Law Offices of Jacqueline Real-Salas

The Name Sounds Odd, but Intentionally Defective Grantor Trusts are Legal

Known as an IDGT, the “Intentionally Defective Grantor Trust,” is valid and works well in certain circumstances, despite an odd-sounding name.

The use of the word “defective” makes it seem like an IDGT might not be legal, but that’s not the case. The “defective” refers to this type of trust not being valid for income tax purposes.

Because it’s a Grantor Trust, all of the income, deductions, and credits are reported on the individual income tax return of the person creating the IDGT, who is called the Grantor or Settlor. This is explained in detail in The Nevada Appeal’s “What is an ‘IDGT?’”

An IDGT is valid for gift or estate tax purposes. The Grantor is also called the “deemed owner” and is separate from the trust. A big benefit of the IDGT is that significant wealth can be transferred by the Grantor without transfer taxes. This is due to the lack of coordination between the regulations for income tax and those concerning gift and estate (transfer) taxes that apply to grantor trusts.

A grantor trust—which is also known as a “living trust”—is revocable. The owner or grantor is allowed to modify the terms, add assets and remove assets from the trust. Income is reported on the individual income tax return, and the grantor trust isn’t required to file Form 1041, an income tax return for estates and trusts.

A typical transaction involves the grantor selling an asset that is expected to grow in value to the IDGT, in exchange for a promissory note for the fair market value of the item, with interest at the applicable federal rate (AFR). Since the transaction is a sale for gift tax purposes, the gift tax doesn’t apply. It’s also a sale for estate tax purposes.

The grantor owns only the promissory note, and when he or she dies, only the value of the note is included in the grantor’s estate. The appreciation passes to the beneficiaries of the trust without any gift or estate tax liability.

Bear in mind that the trust does not pay income taxes. The grantor must report and pay taxes on trust income, whatever form that income takes. However, the grantor pays income taxes from other assets, which serves to reduce the assets of the estate. Payment of these income taxes cannot be reported as a gift. This is useful for high net worth individuals who wish to reduce their estate tax liability.

Reference: Nevada Appeal (January 23, 2017) “What is an ‘IDGT?’”

Want to Create a Disaster? DIY Estate Plan is a Sure Path!

Trying to create an estate plan is a lot like do-it-yourself dentistry. It just doesn’t work.

There are people who think that creating an estate plan is something they can tackle. After all, there’s plenty of information on the web, including templates for important provisions. The cost of cleaning up after you pass, will be long remembered and not appreciated by your heirs.

Modern Medicine’s article “Estate planning: Don’t make these mistakes” says that, in some instances, folks try to create their estate plan without consulting an experienced lawyer. These folks think that because they may have a general understanding of estate planning, they can do it for themselves without the help of an estate planning lawyer. But everyone’s different, and boilerplate forms won’t always cover a specific situation. Take a look at this list of potential estate planning mistakes that you can help to avoid by working with an experienced attorney.

Failing to update your estate plan. Your life and financial circumstances may change over time. As a result, you need to change your estate plan accordingly. You should also make sure to review your plan regularly.

Failing to revise your will. The will that you drafted 15 years ago may no longer apply for a variety of reasons. You can’t just cross-out provisions or names on an old will, add or change information, and initial the document. That won’t work and could revoke the entire will. You need to see an estate planning attorney.

Failing to use more than joint tenancy to avoid probate. Many assets are transferred outside of wills, like assets titled in joint tenancy that pass to the surviving joint tenant, not under your will. Remember this only avoids probate on the first death. When the surviving spouse dies, the home will usually end up going through probate.

Failing to coordinate the will and trust. If you have a will and a trust, you must ensure that the documents are aligned so your wishes will ultimately be carried out. If you don’t, there will be delays and unnecessary expenses.

Failing to title assets correctly. You want your primary residence, vacation home, bank accounts, brokerage accounts, retirement accounts and vehicles to be passed on to the persons you designate. Therefore, be certain to keep beneficiary designations up-to-date and to properly title accounts.

Failing to name successor or contingent beneficiaries. If you don't update a beneficiary designation after a beneficiary dies, there’ll be no successor to receive those assets when you die. You should name more than one beneficiary on your accounts and keep your designations up to date.

Failing to name a person to make health care decisions. Designate someone that you trust to follow your wishes as far as your healthcare decisions in the event you are incapacitated. Depending on the state, this may be called a living will, a medical directive, a health care proxy or an advance health care directive.

Failing to update outdated financial powers of attorney. If you chose a person to make financial decisions for you with a power of attorney some years ago, his or her circumstances may have now changed, along with your situation. Consult with an attorney about how to proceed.

We like to think of ourselves as intelligent and self-reliant individuals. However, there are certain things in life, estate plans among them that are best left to professionals. There is a reason for that. Estate law differs from state to state and templates that you find on the web may not be applicable to your situation. They might also not be legal. Do all the online research you like, but when it comes to creating the legal documents for your estate plan, work with an experienced estate planning attorney.

Reference: Modern Medicine (December 1, 2016) “Estate planning: Don’t make these mistakes”

How a Living Trust Works

Planning for the end of your life is not an easy task, but doing so will make life easier for your loved ones, and isn’t that the most important thing? Putting major assets into a living trust might be another way to protect your heirs.

Understanding how a living trust works will help you decide whether or not it is a tool that can work for you. At its simplest, a living trust is a legal document that owns or holds title to your assets for your own benefit (with you as the trustee) while you are still living. If you should become disabled or die, it transfers these assets via your “successor trustee” to your heirs. These basics are among several useful points covered in a Fox News article, “Why Should I Put My Home in a Living Trust?”

Living trust versus a will. A living trust is similar to a will in that it’s a legal document that instructs how to distribute your possessions after your death. If you have a will when you pass away, your estate goes into probate where the court monitors the distribution of your estate. But if you set up a living trust while you're alive, you’ll work with an attorney to do the paperwork ahead of time and avoid court supervision of the most valuable items you own after you're gone

Whatever you place in the trust can be distributed in just weeks after you pass. Also, a living trust is private, not like a will, which is a public document.

A living trust is typically funded with your assets, such as your home. You also should put any vacation homes in different states in the trust to avoid separate probate proceedings in those states. To place property in a living trust, your estate planning attorney will draw up a new deed in the name of the trust and maintain a list of what's in the trust to make it easier for your successor trustee.

Revocable or an irrevocable trust. The creator of the trust also needs to opt for either a revocable or an irrevocable trust. A revocable trust is one that lets you change what property is in the trust—or even the very existence of the trust itself. This is good for someone who wants to stay in control over his or her assets, right up until the moment he or she can no longer mentally do so, at which point a designated trustee is ready to assume control.

You’ll want to speak with an experienced estate planning attorney to determine if an irrevocable trust is suitable for your situation. Once an irrevocable trust is created and assets are placed in the trust, they cannot be taken out. There are benefits to this kind of trust: assets are not included in your taxable estate.

An estate planning attorney will help you examine the pros and cons of different kinds of trusts.

Reference: Fox News (October 5, 2016) “Why Should I Put My Home in a Living Trust?”

The Key Estate Planning Documents, aka the “Big Three”

These key documents are at the heart of any estate plan. Understanding what they can do to protect you and those you love will make it easy to see how important they are.

Estate planning is so important, and it’s not as complicated as people think. According to a post on NJ 101.5, titled “Here are the important estate planning documents you should have,” all estate plans should include these three documents: a will, a general durable power of attorney and a health care proxy. Here’s what each document is for, and why they matter:

A will lets you give away your assets at your death in the way you want and in a way that’s appropriate for your beneficiaries. In addition, it allows you to name an executor to handle the administration of your estate. If you don’t name one in your will, an administrator will be appointed to settle your affairs. The process goes a lot more easily when you name an executor in your will.

A general durable power of attorney is a document in which you designate a trusted individual as your agent to act on your behalf on financial and property issues in the event you’re unable to do so. If the power of attorney is durable, its effectiveness continues after your incapacity. This will allow someone to act on your behalf if you become incapacitated in the future. Giving this power to an agent—along with the designation of a health care agent in a health care proxy—may eliminate an expensive guardianship proceeding if you become disabled or incapacitated down the road.

A health care proxy lets you designate an individual to act on your behalf for medical decisions if you are unable to make those yourself. A health care proxy is usually coupled with a living will. A living will stipulates your wishes on your continuing care under certain circumstances.

You should review all of your beneficiary designations to be certain they’re current and reflect your wishes on the disposition of each asset. An asset with a beneficiary designation generally deems it a non-probate asset, so it won’t be distributed under your will. Changes to your will do not change the distribution of that property. Retirement accounts and life insurance policies are the most common assets that pass by beneficiary designation, as well as POD (payable on death) and TOD (transfer on death) accounts.

The “Big Three” are the starting point. In some instances, the creation of a revocable living trust that holds property during your lifetime may have a role in your estate plan. Another type of trust is an irrevocable trust. And an irrevocable life insurance trust (ILIT) is used to eliminate the value of the insurance policy proceeds, also known as death benefits, from your taxable estate when you pass.

Every family’s estate planning needs are different, but an experienced estate planning attorney will be able to explain what you need and create the necessary documents.

Reference: NJ 101.5 (September 13, 2016) “Here are the important estate planning documents you should have”

Not Always the Best Option: Trusts

Trusts are not right for everyone, so they need to be fully explored before being created.

If someone says you need a trust as part of your estate plan, you should speak with an experienced estate planning attorney before moving forward. A recent post from NJ 101.5, “The disadvantages to trusts,” notes that there are situations when a trust is not the right planning tool.

Trusts can save on estate taxes but are typically subject to higher income tax rates than those of an individual taxpayer once the “grantor” (i.e., trustmaker) dies. Trusts have to pay income taxes on the income they generate by the assets they hold. Such irrevocable trusts hit the top bracket at a very low income threshold: $12,400 of taxable income in 2016. The top income tax bracket for an individual doesn’t happen until his or her income exceeds $415,050. Also, the additional 3.8% net investment income tax applies at low thresholds.

So, when a trust is being used for estate tax planning purposes, it’s smart to measure the estate tax efficiency of the trust versus the potential income tax inefficiencies of the trust.

These tax rules are in effect when the trust pays its own taxes. However, in some situations, a trust will be a “grantor trust,” which means that the grantor of the trust is still treated as the owner of the trust’s assets for income tax purposes. As a result, since the income of the trust is taxed to the grantor, these lower tax thresholds usually don’t apply.

Aside from the gory details of taxes, remember that the use of trusts for tax or asset protection purposes typically means you give away absolute control over the trust assets—that would apply if the assets were owned by the grantor or the beneficiaries.

A trustee is designated for the trust to conduct investment and distribution decisions. This trustee is, in many instances, a family member and (when properly drafted) the beneficiary of the trust—neither the grantor nor the beneficiary will have the level of access either would have enjoyed had the assets been owned outright and outside of a trust.

An estate planning attorney will be able to help you maintain control over your assets while benefiting from the protective characteristics that a trust provides. These are complex legal instruments and should only be created with the help of an experienced estate planning attorney.

Reference: NJ 101.5 (August 3, 2016) “The disadvantages to trusts”

Investing Trust Assets is Different Than Other Types of Investing

Trusts have different functions and what might be suitable for one type of trust may be all wrong for another.

Financial Planning’s article, “How to invest trust assets,” provides a good overview of commonly used trusts and general suggestions about which types of investments are appropriate for different kinds of trusts. Investing assets is a very individual matter, and recent changes to the tax law must be taken into consideration—as well as current market conditions and available investment products.

Bypass or Credit Shelter Trust: This is a very common trust in estate planning. It shelters the amount of exemption from tax available on death. Usually assets are held in this trust to benefit the surviving spouse—although other relatives can be beneficiaries as well. When the surviving spouse dies, the assets pass to heirs without being taxed in that individual’s estate. That’s why it’s called a “bypass” trust—it jumps over the surviving spouse’s taxable estate. However, with recent changes to the tax laws raising the estate tax exemption to $5 million ($5.45 million for 2016, given the inflation adjustment), the surviving spouse’s estate may no longer have estate tax liability. If that’s the case, then growth inside the trust will result in higher income tax costs to heirs. If this happens, one might consider moving assets out of the trust through permissible distributions or even terminating the trust if allowed.

QTIP Marital Trust: These trusts are intended to qualify for the estate tax marital deduction and obligate the payment of income at least annually to the surviving spouse, who is required to be the sole beneficiary. The income distribution requirement will affect the choice of investment allocation, and thought should be given to protecting the trust and growing it for remainder beneficiaries. This is especially important if they are children from a prior marriage and a husband has formed the trust for his second wife. The assets of a QTIP trust will typically be included in the spouse’s estate—meaning if his or her estate isn’t expected to be taxable, assets in the trust will receive a step-up basis at death with no offsetting tax cost. If that estate is expected to be subject to an estate tax, that risk should be reviewed.

Irrevocable Life Insurance Trusts: These days, life insurance is commonly held in trusts that own other substantial assets. One should determine the cash flow needed to maintain current and anticipated life insurance—with any excess being invested under a longer-term plan. At the insured’s death, the proceeds have to be invested in a manner that fits the post-death trust objectives.

Revocable (Living) Trusts: These trusts are controlled by the settlor who created the trust investments, and as a result, the allocations can be as he or she chooses. However, if the settlor becomes incapacitated and a successor trustee takes over, that person will probably be subject to the standards of a prudent investor and state law. If that is the case, maintaining the settlor’s investment plan might not work. Be sure to confirm the identity of the trustee and that he or she understands the responsibilities. In the event the settlor steps down as trustee, a new investment plan may be needed.

Dynastic (Grandchildren’s) Trusts: This trust was traditionally used to pay for college and was invested in a manner to achieve that goal. But with more 529 plans, grandchildren trusts are rarely used for this reason. Now, they’re usually designed to provide long-term growth for future uses—such as providing cash flow to grandchildren and future generations. Note: these trusts may include a term allowing the trust to own personal use assets. If so, that may be relevant to the investment timeline and risk profile.

GRATs (or Grantor Retained Annuity Trusts): In the past, GRATS were structured for short-term investments with highly detailed asset allocation. The trust would contain only one stock or one type of asset. If it grew, it would be “immunized” by swapping in cash for the highly appreciated assets. When the GRATs ended, the process would be resumed, which was referred to as “cascading” GRATs. However, in the future, it may not be possible to re-GRAT assets sequentially. Planning for GRATs today, especially for individuals who are not elderly, needs to take a longer-term approach. This might include a diversified portfolio to shift performance in excess of the current low interest rates out of the estate over the term of the GRAT. This would be a very different investment approach than in the past.

Trust investing requires a coordinated team effort between your estate planning attorney, financial advisor and tax professional to ensure that all of the parts work smoothly together towards the same end.

Reference: Financial Planning (August 1, 2016) “How to invest trust assets”

How to Address Giving Your Home to Your Heirs

Passing your home to your heirs can occur in a number of ways, depending upon your situation and your family. It’s not a do-it-yourself project—even in the simplest cases.

If you own a home and want to leave it to your loved ones, there are steps you need to take to ensure that your wishes are achieved. According to Fox News, “You're Going to Die—Here Are the Best Ways to Deal with Your Home,”, inheriting a collection of 80s Transformers action figures won’t have a big impact on your heirs, but a sizable asset like a house will.

Here are a few ways to help prepare now.

If you have a couple of kids and a house, as your heirs, the kids will have to wait until after the property passes through probate court. This can take months and can be expensive. Taxes may be levied as well, which can be substantial on a modest home. Once that's done, the kids are then able to take title to the house or sell it; however, there are ways to avoid—or at least minimize—these problems.

1. Tenancy by the entirety. If you're married and own property together, there’s typically not much you need to do to make certain your home is passed on to your spouse. If both spouses have their names on a deed, most states recognize tenancy by the entirety, which says that when one spouse dies, everything he or she owns goes to the other spouse. That's it. No probate at the first death.
2. Joint tenancy. If you're not married or if you want to pass your property to some other relative, you should prepare by transferring part of your interest to that other person to create a joint tenancy. This is nearly identical to tenancy by the entirety, but there is no wedding ring involved. These are the easiest ways to transfer title, but there are downsides. Remember, the other person now owns your property as well. You have now exposed the property to outside control and to the lawsuits, creditors, divorces and other issues of another party. Yes, your property could be lost due to the financial troubles of the person whose name you just added to the title. The better answer may be to create a living trust.
3. Living trusts. If you place property in trust, it means that you’re letting someone else—the trustee—take care of it for the benefit of another person—the beneficiary. However, with a living trust, you can act as the trustee of the property yourself and can elect to pass it on to another person only when you die. You can also change your mind and name a different beneficiary. Trust language can be complicated. This is definitely not a do-it-yourself project. Generally speaking, a living trust will avoid probate, and the transfer is usually smooth and seamless.
4. Land trusts (if valid in your state). Like living trusts, land trusts have the same anonymity and ease of transfer. They also require a setup fee and an annual fee on top of that—though typically this fee is less than $100. Unlike a living trust that can hold all sorts of assets, a land trust can hold only one thing: land. A living trust offers a lot more flexibility. In light of this, land trusts are usually set up when someone wants only to pass down real property or as part of a more complex estate planning strategy.

If you own a home or other real estate property, planning in advance with an experienced estate planning attorney can make settling your affairs easier for those you leave behind.

Reference: Fox News (July 22, 2016) “You're Going to Die—Here Are the Best Ways to Deal with Your Home”

How One Family Preserved a Legacy and a Fortune for Six Generations

We often hear about families who squander fortune; we hear less about families that preserve their wealth and values over generations.

Successful entrepreneurs often struggle with estate planning when it comes to their children. Will knowledge of large inheritances to come create spoiled and unmotivated adults? How can wealth be shared across generations while fostering family values that include a strong work ethic and service to others? In a recent article appearing in Forbes, “The Successful Entrepreneur's Guide to Leaving a Financial Legacy That Won't Spoil Your Kids,” one family’s solution of passing along wealth and empowering generations of children is presented.

The family is one of the richest families in history: The Rockefellers. Their fortune is still going strong today—six generations later. They maintained their fortune by creating trusts to protect the family wealth. Trusts can have specific rules for determining how and when heirs are allowed to access money. This is the key to giving your children access to funds without eliminating their potential to achieve success on their own. Many times entrepreneurs fear leaving their children a large sum of money, but a trust lets you attach some strings.

You can’t do this with a generic trust formed with standard legal documents, but if you hire a qualified estate planning attorney, you can customize a trust to personify your wisdom and values.

A trust is also a great way to pass on your wisdom, knowledge, and experience to the generations that follow. The document can include a Statement of Purpose, which is your life philosophy. This can be reread and utilized for generations to come. This is how you leave a strong financial legacy to your kids.

Creating an estate plan that centers on a financial legacy trust does far more than simply create a trust fund. Working closely with experienced estate planning attorney, you can create a lasting financial legacy that will enhance the next generation by teaching them values that emphasize their responsibilities to protect, preserve and perpetuate the family’s wealth.

Reference: Forbes (June 27, 2016) “The Successful Entrepreneur's Guide to Leaving a Financial Legacy That Won't Spoil Your Kids”

Six Key Estate Planning Documents To Protect Your Loved Ones

We don't learn about the private lives of celebrities who have done their estate planning. Privacy and a faster resolution to settling estates are just two good reasons to create an estate plan.

You really don't have to be a millionaire or famous to create an estate plan, as noted in an article appearing on the Forbes' website, "Prince and Estate Planning: What We Can Learn from the Late Musician's Financial Picture." All you have to do is make sure that you have six basic estate planning documents in place to protect your loved ones from additional stress and worry when you pass away.

Here are the six key documents you should have to protect your assets and your family in the event of your passing:

1. Beneficiary Forms. This indicates who gets the assets in your 401(k)s, IRAs, life insurance policies, pensions, and other financial accounts upon your death. These designations take priority over the directives in your will, so keep them up to date.
2. POD and TOD Designation. A payable on death (POD) form typically says who should receive the money in your checking or savings accounts when you pass away. A transfer on death (TOD) form is similar but typically for brokerage accounts. A TOD deed says who takes over the deed to your home after you die.
3. Durable Power of Attorney. This important document designates a person to make health care or financial decisions for you if you become incapacitated or unable to make them for yourself.
4. Living Will. This is also called an Advance Health Care Directive. It details the way in which you want your doctors to treat you should you become unable to communicate those wishes.
5. Will. This outlines how you want your probate assets divided, as well as who should become guardian of any minor children.
6. A Living Trust. This document, like a will, says how you want your property and funds distributed and who will take care of your minor children. It also appoints a trustee to carry out specific wishes for your assets. Unlike a will, assets held in a trust don't have to go through probate. A trust can be used to help manage your assets and property while you're still alive.

Every situation is different and depends on your circumstances. By working with an estate planning attorney, you can rest assured that your heirs will be protected and your wishes will be carried out.

Reference: Forbes (April 29, 2016) "Prince and Estate Planning: What We Can Learn From the Late Musician's Financial Picture"

Talking with Your Widowed Parent About Preparing a Will

Navigating the process of preparing a new will after one spouse has died is a difficult task. The surviving spouse is likely to need a great deal of kindness to get through this necessary step.

The natural tendency, according to "How to handle a parent not having a will" in New Jersey 101.5, is to postpone the preparation of a will after a husband or wife has passed. Grieving a loved partner is difficult and painful. The last thing they may want to do is get involved with their own will.

Also, if Dad has recently passed away, Mom may be hearing a different message in between the lines: "You're gonna die soon, so please leave me an appropriate share." This makes matters even harder. And talk of drafting a will may bring back painful emotions linked to the father's death. These feelings are to be expected.

But instead of the children pressuring Mom, they should point out some of the benefits a will can provide, such as how a will allows her to specify how her assets will be transferred at her death. This can include making bequests of family heirlooms to specific people or include charitable contributions. If there's no will, Mom won't have any control. Her assets will pass according to the intestate laws of the state.

Probating an estate without a will can mean more time and money than an estate with a will. In addition, not having a will leaves the heirs to contend with it on top of their grieving.

Proper planning allows Mom to minimize estate taxes, inheritance taxes, and even some income taxes depending on her circumstances. This allows more wealth to pass to her heirs.

If you have tried having this conversation and your parent is simply not able to move forward, you may need to be patient. If time passes and they still cannot or will not address the issue, consider asking a close family member or friend to bring up the topic and see if that has more success. You may also want to speak with an estate planning attorney and ask your parent if she or he is willing to meet with the attorney, with or without you.

Reference: New Jersey 101.5 (April 7, 2016) "How to handle a parent not having a will"