Estate Planning for Second Marriages and Blended...
Transcript of Estate Planning for Second Marriages and Blended...
Estate Planning for Second Marriages and Blended Families Maximizing Tax Benefits, Incorporating Pre- and Postnuptial Agreements, and Meeting Obligations to Children and Spouses
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
The audio portion of the conference may be accessed via the telephone or by using your computer's
speakers. Please refer to the instructions emailed to registrants for additional information. If you
have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
TUESDAY, NOVEMBER 13, 2012
Presenting a live 110-minute webinar with interactive Q&A
Bridget K. Sullivan, Member, Sherman & Howard, Denver
John T. Midgett, Shareholder, Midgett & Preti, Virginia Beach, Va.
Kristin A. Pace, Partner, Fitzgerald Abbott & Beardsley, Oakland, Calif.
Sound Quality
If you are listening via your computer speakers, please note that the quality of
your sound will vary depending on the speed and quality of your internet
connection.
If the sound quality is not satisfactory and you are listening via your computer
speakers, you may listen via the phone: dial 1-866-961-9091 and enter your PIN
when prompted. Otherwise, please send us a chat or e-mail
[email protected] immediately so we can address the problem.
If you dialed in and have any difficulties during the call, press *0 for assistance.
Viewing Quality
To maximize your screen, press the F11 key on your keyboard. To exit full screen,
press the F11 key again.
For CLE purposes, please let us know how many people are listening at your
location by completing each of the following steps:
• Close the notification box
• In the chat box, type (1) your company name and (2) the number of
attendees at your location
• Click the SEND button beside the box
FOR LIVE EVENT ONLY
If you have not printed the conference materials for this program, please
complete the following steps:
• Click on the + sign next to “Conference Materials” in the middle of the left-
hand column on your screen.
• Click on the tab labeled “Handouts” that appears, and there you will see a
PDF of the slides for today's program.
• Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.
5
Estate Planning for Second
Marriages and Blended Families
Crafting Estate Plans to Incorporate
Pre- and Post-Nuptial Agreements
John T. Midgett
6
Overview
“Marriage is the triumph of imagination over
intelligence. Second marriage is the triumph
of hope over experience.” – Oscar Wilde
7
Challenges and Issues
Ethical Issues of Joint Representation
Titling of Assets
Beneficiary Designations
Choices of Fiduciaries
8
Ethical Issues of Joint Representation
Model Rules of Professional Conduct
Rule 1:7 – a lawyer shall not represent a client if
the representation involves a current conflict of
interest.
ACTEC Commentaries
RE: MRPC 1.7: Some conflicts of interest are so
serious that the informed consent of the parties is
insufficient to allow the lawyer to undertake or
continue the representation (a “non-waivable
conflict).
9
Some Indications of Potential Conflicts of
Interest
Pre-Nuptial Agreement
Post-Nuptial Agreement
Either or both spouse has a child or children
from a prior relationship
Great Disparity in Assets of the Parties
Great Disparity in the Ages of the Parties
Past Representation of a Single Party
10
Issues the Lawyer Should Consider
Laws of Intestate Succession
Elective Share Laws
Statutes favoring “Omitted Spouses”
Joint Tenancy issues
Beneficiary Designations on Life Insurance
and Annuities
Beneficiary Designations on Qualified
Retirement Plans
11
Laws of Intestate Succession
Statutory “will”
Is the share for the surviving spouse too little
or too large?
How are children to be treated?
Children from prior relationships
Children with surviving spouse?
The spouse’s children from prior relationships?
12
Elective Share Laws
Surviving spouse may be entitled to a
percentage of the TOTAL estate, including
non-probate assets
Usually involves litigation to determine
Expensive
Divisive
13
“Omitted Spouse” statutes
Testator made a will (avoiding intestacy) but
subsequently marries
Invokes statutory presumption that Testator
did not intend to disinherit spouse
14
Joint Tenancy Issues
Joint Tenancy with Surviving Spouse
With Rights of Survivorship
Without Rights of Survivorship
Joint Tenancy with Children
With Rights of Survivorship
Without Rights of Survivorship
15
Beneficiary Designations – Life Insurance
Coordinates with Pre or Post Marital
Agreements?
Who is in control of proceeds?
Balancing economic needs
Each policy must be examined and the
beneficiary changed, if needed
16
Beneficiary Designations – Qualified
Retirement Plans
Consider Pay-out options available to
surviving spouse
Who controls balance, if any, at survivor’s
death
Trusts as beneficiaries
“Oldest Beneficiary” rule for measuring lives
Marital deduction issues – Battle between RMD
and mandatory income payout. See Rev. Rul.
2006-26.
17
Issues the Lawyer Should Consider
Presence and Effect of Pre- and Post-Nuptial
Agreements
Presence and Effect of Divorce Decrees and
Property Settlement Agreements
Buy-Sell Agreements
18
Issues the Lawyer Should Consider
Family Dynamics
Putting the “fun” in dysfunctional
“What we have here is a failure to communicate!”- from
the movie Cool Hand Luke
Jealousy and Greed
Control and Management
Balancing the interest of “Yours, Mine and Ours”
November 13, 2012
Bridget Sullivan, Esq. Sherman & Howard L.L.C.
633 17th Street, #3000
Denver, CO 80202
(303) 299-8130
Discussion of Prenuptial and Postnuptial Agreements
Estate Planning for Second Marriages and
Blended Families
20
Bridget Sullivan is a Member in the Tax & Probate Department of Sherman & Howard’s Denver office. She practices in the areas of estate planning, wealth transfer planning, estate administration, trust administration, and litigation related to trusts and estates. Ms. Sullivan focuses on sophisticated estate planning techniques and prenuptial agreements. She has counseled clients on a variety of wealth transfer strategies and charitable giving techniques to accomplish family giving objectives while minimizing the impact of gift, estate, generation-skipping transfer, and income taxes. Ms. Sullivan graduated from Yale Law School in 1990. She is named in Best Lawyers in America for Trust and Estates and is named as a Colorado Super Lawyer.
Bridget K. Sullivan, Esq.
21
1. INTRODUCTION
• The principal purpose of a marital agreement is to
alter the rights otherwise provided by law of one or
both spouses to the property of the other spouse,
whether upon termination of the marriage by
divorce or by death or both.
• Many states have a marital agreement act, which
determines the rights of parties who have entered
a marital agreement, the types of matters that
parties may agree to and the enforceability of
marital agreements.
22
2. REASONS FOR HAVING A MARITAL AGREEMENT
• Create certainty with respect to the disposition of
property at the end of a marriage.
• Protect family legacy assets and provide assurance
to the senior generation which may have built the
family wealth.
• Protect family owned or closely held business
interests.
23
• Protect the interests of children from a prior marriage.
• Protect family trusts in a divorce.
• Provide security and certainty to the less wealthy
spouse.
• Simplify and reduce the expense that often
accompanies divorce or litigation upon death of the
spouse.
24
• Waivers of Surviving Spouse Rights
– A marital agreement may govern the rights of the
parties in the event of the termination of the
marriage by death of either party.
– The agreement may include a partial or complete
waiver of property rights arising at death.
– The agreement may also include a promise to
provide for a substitute transfer of property to the
waiving spouse.
3. RIGHTS OF SURVIVING SPOUSE UPON DEATH OF
OTHER SPOUSE
25
– While both parties to a martial agreement may agree to waive – in whole or in part – their respective property rights arising at death, each party remains free to leave more property to the other than would be required by the agreement.
– A release and waiver of “all rights upon death” or equivalent language in a marital agreement encompasses the waiver of several statutorily granted spousal rights and priorities.
26
• Status as Surviving Spouse
– A person who is divorced from a decedent or whose
marriage has been annulled is not a surviving
spouse.
– However a decree of separation does not terminate
the status of husband and wife for death purposes.
A husband and wife are considered married
regardless of whether a divorce action has been
instituted.
– A marital agreement can modify these provisions,
stating specifically that a separation decree or the
filing of an action for divorce terminates all surviving
spouse rights.
27
• Intestate Share of Surviving Spouse
– If a person dies without a will, the decedent’s property will be distributed in accordance with the applicable statute of intestate succession.
– Under many states, the surviving spouse’s share of the intestate estate is dependent upon the circumstances of the parties, including whether there are adult or minor children of the marriage and whether the decedent has adult or minor children from another relationship.
– Under the law of many states, the surviving spouse receives the entire intestate estate (1) when the decedent has no surviving descendants or ancestors or (2) when all of the decedent’s surviving descendants are also descendants of the surviving spouse and there are not other descendants of the surviving spouse who survive the decedent (i.e., it was likely a first marriage for both spouses).
28
• Spouse’s Elective or Statutory Share
– Dower refers to the legal right or interest that a wife acquired in the estate of her husband. It consists of the right to one-third of the husband’s real property. Curtesy is the common law life estate given to a husband in the real property of a deceased wife. Many states have abolished dower and curtesy, replacing these common law rights with statutory rights to an elective or forced share.
– Absent a marital agreement, the surviving spouse has the right to an elective share of the augmented estate. Uniform Probate Code states, such as Colorado, have adopted a right to elect an amount not greater than 50% of the “augmented estate”). Under the Uniform Probate Code, the percentage of the augmented estate to which the surviving spouse is entitled is determined by the length of time the spouses were married, but is essentially as follows:
29
If the Decedent and the Spouse The Elective Share
Were Married to Each Other: Percentage Is:
• Less than 1 year Supplemental amount only
• 1 year but less than 2 years 5% of the augmented estate
• 2 year but less than 3 years 10% of the augmented estate
• 3 year but less than 4 years 15% of the augmented estate
• 4 year but less than 5 years 20% of the augmented estate
• 5 year but less than 6 years 25% of the augmented estate
• 6 year but less than 7 years 30% of the augmented estate
• 7 year but less than 8 years 35% of the augmented estate
• 8 year but less than 9 years 40% of the augmented estate
• 9 year but less than 10 years 45% of the augmented estate
• 10 year or more 50% of the augmented estate
30
• Augmented Estate
– The augmented estate is comprised of property owned by
the decedent at death as well as certain pre-death gifts to
the surviving spouse and to third parties. The augmented
estate is a statutory concept created to prevent
disinheritance of a spouse through transfers to others
while at the same time equitably accounting for inter vivos
and testamentary transfers to the spouse.
• Pretermitted Spouse
– Absent a marital agreement, if a married person dies
having executed his or her will prior to the marriage, and
such will does not provide for the surviving spouse, then
the surviving spouse has the right to take a share of the
estate as a “pretermitted spouse.” The pretermitted
spouse’s share of the estate is generally equal to the
spouse’s intestate share.
31
• Family and Exempt Property Allowances
– Absent a martial agreement, in many states a surviving spouse is entitled to the family and exempt property allowances. These allowances are in addition to the intestate or elective shares. These are generally modest amounts.
• Priority to Serve as Personal Representative or Executor
– In many states, the priority to serve as personal representative or executor is established by the decedent’s will. However, in the absence of a will or if the will fails to nominate someone who can act in such position, the surviving spouse has priority to act. This priority to serve can be waived in a marital agreement.
32
• Federal Law Rights to Retirement Plan Assets
– The survivorship rights in and benefits under qualified retirement plans are governed by federal law, including ERISA and other provisions of the Internal Revenue Code, it is federal law, and not state law, that governs when and how a participant may obtain a valid waiver of survivorship rights and interests in such plans.
– A participant in a retirement plan cannot obtain a valid waiver of spousal survivorship rights prior to the parties’ marriage. Thus, the general waivers of “all rights upon death” or even a specific waiver of rights to a retirement plan, will not constitute an effective waiver of spousal survivorship rights in a retirement plan.
– Waivers in a prenuptial agreement must be coupled with mutual promises to execute separate retirement plan waivers after the parties are married.
33
5. WAIVERS OF SURVIVING SPOUSE ENTITLEMENTS IN
MARITAL AGREEMENTS
• Waiver of statutory and common law rights upon
death.
– A release and waiver of “all rights upon death” or
equivalent language in a marital agreement
encompasses the waiver of statutorily granted spousal
rights and priorities.
– Such waivers can be done in a general waiver or in a
more specific laundry list of waivers.
34
– My laundry list (covering Colorado law) generally appears
as follows:
• “Specific Waiver. Upon the death of either of us, the
other waives the following:
– The right to take an intestate share under Colo. Rev.
Stat. 15-11-102 or 15-11-301;
– The right to an elective share under Colo. Rev. Stat.
15-11-201, and to take any interest in the
augmented estate under Colo. Rev. Stat. 15-11-202;
– The right to an exempt property allowance under
Colo. Rev. Stat. 15 11-403;
– The rights of an omitted spouse under Colo. Rev.
Stat. 15-11-301;
– The right to a family allowance under Colo. Rev.
Stat. 15-11-404;
35
– The right to a homestead interest under Colo.
Rev. Stat. 38-41-201 and 38-41-204 (as to each
other, but not as to third parties);
– The right to act as a personal representative or
trustee of the estate or trust of the other, unless
specifically nominated or designated by the other;
– All rights to any pension plan, profit sharing plan,
deferred compensation plan or retirement benefits
and cash accumulations in life insurance which
have or might have accrued for the benefit of the
other, unless specifically designated as
beneficiary; each of us agrees to execute the
documents necessary to effectuate that waiver as
required by the terms of the pension plan, profit
sharing plan, deferred compensation plan or
retirement benefit plan, state law or federal law;
36
– Any rights to contest any disposition of property by
the other by any inter vivos trust;
– Any provisions of the Colorado Marital Agreement
Act, Colo. Rev. Stat. 14-2-301 through 310 in
conflict with this Agreement; and
– Any rights either of us might have to claim any
portion of the estate of the other under the laws of
any jurisdiction other than Colorado which are of
like or similar purpose to the enumerated Colorado
statutes that provide dower, curtesy, forced
heirship, community property or marital property
interests or any other right to claim against the
estate of a deceased spouse by a surviving
spouse.”
37
• Limitations on Waivers If There Are Children of the
Marriage
– Note, in cases of young couples marrying with family
wealth who do not have children from previous marriages,
sometimes these waivers of rights upon death are
appropriate only if there are no children of the marriage.
– However, if there are children of the marriage, it may not
make sense to have the less wealthy spouse waive “all
rights upon death.” If the wealthier spouse fails to follow
up with estate planning or with proper estate planning, the
less wealthy spouse, now the parent of the children of the
marriage, may be disinherited.
38
• Community Property Waivers
– I practice in Colorado, which has adopted the Uniform
Probate Code state and is not a community property
state. An exhaustive discussion of community property is
outside the scope of this outline.
– Generally, community property is owned by both spouses
equally. Community property does not include property
owned by a spouse prior to marriage, property gifted from
one spouse to the other, property inherited by a spouse
or property which was separate property prior to the time
the spouses moved to the community property
jurisdiction. The titling of property is not determinative of
its status. Earned income of the spouses is community
property. Income from separate property is community
property in some jurisdictions and not in others.
39
– Frequently, parties execute a marital agreement in one state
and move to another jurisdiction. All practitioners should be
careful to draft waivers of rights upon death broadly enough
to cover rights granted in any jurisdiction. A well drafted
waiver of rights upon death will include a specific waiver of
any property rights based on the laws of community property.
– From an estate planning perspective, one benefit of
preserving community property is that the entire property
receives a step-up in basis at the death of the first spouse.
I.R.C. § 1014 (b)(6). Under Section 1014(b)(6), even though
only the decedent spouse’s one-half interest is includable in
his gross estate, the entire community property obtains a
stepped up basis. This is perhaps the greatest advantage of
community property. Because of this advantage, a lawyer
preparing a marital agreement for clients in a community
property state or clients who have migrated from a community
property state will want to consider whether to retain the
community property character of certain assets.
40
6 SUBSTITUTE TRANSFERS IN EXCHANGE FOR
WAIVERS OF SURVIVING SPOUSE RIGHTS
• It is common for parties who enter into mutual
waivers of rights upon death to agree to make
substitute transfer to each other, either during the
marriage or at the time of death. Like most
provisions of a marital agreement, the wealthier
party may seek complete waivers from the less
wealthy party in exchange for certain promised gift
transfers during marriage and/or certain transfer
upon death.
41
– Federal Gift Tax Marital Deduction Issues
• Gifts to a Spouse During Marriage. Transfers to the spouse during the marriage will qualify for the unlimited deduction for gift tax purposes, so long as such transfers are made outright to the surviving spouse or to a qualifying trust. I.R.C. § 2523.
• A gift of a life estate or terminable interest will not qualify for the gift tax marital deduction, unless such transfer is a qualified terminable interest as described in I.R.C. § 2523(f).
• Outright gift transfers are obviously simplest from the perspective of qualifying for the gift tax exclusion. However, clients may be adverse to such outright transfers and may wish to make transfers in trust for the spouse.
• If an inter vivos trust is created for the spouse, be sure the trust qualifies as a QTIP trust. If a QTIP trust is created and funded during the marriage, be sure to make a timely QTIP election. The IRS provides no relief for a late filed QTIP election for an inter vivos QTIP trust.
42
There are several significant advantages of a lifetime
QTIP trust in a marital agreement setting.
- It allows the wealthier spouse to provide an income
stream to the less wealthy spouse during the marriage,
after the wealthier spouse’s death, and in the case of a
divorce (as maintenance).
- At the death of the beneficiary spouse, regardless of
the order of deaths, the trust assets will pass to the
beneficiaries selected by the wealthier spouse
(presumably the children from the first marriage).
- The unified credit and GST exemption of the less
wealthy spouse can be fully utilized, saving the
wealthier spouse’s beneficiaries estate tax.
43
• Cautions. Be wary of provisions which transfer a property to the less wealthy spouse during the marriage, such as title to a residence, but provide that if a divorce were to occur the residence shall revert to the wealthier spouse. This may be attractive from an estate planning perspective and it may be attractive to the less wealthy spouse because she will hold the residence outright (rather than in a marital trust) at the wealthier spouse’s death. However, this arrangement may not qualify for the gift tax deduction as an outright transfer to the less wealthy spouse. Rather it will likely be treated as a terminable interest because the interest transferred to the less wealthy spouse will terminate or fail upon an event (the divorce) and because the donor retains in himself an interest in such property (the right of the property to revert to the donor upon a divorce). I.R.C. § 2523(b).
44
– Also be wary of drafting provisions which require the
wealthier spouse to make transfers during the marriage
or upon termination of the marriage to the children of the
less wealthy spouse. Such contemplated gifts should
qualify for the gift tax annual exclusion (currently
$12,000 or $24,000 if the spouses will gift split) or the
exclusion for payment of certain educational or medical
expenses. I.R.C. § 2503.
45
– Gift Splitting. A marital agreement may request the less
wealthy spouse to agree to gift splitting during the
marriage, thereby allowing the wealthier spouse to
maximize gifting to descendants. Be specific about
whether the less wealthy spouse is consenting to gift
splitting for annual exclusion gifts only or whether he/she
is also consenting to use of his or her lifetime gift tax
exemption.
46
• Federal Estate Tax Marital Deduction
– The substitute transfer of property described in a marital
agreement should qualify for the federal estate tax marital
deduction. If the form of the transfer qualifies for the
unlimited marital deduction, the property transferred will
pass free of the federal estate tax at the transferring
party’s death. When a martial agreement provides for a
marital deduction qualifying transfer, such as a QTIP trust,
the agreement should explicitly allocate liability for the
estate tax arising at the survivor’s death (presumably from
the assets of the QTIP trust).
– The following common forms of testamentary spousal
transfers will qualify for the unlimited marital deduction.
47
• An outright, unrestricted transfer of property;
• A transfer for a qualified terminable interest property
(QTIP) trust;
• A transfer to an estate trust or a power of appointment
trust;
• A transfer to a qualified domestic trust (QDOT) for a
non-citizen surviving spouse;
• A transfer of the right to unitrust or annuity payments
from a charitable remainder trust.
48
• QTIP Trusts
– Estate planners frequently use QTIP trusts to provide for
a second spouse, particularly when a party wishes to
preserve wealth for children of a prior marriage. A
testamentary marital trust, created under the decedent’s
will or revocable trust will qualify for the marital deduction
as a QTIP trust if:
• Property passes from the decedent to the QTIP trust;
• The governing instrument requires all income to be
distributed at least annually to the surviving spouse;
• No other beneficiary may have any rights in the trust during
the surviving spouse’s lifetime; and
• The personal representative or executor makes the
corresponding election on the federal estate tax return filed
for the decedent’s estate. I.R.C. § 2056(b)(7).
49
• The obvious benefit of the QTIP trust is that the
surviving spouse need not be given a general power of
appointment over the trust and therefore may be
prevented from disinheriting the remaindermen of the
trust (presumably, the deceased spouse’s children from
a prior marriage).
• Another advantage of the QTIP trust is that if the
surviving spouse has a minimal estate of his or her
own, the unified credit of that less wealthy surviving
spouse can be utilized for the benefit of the wealthier
spouse’s beneficiaries. The same is true of the less
wealthy surviving spouse’s generation skipping transfer
tax (GST) exemption.
50
– Standards and Guidelines for Principal Distributions.
Provided that the surviving spouse is entitled to the
income from the trust, at least annually, the surviving
spouse need not be given any other beneficial interests to
the principal of the trust. Additional access to principal,
however, is frequently given to the surviving spouse for
health, support, and maintenance. Many times the marital
agreement will specify under what circumstances principal
may be accessed by the surviving spouse.
51
– Selection of Trustees.
• The marital agreement may specify that a third party will serve as sole trustee or as co-trustee with the surviving spouse to ensure better protection to the trust assets for the remainder beneficiaries.
• “Neutral” trustees and successor trustees are generally advisable. The surviving spouse as sole trustee generally provides less protection to principal than the deceased spouse may want.
• On the other hand, a child of the decedent (the step-child of the surviving spouse) as trustee may cause family discord.
• A surviving spouse might be allowed to select a trustee among a group of mutually agreeable potential trustees.
• Or, a surviving spouse could be authorized to appoint an institutional trustee.
52
– Selection of Assets.
• The marital agreement may provide specific directions
with regard to what assets will be directed into the
QTIP trust for the benefit of the surviving spouse.
• If there is a closely held business, both spouse’s may
favor terms prohibiting such closely held stock from
passing to the QTIP trust.
• If the wealthier spouse holds promissory notes from
children, the less wealth spouse may want to include a
provision specifically prohibiting those types of assets
from being used to fund the QTIP trust.
53
– Residence.
• Frequently, the marital agreement will address the use
and disposition of the residence by the non-owner
spouse after the death of the owner spouse.
• If the residence is transferred to the QTIP trust, it will
be important to include provisions in the QTIP trust so
that the surviving spouse’s rights to the residence will
constitute the necessary qualifying income interest (i.e,
the surviving spouse must have the right to demand
that unproductive property be made productive).
54
• Use of Life Insurance in Conjunction with a Marital
Agreement
– Some parties to a marital agreement favor a waiver by the
less wealthy spouse of all rights upon death of the
wealthy spouse coupled with a death benefit paid to the
surviving spouse pursuant to a life insurance policy.
– If the wealthy spouse owns the policy and designates his
or her spouse as the beneficiary, the policy proceeds will
be included in the decedent’s estate, by will qualify for the
estate tax marital deduction.
– If the surviving spouse is both the owner and the
beneficiary of the policy, the policy proceeds will not be
included in the decedent’s gross estate.
55
– The parties to the marital agreement may want to address
specifically what type of policy is to be acquired to satisfy the
provisions of the agreement. Term insurance vs. permanent
insurance.
– The parties to the agreement also may want to specify that
the beneficiary spouse be the owner of the policy.
– The agreement should specifically address which party will
have the obligation to pay the premiums.
56
– If you represent the beneficiary spouse, consider drafting
a backstop provision which will give the surviving spouse
a right to claim against the decedent’s estate if, for any
reason, such insurance is not in place at the death of the
spouse whose life was to be insured.
– Consider using a QTIP trust or an irrevocable life
insurance trust as the beneficiary of the insurance policy if
the wealthy spouse wishes to have the policy proceeds
remaining after the surviving spouse’s death pass to his or
her children from a previous marriage.
57
• Joint Tenancy
– Clients should be advised regarding the implications of joint
tenancy and the possibility of defeating all of the careful
planning for death in the marital agreement by holding
property as joint tenants with rights of survivorship.
– Consider including a provision in the marital agreement
which gives the wealthier spouse credit for joint tenancy
transfers against any required devises to the surviving
spouse. I generally include the following language:
58
• “Effect of Jointly Held Property, Beneficiary
Designation Property, or Transfer on Death Property
Payable to Joe. If Jane predeceases Joe, the
obligation to provide Joe with an outright disposition of
cash or marketable securities having a fair market
value of $500,000 under paragraph ______ shall be
deemed satisfied to the extent of the date of death
value of any cash or marketable securities passing by
beneficiary designation or transfer on death
designation and to the extent of one-half of the date of
death value of cash or marketable securities passing
by joint tenancy or tenancy by the entireties as a result
of Jane’s death.”
OR
59
“If Jane predeceases Joe, the obligation to provide Joe
with $2,000,000 in a marital trust under paragraph ____
shall be deemed satisfied to the extent of the date of
death value of any property passing by beneficiary
designation or transfer on death designation and to the
extent of one-half of the date of death value of joint
tenancy or tenancy by the entireties property passing to
Joe as a result of Jane’s death. If the value of property
passing to Joe by beneficiary designation, transfer on
death designation, joint tenancy or tenancy by the
entireties should exceed the required amount payable to
Joe pursuant to paragraphs _____, then Jane’s estate
shall have no further obligation to Joe under this
Agreement, nor shall Joe have any obligation to return
funds to Jane's estate.”
60
7. DIVORCE AND TRUSTS – PROTECTING TRUSTS IN
A MARITAL AGREEMENT
• The development of the law in most states regarding
treatment of interests in trusts as property for
purposes of property division in a dissolution
proceeding has been quite varied and, at times,
inconsistent.
• It is critical that the drafter of prenuptial agreements
understand the law of his or her state which governs
treatment of trusts in divorce.
61
• Best to address all trusts of which your client is a
beneficiary (even a remainder beneficiary) in the marital
agreement to ensure that those trust interests are not
subject to litigation if the marriage ends in divorce.
Bottom Line: Your client should have a prenuptial
agreement if he or she is the beneficiary of trusts.
62
8. DISCLOSURE OF ASSETS, LIABILITIES, INCOME,
AND BENEFICIAL INTEREST IN TRUSTS
• In order for a prenuptial agreement to be
enforceable, each of the parties to a marital
agreement will need to make full financial disclosure.
Each party should prepare (or have prepared) the
following:
– A net worth statement, detailing with reasonable
accuracy all assets, liabilities, financial obligations,
and net worth. Hard to value assets such as closely
held business interests, should be valued on a
reasonable basis if no formal valuation exists. The
basis for such “reasonable estimate” should be
provided to the other party and his or her counsel.
63
– Income information for the last three years.
– All beneficial interests in trusts should be disclosed, even
if your client is a remote or remainder beneficiary. A
copy of the trust agreement and a detailed statement
regarding the assets of the trust should be included.
• These should be provided to each party and the
attorneys. They will also be attached as exhibits to the
prenuptial agreement.
• Failure to disclose adequately is a significant ground
for challenge of marital agreements. Err on the side of
over disclosure.
64
9. TREATMENT OF DEBT
• Generally, prenuptial agreements define separate
and marital debt, so that if there were to be a
divorce, it is clear how debt should be allocated.
– Generally, all debt which one party enters the
marriage with is defined to be his or her separate
debt, and vice versa.
– You would then want to define debt which is incurred
during the marriage as either separate debt or joint
debt, depending on the nature of the debt, and the
clients’ expectations for how that debt will be treated.
65
10. COORDINATION OF ESTATE PLANNING
DOCUMENTS WITH THE MARITAL AGREEMENT
• Maintenance of Testamentary Documents
– If the marital agreement requires that wills, trusts,
beneficiary designations, deeds, or other documents be
prepared to reflect the agreement reached, this can be
done by one of two methods: (1) the marital agreement
can be drafted as a specific roadmap which will contain the
essential terms of the documents that will be prepared at a
later date, or (2) the marital agreement can include
concurrently prepared and executed documents as exhibits
to the agreement.
– If the parties execute a marital agreement which provides a
general waiver or “all rights upon death” or similar
language, be sure to advise your client to maintain updated
estate planning documents after the marriage if your client
does in fact wish to leave property to the spouse.
66
• Enforcement for Breach
– If the marital agreement requires a spouse to devise
property to the surviving spouse, the agreement constitutes
a contract to devise property.
– Be sure to consult your state laws regarding contracts to
make a will or devise to ensure that the marital agreement
satisfies any specific requirements.
– The surviving spouse would then be treated as a claimant
against the decedent’s estate and would have to comply
with the claims statutes.
– If you represent the spouse who is to receive the devise in
accordance with the marital agreement, consider including
language which extends the surviving spouse’s time for
making a claim and which reimburses the surviving spouse
for attorney’s fees incurred in connection with the claim.
67
• New Estate Planning Clients – Verify Whether a Marital
Agreement Exists
– New estate planning clients may not mention the existence
of an old marital agreement. Estate planning attorneys
should specifically confirm with clients whether or nor a
marital agreement exists, and if one does, obtain a copy.
– Have a discussion with both spouses about whether a joint
representation makes sense in light of the marital
agreement or whether one party may want to engage
separate counsel to review the estate planning documents
on his or her behalf.
68
• Estate Planning Clients with Grown Children
– When preparing estate planning documents for wealthy
clients with grown children, consider having a discussion
with those clients regarding whether the children have or
should have marital agreements in place. This may
affect whether a client decides to leave property outright
or in a lifetime trust to an adult child.
ESTATE PLANNING FOR SECOND
MARRIAGES AND BLENDED FAMILIES
Tax Issues Unique to the Blended Family
and Structuring Estate Plans Using Trusts
Kristin A. Pace, Esq.
Fitzgerald Abbott & Beardsley LLP
1221 Broadway, 21st Floor
Oakland, California 94612
(510) 451-3300
November 13, 2012 #483564
Tax Issues Unique to the Blended Family
Where we today now that the election
is over?
• President Obama’s Estate / Gift Tax
Wish List
• Working with What We Have
70
Tax Reform Act of 2010 (the “Act”)
• Increased Exemption
• Portability – Is this still a viable
planning option?
• Planning for the sunset of the Act at the
end of 2012
71
72
Tax Reform Act of 2010 (the “Act”)
Increased Exemption
• Formula funding problems
• Under-funded spouse
• Gift splitting
73
Increased Exemption
• Formula funding problems
Beware of unintended results
Depending on who the beneficiaries of the bypass
trust are, spouse or children could wind up with a
reduced share of the trust estate
Economic volatility can affect beneficial interests in
the QTIP trust and the bypass trust depending on
type of funding formula utilized (i.e. pecuniary
marital vs. pecuniary bypass)
74
Increased Exemption
• Under-funded spouse
Outright gift to spouse during lifetime does
not work well in the blended family setting
Transmutation Agreements
Lifetime QTIP trust as an alternative
Ethical issues
75
Increased Exemption
• Gift splitting
Annual exclusion planning
Exemption planning
Ethical issues
76
Tax Reform Act of 2010 (the “Act”)
Portability
• Very limited applicability, but could work well if
underfunded spouse dies first
• Remarriage: portability only applies to the last
deceased spouse’s unused exemption
• Expires December 31, 2012
• Need to file 706 in order to take advantage of
portability regardless of estate value
77
Tax Reform Act of 2010 (the “Act”)
Planning for the sunset of the Act at the
end of 2012
• Planners should revisit the use of formula
clauses to avoid unexpected results
• In the immortal words of Yogi Berra, we
may be facing “déjà vu all over again”
78
Planning for the sunset of the Act at
the end of 2012
What “déjà vu all over again” could look
like:
December 2012 may look a lot like
December 2010
Polarization in Congress could also result
in delays
79
Use of Trusts in Creating Blended
Family Estate Plans
• QTIP trusts: testamentary and lifetime
• Bypass trusts
• Alternative trusts
• Who should act as trustee?
80
Use of Trusts in Creating Blended
Family Estate Plans
• QTIP trusts: testamentary and lifetime
All income to surviving spouse: accounting income vs. net taxable income
Disadvantage: No other current beneficiaries allowed
Funding issues: partnership interests, IRAs, non-income producing assets
Should surviving spouse be given limited power of appointment?
81
Use of Trusts in Creating Blended
Family Estate Plans
• Bypass trusts
Who should be the beneficiaries? Spouse
Children
Sprinkling trust
Funding issues Legacy assets if children are beneficiaries
82
Use of Trusts in Creating Blended
Family Estate Plans
• Alternative trusts
Spousal Limited Access Trusts
Irrevocable Life Insurance Trust
Non-Charitable Unitrust
Charitable Planning
Intentionally Defective Grantor Trusts:
Planning for the Family Business
• Spousal lifetime access trust (“SLAT”) provides one method to “lock-in” at least one spouse’s $5 million gift tax exemption
Consider Spousal Lifetime Trust for 2012 Planning for Second Marriages
83
Spousal Lifetime Access Trust
SMITH FAMILY 2012
IRREVOCABLE TRUST (“Bucket”)
Distributions can be made for
benefit of Spouse, Children,
and their Descendants
Lifetime 2012
Trust for
Child #1
Upon termination of the Smith Family
2012 Trust, property would be divided
into equal shares for Children
Lifetime Trusts
for Child #1's
Descendants
Lifetime 2012
Trust for
Child #2
Lifetime Trusts
for Child #2's
Descendants
84
• One spouse (in this example, Husband) would be the creator (“settlor”) of the SLAT
• The SLAT would be established primarily for the benefit of Wife and the Children
• For a second marriage, it is recommended that a person other than Wife would be Trustee of the SLAT for purposes of making distributions to Wife; Wife could be Trustee of the SLAT for purposes of making distributions to the Children
Structure of the SLAT
85
• Trustee has the sole and absolute discretion to make distributions to Wife during her lifetime
• Trustee would be prohibited from making distributions that would satisfy Husband’s support obligation (which attaches by reason of their marriage)
• Trustee would be prohibited from making distributions to wife if marriage terminated by divorce
Structure of the SLAT
86
• Distributions could also be made to the Children or Grandchildren
• The trust instrument could give Wife a testamentary special power of appointment, but only among Husband’s descendants
Structure of the SLAT
87
Benefits of Using a SLAT
• Husband “locks-in” the use of his $5,120,000 gift and GST tax exemptions while still giving Trustee significant flexibility in distributing assets for the benefit of Wife
• By using the gift tax exemption now, all future income and appreciation attributable to the SLAT is also removed from Husband’s gross estate
• SLAT can grow tax free, as it is a grantor trust, so husband will pay the SLAT’s income tax liabilities.
• As a grantor trust, husband can substitute assets between himself and the SLAT with no capital gain
• As a grantor trust, husband can pay rent for the use of SLAT assets with no income tax consequences.
88
• Though the gifted assets would be held in trust, such assets would still be available to Wife if a financial need arose
• Flexibility is maintained through Wife’s Power of Appointment
Benefits of Using a SLAT
89
• The trust could be structured, if desired, as a “grantor trust;” if structured this way, the SLAT assets will grow, from the Children’s point of view, tax free
• Husband could also allocate his $5 million federal GST tax exemption to the SLAT
Benefits of Using a SLAT
90
Risks & Other Considerations
• A SLAT is not tax-efficient if cash flow from the gifted assets is needed for day-to-day living
• A SLAT should typically be funded only with assets a couple is comfortable giving away
• No distributions may be allowed to Husband
91
• Is it possible for both Husband and Wife to create SLATs?
• Technically possible to create two SLATs, but it is generally not advisable because of “reciprocal trust” doctrine
Risks & Other Considerations
92
Risks & Other Considerations
Mortality
• If Husband and Wife create a SLAT, Wife’s mortality risks should be considered
Divorce
• Similarly, the potential effects of a future divorce should be carefully considered before creating a SLAT
• Draft for termination of Second Wife’s rights if a divorce occurs
93
94
Alternative Trusts
Irrevocable Life Insurance Trust
• Create an inheritance for spouse or children
• Especially useful when second spouse is
close in age to children from first marriage
• Advantage: No estate tax on proceeds if
trust is properly structured
• Disadvantage: Inflexibility if spouse is
named as beneficiary
95
Alternative Trusts
Non-Charitable Unitrust
• Advantage: Can help to alleviate tension
between income and remainder
beneficiaries
96
Alternative Trusts
Non-Charitable Unitrust Sample
Provision:
“The Trustee shall pay to or apply for the benefit of
the Surviving Spouse each year the greater of (a)
the entire net income from the Marital Trust or (b)
four per cent (4%) of the fair market value of the
Marital Trust determined as of the end of the
preceding year, in monthly or other convenient
installments as the Surviving Spouse may request,
but in no event less often than annually.”
97
Charitable Planning
• Charitable Lead Trusts: “Jackie O Plan”
• Charitable Remainder Trusts
Alternative Trusts
98
Intentionally Defective Grantor Trusts:
Planning for the Family Business
• Can be used for succession planning (i.e. transfer
of business to the next generation)
• Advantages:
Spouse is entitled to income stream from
Promissory Note
Spouse’s status is reduced to that of a creditor
Children are left to manage the business without
interference from spouse
Alternative Trusts
99
Intentionally Defective Grantor Trusts
• Disadvantages
Complex planning transaction
Business must have cash flow to support the
Promissory Note
Alternative Trusts
100
Use of Trusts in Creating Blended
Family Estate Plans
• Who should act as Trustee?
Need to consider the purpose of the
trust
Need to consider the make up of the
trust beneficiaries
Consider corporate or professional
fiduciary
101
Use of Trusts in Creating Blended
Family Estate Plans
• Who should act as Trustee?
Why is this important?
Trustee chooses the team
Lawyer
Investment advisor
CPA
Trustee makes tax elections
Trustee funds the trust
Trustee invests trust assets
102
Issues Relating to Children
Title to Assets
Joint Tenancy
Without survivorship
With survivorship
Payable on Death or Transfer on Death
Provisions
John T. Midgett, Shareholder
Midgett & Preti
Issues Relating to Children
Gifting
Does the creation of a post-marital agreement
binding the surviving spouse to provide for the
decedent’s child create a gift transaction?
See PLR 201116006 and 201216005
103
104
Issues Relating to Children
Beneficiary Designations
Life Insurance
Annuities
Qualified Retirement Plans
Outright payment
Conduit Trusts
John T. Midgett, Shareholder
Midgett & Preti
105
Issues Relating to Children
“Anti-Vulture” Distributions
Leaving assets to children at death may eliminate
potential conflict between the children (especially
those from a prior marriage) and the surviving
spouse by minimizing the necessity for the
children to circle the spouse like vultures awaiting
his/her death to “get our rightful inheritance”.
John T. Midgett, Shareholder
Midgett & Preti
106
Issues Relating to Children
Outright Distribution v. Use of Trust
Structuring Distributions in Trust
“Pot” or Common Trusts v. Separate shares
Handling great diversity in ages of children
Distributions upon attaining certain age
Distributions at specified dates
Who should control?
John T. Midgett, Shareholder
Midgett & Preti
107
Issues Relating to Children
Child as an Agent under a Durable Power of
Attorney
Conflicts with surviving spouse
Conflicts with other siblings – Whole/Half/Step
Compensation Issues
Communication/Reporting
John T. Midgett, Shareholder
Midgett & Preti
108
Issues Relating to Children
Child as an Agent under Advance Medical
Directive
Conflicts with surviving spouse
Conflicts with other siblings – Whole/Half/Step
Dealing with the Emotional Issues
Communication/Reporting
John T. Midgett, Shareholder
Midgett & Preti
109
Issues Relating to Children
Child Acting as Trustee of Trust
Control over the surviving spouse’s share?
Conflicts of Interest?
Contempt?
Communication issues
Compensation Issues
John T. Midgett, Shareholder
Midgett & Preti
110
Issues Relating to Children
Child as Executor
Many of the same problems as serving as
Executor
Requires resident of state where Decedent lived
Probate as a public forum for family disharmony
John T. Midgett, Shareholder
Midgett & Preti