Over the past few years — in fact, ever since houses began to appreciate at double-digit rates — hoards of “millionaire” real estate “experts” have come out of the woodwork; willing to share their “secrets” with the un-washed for a mere pittance, if you can call several thousand dollars a “pittance”. It seems a staple of these ads that, as a result of a single presentation, you’ll learn the secret of how to become fabulously wealthy virtually overnight. I remain skeptical. I make it a policy not to pay much attention to people who run expensive full page ads trying to give away their special insider secrets for free to all comers.
I really don’t know whether anything new can be added to the information contained in all of the of “How To” books and seminars already being offered in the market; but I do see a missing element: Nobody deals with the fundamental question of WHY anyone should strive so hard to become wealthy. I can understand why people would like to have money to be able to live with a reasonable amount of ease, comfort, and security; but, many entrepreneurs continue to spend valuable years working well beyond the point at which they have achieved this. There’s nothing wrong with continuing to pile up money that’s needed, but this can become a mindless obsession unless there’s a worthwhile purpose to it. Providing financial security for one’s family surely be a worthwhile purpose; but, will they ever be able to?
That brings me to the subject of this month‘s letter: Regardless how hard you work, or how successful you are, it‘s going to be all for naught unless you take steps to guarantee your spouse, kids — and others whom you name — will be able to take full advantage of your assets upon your demise. All of us secretly feel immortal, and we put off doing the hard work that estate planning requires because we can’t see any immediate need for it. Nonetheless, avoiding making preparation for this certain event only penalizes those who are most important and dearest to us; our families and all who depend upon us for their financial security.
I can speak with some authority on this subject. A year ago, I lost my wife of 50 years without any warning. All those future plans that I had arrogantly laid out for our “golden years” suddenly became obsolete. In DD’s case, the onrush of fatal illness took her life in only 12 days. Death can come much quicker: Over the past couple of years, one friend collapsed suddenly without warning, felled by a disease that attacked her brain stem. Another was instantly killed in a vehicle accident. Yet another’s heart just stopped ticking. He was in the prime of life with no apparent illness at all. Fortunately, in every case, an estate plan had been set up. Otherwise, there wouldn’t have been time to set one up. The consequences would have been financial havoc and hardship.
Unpredictable things happen that nobody can foresee. I’m not going to drag you through a harangue about getting a Living Trust, a Pour-over Will, and friends lined up to take care of your family. Either you have set up your estate plan or you haven’t; but at least consider what could happen to your loved ones if your life were ended by an accident today simply because you drove onto a public roadway.
What would become of your business, assets, income, debts, and family’s lifestyle if you died this instant without warning? By making adequate preparations ahead of that event, you will save your survivors years of legal and financial turmoil. This goes directly back to my opening question; are you only working for yourself, or are you truly working for your family and those who will come after you? Only you can provide the answer; but if the latter is true, it‘s folly not to start now to make things easier for them for the time when you can‘t be with them; or vice versa. I thought I’d done all that, but, I also thought I’d die first. I got a rude awakening. In the following pages, I’m going to recount for you some of the challenges that I encountered in settling my wife’s estate that you might be able to avoid in the event you or your spouse suddenly disappeared from the scene.
UN-DOCUMENTED GOOD INTENTIONS DON’T COUNT . . .
MEDICAL DIRECTIVES: In Florida, a young, brain-dead woman has been kept alive only by artificial means for 13 years as a legal battle between her parents and her husband continues to exhaust family resources. All this could have been avoided if she’d only expressed her own wishes as to the extent of the medical care she wanted and had executed a Medical Power of Attorney and Medical Directive appointing a non-family member to do what has been directed. Do this with care! Hospitals get very nervous about later being sued by heirs for either unhooking a patient to soon, or leaving one hooked up too long, so they sometimes disregard the patient’s wishes. Although my Medical Directive had been jointly drafted by Harvard’s Law and Medical Schools, executed by my wife, witnessed, and notarized; the hospital staff was bent on ignoring it until my wife verbally confirmed that she wanted it followed. You may not be able to do this, so get a Medical Directive executed to specifically define the limits of “heroic” treatment for every family member. Do it NOW!
HOLDING ASSETS: Community Property States have their own rules, but holding real estate in “Joint Tenancy With Right of Survivorship“ reduces its step up in basis at death by 50%. Holding bank, brokerage, and money market accounts as “Tenants in Common” creates big problems when trying to close them down. Half of such accounts can be locked up in the estate of the first to die for months. Many institutions will block any attempt to withdraw funds without seeing either a Living Trust or the order of a Probate Court giving a person the right to withdraw funds. Ditto for Lock Boxes. So, title all accounts either into your Living Trust or into the name of a Trust or LLC, and provide for survivors to control them if you die.
POWER OF ATTORNEY: Without the legal power to act for another person, even the most obvious acts can’t be performed. Documents have to be signed to buy, sell, lease, Option, evict, mortgage, release liens, file taxes, contract, and to resolve legal or financial problems. A General Power of Attorney signed by a spouse who might not be able act for him or herself can save a mountain of paperwork and expensive legal procedures trying to protect and conserve assets. Spouses and adult children should sign several original Powers of Attorney and put them away in a safe place where they can be found if needed. Remember, a Power of Attorney is no longer valid after the death of the signer. That’s where holding title in Trust reigns supreme.
LIFE INSURANCE POLICIES can be both bane and boon. As a rule, beneficiaries should own life insurance policies that benefit them. This way, there is no estate or income tax due when they pay off. But, this can be a trap when a deceased spouse owns a policy insuring the death of a surviving spouse. If the insurance policy doesn’t reflect that the surviving spouse shall become the new owner upon the death of the deceased spouse — or the policy hasn’t been endorsed over into a Living Trust — probate proceedings may have to be endured just to get the policy endorsed over to the survivor’s living trust even when no distribution is due.
Sometimes, life insurance policies reflect beneficiaries themselves have died without assigning policy payouts to their own survivors. Or, they may have named a Trustee to receive the proceeds, but the Trust document, the Trustee, or both, can’t be located. The insurance company is happy to just sit on the policy proceeds while the heirs sort out the problems. This would be a good time to dig out your insurance policies and confirm that both the beneficiaries and the current owners are clearly identified. Having the insurance policy pay into a Trust, and providing for successor beneficiaries in it isn’t a bad idea either. In any event, be sure to send in the insurance policy to the company to have the policy endorsed to reflect both the desired ownership as well as the beneficiaries.
PENSION PLANS and IRAS: Retirement plans usually name successor beneficiaries. Surviving spouses pay no estate tax on plans, but other heirs do. There are complex IRC rules that differentiate between spousal vs non-spousal heirs as well as between spouses of deceased parties who die before or after they begin taking mandated distributions. Make sure your plan is inherited by the right party.
THE DEVIL’S IN THE DETAILS . . .
Every estate has to name a “fall guy” who will responsible for insuring that all the bases are touched, and all things done according to regulations. This can be a “Personal Representative”, an “Administrator”, a “Trustee”, an “Executor”, etc. The important thing to bear in mind is that this person is personally liable for State and federal taxes that aren’t paid, or distributions made to the wrong party in the wrong amount. You can be sure that the heirs will be watching closely.
Most heirs would like to duck this chore; so they hire a lawyer. Can you imagine how confusing things would get to be for a garden-variety estate lawyer to try to sort out all of the convoluted real estate transactions that entrepreneurs get into? Be fair; test yourself. Although you were a party to your transactions, can you sort out all of the property exchanges, leases, Options, creative financing schemes, present and remainder interests in title, etc.? What chance do you think a stranger would have doing it after you‘ve passed on? Can you see your assets being liquidated at distress-sale prices to pay for appraisals, legal fees, accounting and filing of tax returns? How much security do you think would remain for your heirs? How soon do you think they’d be able to get their hands on the assets that remained?
Bear in mind that most of the professionals who will be hired will either be working on a fee based upon the size of the estate, or on an hourly basis at a fairly high rate of pay. If you want any of your assets to reach your heirs intact, your only recourse is to leave an organized, easy-to-find paper trail of transactions, debts, Options, obligations, commitments, projects in process, etc. These should be indexed to the properties and assets so that they can be sorted out by the unfortunate who has to prepare all the reports. I thought I’d done this, but it still required almost a year to do all the things that had to be done. I shudder to think of how difficult it would have been for my family if I’d died first.
Here are just a few of the tasks that someone must do:
INVENTORYING ALL ASSETS AND LIABILITIES: Just as an exercise, take a note pad and stroll through your house jotting down all the furnishings, clothing, appliances, tools, valuables, vehicles, recreational equipment, and other “stuff” you now own. Now, let’s move over to the files and count Notes, Deeds, Options, Leases, Contracts, etc. Don’t forget to include insurance policies, stocks, bonds, T-Bills, CDs, etc. It’s all got to be counted; and more importantly, accurately valued.
ASSET VALUATION: To get values, you’re going to have to write a lot of letters to brokers, agents, appraisers, etc. to get them to value assets that may be out of your area. This is a real drag, but must be done. The values that you assign these assets are going to become their basis for tax purposes, so it’s important that you do this job right. Unlimited assets can be transferred tax-free between spouses without any form 706 estate-tax return being required; however, the IRS has up to 3 years following the filing of the form 706 to challenge the value of any assets left to non-spousal heirs. This period extends indefinitely when the form isn’t filed.
The IRS has an incentive to value assets highly. In 2005, when the value of net assets, less debt, exceeds $1,500,000, the first dollar in excess is taxable to non-spousal heirs starting at 45%. This includes assets left in supposedly “tax-free” Roth IRAs. Easily valued stocks, bonds, and Notes aren’t much trouble, but appraising Leases, Trusts, Corporations, LLCs and businesses can be time-consuming and expensive. One way to establish value is to contract to sell the property to a bona fide buyer who negotiates at “arms-length”. Another way would be to sell an Option on the asset. This effectively limits its value to the Option strike price.
VETERAN’S RECORDS: Separating servicemen are issued Form DD-214 on which their military career is reflected. This has a direct bearing upon medical treatment, pension benefits, and even long-term care when it is needed for both a qualifying veteran and his or her spouse. Records of military service should be segregated and filed for ready access. I filed mine in the public records for easy retrieval.
THE GOOD, BAD, AND UGLY: CORPORATIONS, LLCS, AND TRUSTS
All those clever tax and financial privacy strategies that worked so well while you were alive can create their own set of problems after you die. Each has its own plusses and minuses, so let’s consider them one at a time:
CORPORATIONS: Many people hold assets inside corporations for both business and privacy reasons. When the corporate owner dies, the value of corporate stock is stepped up to the fair market value based on the assets inside the corporation, plus “goodwill”; but the assets themselves remain at their old depreciated values. Selling assets and replacing them with cash, makes corporate shares a lot easier to value; but selling assets also triggers corporate income tax; and the cash is still locked up inside the corporation. You can borrow it if you need to pay estate bills, but it will eventually be taxed again to your heirs.
Things really get dicey when Mom and Dad each had separate corporations and the two corporations each owned half of a third corporation. When Dad dies, and Mom inherits his corporation, she will suddenly find herself the owner of a controlled group of corporations. Income, assets, and liabilities of all three corporations will be mixed together. Combining these could give rise to problems with personal holding company income and excessive retained earnings. The solution may be for Dad’s Trustee to immediately terminate or merge these corporations upon his death.
Another way out is to convert C-corporations to S-corporations. An S-corporation can’t be a member of a controlled group or a personal holding corporation. Liquidating the C corporations, you might escape tax free combining losses with gains. You can avoid tax on the built up gains on appreciated assets inside the new S corporation so long as you wait at least 10 years before taking them out. With an inherited S corporation, inherited shares get a step up in basis as with a C corporation; but the assets can be distributed as a tax-free withdrawal of capital up to the stepped up value of the shares. That can be a real bonanza for the inheriting owner when the S-corporation has lots of cash and marketable assets.
LLCs: It’s much better to die with an LLC taxed as a partnership. Upon death, the value of both the shares of the LLC as well as the assets inside the LLC get a step up in basis to appraised fair market value. They can be withdrawn or sold tax-free by the inheriting owner at will with no negative income tax ramifications.
TRUSTS: No spouse or child of the beneficiary of a trust has any inherent rights in it unless the trust agreement says so. You need to check every trust you hold assets in, including land trusts, personal property trusts, common law trusts, and asset protection trusts to insure they contain a provision for passing the beneficial share on to a designated heir. And, you should insure that the assets that you have listed as being in the trust actually have been conveyed into the trust. It’s amazing how easy it is to overlook significant assets such as valuable personal property, precious metals, jewelry, etc. Unless these have been passed to you by gift or bequest, those that aren’t in trust may have to go through a long and expensive probate process in order to pass them on to heirs.
You may be startled to learn that Revocable Grantor trusts become Irrevocable Non-Grantor trusts upon the death of the Grantor, whether or not he or she happens to be a beneficiary. A tax I.D. number must be applied for and Form 1041s completed for the remainder of the fiscal year following the date of death. The same holds true for a Living Trust. It then becomes the estate trust and you’re going to have to set up books and to keep accounts in order to file tax returns. If your land trust language allows you to terminate the trust upon the death of the Grantor and distribute the assets to his or her living trust, that will reduce filing requirements and simplify the trust tax reporting a lot. A book, “How To Settle Your Living Trust” by Henry W. Abts III was very helpful to me in doing this.
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