Protect Assets. We live in the most litigious country in the world. You do not need to be rich to be sued. Protecting what you have from liability is an important part of estate planning. After all, if you lose your assets to a creditor, there may not be an estate to plan. Asset protection planning is not just

3 3 about having adequate property and casualty insurance it also entails taking advantage of those asset categories that are automatically protected from creditors under state and federal law (e.g., retirement plans and life insurance). And, for assets that fall outside protected categories under state and federal law, an asset protection lawyer can help you design and implement a customized asset protection plan (e.g., family LLCs, domestic asset protection trusts, and offshore asset protection trusts). Plan for Cottage Succession. Many cottage owners want to make sure the family cottage stays in the family. They would like future generations to have the same opportunity for family bonding and memories that they had. This cannot be accomplished by simply deeding the cottage to the children at death and hoping that it is not lost to creditors or ex-spouses. Another problem is the potential for dissension among the children (and their descendants) in figuring out how to share the cottage fairly (e.g., who gets to use the cottage during the major holidays) and paying for its upkeep, utilities, and property taxes. An experienced attorney can help establish a cottage trust or cottage LLC to assure that the handing down of the cottage is not left to chance. Plan for Business Succession. It is not uncommon in a family business for one or more children to be active in the business, while others are not active. An estate plan can assure that the active children succeed to the business while, at the same time, treating the inactive children fairly (if not equally). If there are no children likely to succeed to the business, then the estate plan can address who will manage the business (in the event of the owner s death or incapacity) until the business can be sold. A common approach is to create a management committee of three to five persons (e.g., key employees, advisers, family members, etc.) to operate (or sell) the business upon the owner s death or incapacity. Create Special Needs Trusts. When a person with a disability depends on government assistance, his/her benefits will be in jeopardy if they receive an inheritance other than in a qualified Special Needs Trust (SNT). The assets in an SNT are not considered owned by the beneficiary in determining eligibility for public benefits like Supplemental Security Income, Medicaid and subsidized housing. In addition to preserving such benefits, the SNT provides the beneficiary with items not covered by public benefits, such as assistive technology, clothing, and entertainment. For this reason, SNTs are also referred to as supplemental needs trusts. Minimize State Death Taxes. If you live in one of the 20 or so states that imposes a death tax or an inheritance tax, tax planning is still relevant. All of these states have varying levels of exemptions against the tax. There are four ways to avoid state death taxes. First, you can move to a state (like Michigan and Florida) that does not impose a state death tax. This is commonly done by persons spending the winter months in such states. Second, the credit shelter/ family trust (for the benefit of your spouse) that was used in the past to shelter the federal estate tax exemption amount can be used to shelter the state estate tax exemption amount. Third, a Spousal Lifetime Access Trust (SLAT) can be used to shelter your $5.25 million gift tax exemption lessening your estate for state estate/ inheritance tax purposes. Finally, you can make lifetime gifts using your $14,000 annual gift tax exclusion and $5.25 million gift tax exemption to reduce your estate and, therefore, your state death tax. Plan for Pets. While you cannot leave property to your pets, you can make arrangements for them to be taken care of after you die. You can do this in one of two ways. In your Will or Living Trust you can leave your pet and the funds to take care of your pet to a trusted caregiver. Alternatively, in most states (including Michigan), you can establish (in your Will or Living Trust) a pet trust. Under this arrangement, the Trustee (usually someone other than the caregiver) holds, administers, and distributes the trust funds (to the caregiver) as needed for the pet s health, care, and maintenance. The pet trust can also compensate the caregiver for his/her services. Organize Financial Records. To make it easy on your fiduciaries, list account numbers and pertinent information about your bank accounts, investments, life insurance, auto and personal loans, credit cards, mortgages, safe deposit boxes, etc. List the location of valuable documents (e.g., deeds, car titles, military records, birth and marriage certificates, divorce decrees, estate planning documents, tax returns, etc.). In addition, list your personal data, such as Social Security Number, driver s license, VA claim number, etc. If you store any of the aforementioned information on your computer, make a list of all passwords and where the information can be found. Plan Your Funeral. Most people have a strong sense of their burial desires, whether based on religious beliefs or personal preferences. Decisions such as cremation or interment, viewing or no viewing, and religious service or a memorial, COPYRIGHT 2013 JULIUS GIARMARCO, ESQ.

4 4 should be reduced to writing. But, if you include your wishes in your Will, your survivors may not read them until it s too late. Instead, make a separate writing detailing your funeral and burial wishes and give it to your spouse and family. Title Assets Properly. Since retirement plans, annuities, life insurance, and some other assets pass by beneficiary designation, they are not affected by your Will or Living Trust. The same is true of jointly-titled property which passes automatically to the surviving joint tenant. Thus, these assets must be coordinated with your Will and/or Living Trust so the assets pass according to your wishes. Particular attention must be given to retirement plans in order to stretch the payments over the longest period of time allowed. While other non-tax issues could be addressed, those listed above are most commonly considered when putting together a well-designed estate plan. In general, everyone who owns property should have an estate plan. It is best to consult with an experienced estate planning attorney to ensure that your goals for your family and wealth are properly accomplished. THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. BRAVE NEW WORLD: TAX PLANNING FOR MARRIED SAME-SEX COUPLES By Thomas P. Cavanaugh J.D. On June 26, 2013, the U.S. Supreme Court held that Section 3 of the 1996 Defense of Marriage Act ( DOMA ) was unconstitutional. In doing so, the Court struck down the federal definition of marriage as meaning only a legal union between one man and one woman as husband and wife, and the word spouse referring only to a person of the opposite sex who is a husband or a wife. Many questions arose following the Supreme Court s opinion since it is expected that the decision will, at least according to Justice Kennedy, affect over 1,000 federal statutes. On August 29 th, the IRS attempted to answer some of those questions through its issuance of Revenue Ruling and Notice IR The IRS and the U.S. Department of Treasury concluded that same-sex couples, legally married in jurisdictions that recognize their marriages, will be treated as married for federal tax purposes. This ruling applies regardless of whether the couple resides in a state that does not recognize same-sex marriage. For example, a same-sex couple residing in Michigan travels to New York for a period of time and, while there, gets married. The couple returns to their residence in Michigan, where they continue to live. Since they were legally married in New York, they will be treated as married for purposes of federal tax law even though Michigan does not recognize same-sex marriage. Any same-sex marriage legally entered into in one of the thirteen states that currently allow for same-sex marriages, the District of Columbia, a U.S. territory or a foreign country will be covered by IR The IRS looks to state or foreign law to determine whether individuals are married. So, in the example above, had the couple married in Canada, they would still be considered married for federal tax law purposes even though they reside in Michigan. However, the IRS ruling states that a same-sex couple in a civil union, domestic partnership, or other similar non-marriage relationship will not be treated as being married under federal tax law. Under these rulings, legally married same-sex couples will be treated as married (just like traditional, domestic marriages) for all federal tax purposes, including gift and estate taxes. For example, the unlimited marital deduction and gift splitting will now apply to legally married samesex couples. This ruling also applies to their filing status, taking the standard income tax deduction, employee benefits, rights under the Retirement Equity Act of 1984, and claiming personal and dependency exemptions. Legally married same-sex couples generally must file their 2013 federal income tax returns using either the married filing separately or married filing jointly status returns. For those couples living in states which do not recognize same -sex marriages, care must be taken when filing state income tax returns. Generally, the statute of limitations for filing a refund claim is three years from the date the return was filed or two years from the date the tax was paid, whichever is later. Returns that fall within this statute of limitations are referred to as open years and those that fall outside of this statute are referred to as closed years. The IRS has stated that legally married same-sex couples may (not must) file amended returns or seek refunds for open years. In other words, refund claims can still be filed for tax years 2010, 2011, and This ruling also applies to estate and gift tax returns and refunds. In its rulings, the IRS does not permit legally married same-sex couples to amend returns or seek refunds for closed years.

5 5 The Treasury Department and the IRS will begin applying the terms of these two rulings on September 16, 2013, but taxpayers who wish to rely on their terms for earlier periods may choose to do, provided that the statute of limitations for an earlier period has not expired. It is expected that the IRS, as well as other federal agencies, will continue to provide guidance on the application of the Supreme Court s decision to their programs. We will provide relevant updates as more information becomes available. THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. TRUSTS OR CORPORATIONS: WHICH WORK BETTER AS FOUNDATIONS? By Salvatore J. LaMendola, J.D., C.P.A. Introduction. Private foundations make up one slice of the 501(c)(3) pie. But even that slice can be subdivided into private foundations that are organized as charitable trusts ( trusts ) and those that are organized as non-profit corporations ( corporations ). This article explores the advantages and disadvantages of each. Future Control Advantage: Trusts. There is no question that whether organized as a trust or corporation, the private foundation gives its founders maximum freedom to determine how their gifts will be invested and distributed. But in the hands of future boards, that kind of freedom can be cause for concern. For example, if a founder wishes to limit who gets to sit on the board, what causes will receive funding, what communities will benefit, or how long the foundation will last, then a trust is generally preferred. Example: The Smith Foundation. Stan and Shirley Smith sold their family business last year. They now wish to create a private foundation with some of the proceeds. The one limitation they desire is that only bloodline descendants sit on the board. If they organize as a corporation, this restriction can generally be removed from the bylaws by the majority vote of a future board. Thus, after Stan and Shirley pass away, the Smith children could add their spouses to the board by merely adopting new bylaws with the restriction removed. In contrast, if the same limitation were contained in a trust, removing it would be impossible (assuming the trust prohibits decanting ). Current Control Advantage: Trusts. Organizing as a corporation in some states can also bring unwelcome limitations on the founders themselves, for in these states (Michigan included) at least three directors are required at all times. While both founders are alive, this does not present a problem since they have the majority vote. But when one passes away (or becomes disabled), the risk of the other losing control becomes real. Example: The Jones Foundation. Jeff and Janice Jones organize their foundation as a Michigan non-profit corporation. To meet Michigan s three director requirement, they name their son, Tim, as the third director. Things run fine until Jeff passes away. At that point, the Jones s daughter, Tammy, joins the board. Now able to out-vote their mother Janice, Tim and Tammy start funding causes that Janice opposes. And, heedless of their advisors warnings, Tim and Tammy also vote themselves compensation packages that the IRS would oppose on audit. Having ruled out going to court for a remedy, Janice s only remaining options are to try persuasion or resign. (The latter was Henry Ford II s choice with respect to his grandfather s corporate foundation.) In contrast, with a trust, none of the Jones children need ever be involved until both Jeff and Janice pass away (or become disabled). And even then, trust-based limitations on causes to be supported and compensation to be taken can prevent the abuses described above. Liability Standard Advantage: None. Generally, corporate boards are subject to a lower standard of care (often called the business judgment rule ). This means that corporate board members are liable only for acts committed out of gross negligence and willful misconduct. On the other hand, trustees are generally subject to a higher, simple negligence standard. But if a foundation will be passive (as most are, merely funding other organizations and not undertaking any charitable activities of its own), the difference in standards is not significant. (In fact, there might not be a difference at all, for according to anecdotal evidence, directors and officers (D & O) insurance carriers charge the same rates for passive trusts as they do for passive corporations.) And, under many state laws (Michigan included), careful drafting can lower the trustee s standard from simple negligence to bad faith and reckless indifference. Finally, when it comes to investing, there is no difference in standards. Corporations and trusts are both subject to the same prudent investor rule. COPYRIGHT 2013 JULIUS GIARMARCO, ESQ.

6 6 Taxes on Capital Gain UBTI Advantage: Trusts. Whether organized as a corporation or a trust, every foundation is subject to the net investment income, selfdealing, underdistribution, excess business holdings, jeopardizing investment, and taxable expenditure excise taxes. In addition, unrelated business taxable income (UBTI), such as S-corporation or LLC earnings (and the proceeds from the sale of S-corporation and LLC interests), will be subject to normal income and capital gains taxes, at either corporate rates (if organized as a corporation) or trust rates (if organized as a trust). The rates of tax that corporations and trusts pay on ordinary income are generally comparable. However, the 20% capital gains rate enjoyed by trusts will generally be preferred. (There is no 3.8% surtax on net investment income in this arena because that tax applies only to non-charitable trusts.) Changing Course Advantage: None. What if the founders who organized as a corporation now wish they had used a trust? Will a change of course result in negative tax consequences? The answer is no. Whether from corporation to trust or vice versa, the transfer of assets between foundations that are under common control results in no negative tax consequences. Treas. Reg (a)(9)(i). Conclusion. Trusts have the advantage when it comes to control and taxation of capital gain UBTI. Where passive foundations are concerned, there is no tradeoff for these advantages in the form of a higher liability standard. Thus, trusts should not be overlooked when planning new foundations. (In fact, all testamentary foundations are trusts.) Where a corporation is in place but a trust is now desired, changing course brings no adverse tax consequences. THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. Our estate planning attorneys provide soundly based estate and business succession plans utilizing: Revocable Living Trusts Irrevocable Life Insurance Trusts Qualified Personal Residence Trusts Grantor Retained Annuity Trusts Sales to Grantor Trusts Business Succession Plans Split-Dollar Plans (Private and Employer) Generation Skipping Transfers Charitable Trusts Buy-Sell Agreements Retirement Plan Trusts Asset Protection Planning This newsletter is designed to provide accurate (at the time of printing) and authoritative information with regard to the subject matter covered. It must not be used as the basis for legal or tax advice. In specific cases, the parties involved must always seek out and rely on the counsel of their own advisors. Thus, responsibility for modifying and guiding any party s action with respect to legal and tax matters is placed where it belongs - with his or her own advisors. CIRCULAR 230 DISCLAIMER: NONE OF THE ARTICLES IN THIS NEWSLETTER ARE INTENDED OR WRITTEN BY THE VARIOUS AUTHORS OR GIARMARCO, MULLINS & HORTON, P.C., TO BE USED, AND THEY CANNOT BE USED, BY YOU (OR ANY OTHER TAXPAYER) FOR THE PURPOSE OF AVOIDING PENALTIES THAT MAY BE IMPOSED ON YOU (OR ANY OTHER TAXPAYER) UNDER THE INTERNAL REVENUE CODE OF 1986, AS AMENDED.