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Mark J. Welch
Attorney at Law
Estate Planning, Probate & Trust Law
5820 Stoneridge Mall Road, Suite 100
Pleasanton, CA 94588-3275
(510) 462-8483
(510) 417-1331 fax
www.ca-probate.com
February 1, 1996
February 1, 1996
John and Mary Smith
123 Main St.
Pleasanton, CA 94566
Re:Estate Planning; Estate Tax and Probate Fee Projections
Dear Mr. and Mrs. Smith:
I am writing to follow up on our meeting last week. The purpose of this letter is to summarize some of the matters we discussed during that meeting, and to identify various issues regarding your estate planning situation. This should help you decide what step to take next.
In addition, by "echoing" the information I heard, I hope you can both review it and correct any misunderstandings, to avoid later confusion.
Your Property
The table on the following page is intended to summarize the information you provided during our meeting, and to identify the values that would apply for probate and estate tax purposes after both of you have died. Most of the numbers you provided were rough estimates, and you had never attempted to assign any value to your interest in the two businesses.
{table goes here - table contains financial/property data (with separate columns identifying (1) net worth while alive, (2) property subject to probate at the second death, and (3) property subject to estate tax at the second death}
Your Family and Goals:
You have been married for three years. You have one child, Molly Smith (age 16 months), and you are expecting another child soon.
When we met, you indicated that your main goal is to have your affairs in order - mainly to prepare wills to provide for your family if either of you died unexpectedly.
Summary Analysis
Based on the above information, it seems clear that you face potential estate tax exposure under current tax law. In addition, I have serious concerns about whether a substantial portion of your estate will also be subject to probate upon either or both deaths, unless you create and implement a revocable living trust.
The main estate-planning issues for you to address are (1) reducing or deferring federal estate taxes; (2) considering whether to take steps to avoid probate at each death; and (3) the potential for obtaining a 100% "adjusted basis" on your residence and investment accounts when the first of you dies, in order to avoid capital-gains taxes if the survivor needs to sell that property.
Because you own a 50% interest in two businesses, I would strongly recommend that you consider developing a plan to take effect in the event that either co-owner dies or becomes incapacitated. Normally, such a plan would include a combination of written agreements (such as a buy-sell agreement) and insurance (including life insurance and disability insurance). In any event, I strongly recommend that you consider whether you need life insurance to provide for your family in the event either of you died while your children are young.
Current or Prior "Estate Plan"
My understanding is that neither of you has ever prepared a will or any other estate-planning documents. Therefore, your property would pass according to California's "intestate succession" laws. Under those laws, all "community property" would pass to the surviving spouse, and one-third of the deceased spouse's "separate property" would pass to the surviving spouse and the other two-thirds to your children. My general understanding is that Mary does not have any significant "separate property," so that if she died first, all of her property would pass to John. However, John owned the business for some time before your marriage, and provided funding for his SEP-IRA before marriage, so that would be considered "separate property" which would be divided by Mary and the children if he died first. Of course, if you both died, all property would pass to your children; if you did not die simultaneously, then there would probably be a federal estate tax due if the survivor's estate exceeded $600,000.
Any property passing to your children would be subject to a court-supervised "guardianship of the estate," even if one parent survives.
Estate Taxes
Currently, federal and California estate taxes apply only to estates which exceed $600,000 in value, and exclude bequests to a surviving spouse. The Republican "Contract With America" pledges to raise this to $700,000, and to index that amount to inflation; as I write this, it is unclear whether this provision will be included in the new budget act.
Because you have never attempted to assign a value to your business and have no intention of selling it, it is very difficult for me to project what estate tax liability you may face in the future. In addition, I assume that your estate will continue to grow rapidly in the future, and that you are unlikely to die for many years.
There is no estate tax on any property passing to a surviving spouse; therefore, there should be no estate tax owed when the first of you dies. However, at the second death, there would be an estate tax on the survivor's estate if its value is greater than the applicable exemption amount (currently $600,000). The tax starts at a marginal rate of 37% for amounts above $600,000 through $750,000, and gradually rises to a maximum rate of 55%.
If your business interests were valued at $100,000 each, then the total value of your estate would be $671,000; if the survivor of you died owning that amount, there would be a federal estate tax of about $26,000. Obviously, the value of your business will directly affect the amount of the federal estate tax.
However, if some property were left directly to your children, or to a trust that "captures" the first spouse's estate-tax exemption amount after the first of you dies, then that property would not be taxed at the second death. In addition, any appreciation would be taxed only as a capital gain and not as part of the survivor's estate subject to much higher federal estate taxes.
Given your uncertainty regarding the value of the business, I do not think it would be advisable to create an estate plan that creates a "mandatory" exemption trust. However, I strongly recommend that you implement a "wait and see" estate plan that would permit the surviving spouse to review their situation after the first death, and to "disclaim" property which could then pass into an exemption trust, thereby providing tax planning as an option if the total estate value is substantial after the first death.
Probate
Formal probate proceedings are not required for property which passes to a surviving spouse. However, probate is normally required for property passing to an "exemption trust" at the first death in a married couple. At the second death, virtually all of the survivor's property would be subject to formal probate administration proceedings. In determining the value of property subject to probate, debts are not counted.
However, formal probate is avoided for property which passes automatically at death. For example, your IRA accounts will pass directly to the named beneficiary. Further, if you create a revocable living trust and transfer your property into that trust, it will not be subject to probate at your death.
As shown in the table on page 2, the total value of your estate subject to probate after the second death would be about $776,000 plus the value of your interest in the two businesses.
Probate fees for an estate of $776,000 would be $16,670 for the executor plus another $16,670 for the estate attorney, for a total of $33,340. However, it is possible that the executor would waive all or a portion of their fee, and the attorney's fee is negotiable and would probably be somewhat lower.
In addition to probate fees, there are substantial delays (a minimum of five months, and typically 8 to 12 months) while the probate proceeding works its way through the court. While there are special procedures to permit distributions from the estate during administration, it is generally preferable to avoid probate entirely by creating a revocable living trust that provides for orderly disposition and management of property after death.
However, a revocable living trust adds complexity and "hassles" to your ongoing ownership and management of your property. If you create a revocable living trust, you must transfer title to your real estate and investment accounts (except IRAs) into your names as trustees of your trust. I generally do not recommend living trusts for young couples who anticipate frequent "transitions" (such as the birth of additional children, possible moves to larger homes, rapid growth of savings, and probable changes in business assets). In short, the cost and hassles associated with a living trust are simply not justified by the very low risk that either or both of you will die in the next decade or two.
For these reasons, I am not recommending that you establish a revocable living trust at this time. However, you must keep in mind that as your situation changes - especially as your net worth increases - you should regularly review your situation, with the understanding that at some time in the next 20 years or so, you will probably establish a revocable living trust. Of course, if either of you dies or is diagnosed with a serious illness, you should promptly implement a revocable living trust.
Community Property & Adjusted Basis
I do not have a copy of your deed to your residence, but I assume that you own your home as "joint tenants." In addition, I assume that most of your investment accounts are owned in "joint tenancy."
There is already some deferred capital gain in your residence; we did not discuss whether there may be additional deferred gains from prior homes that either or both of you have owned.
If one spouse dies, and title is held in "joint tenancy," then the survivor will own the entire home, and the portion inherited from the deceased spouse will receive an "adjusted basis" - so that the inherited half is treated as if it were purchased for fair market value on the date of death. The effect is to wipe out half of the gain on the residence. However, if the survivor must then sell the home, there will still be a taxable capital gain. (Often, this gain is offset by the once-in-a-lifetime exclusion of up to $125,000 in gains, available to persons over age 55; the entire gain could also be "rolled over" into a replacement home.)
However, much more favorable tax treatment is available to property which is owned as "community property," because the IRS grants such property a 100% adjusted basis, rather than only half. For this reason, it might be appropriate to change the title to your home and joint securities accounts, to insure that it obtains the maximum tax benefits at either death.
However, any such "transmutation" would affect your rights in the unlikely event of a divorce. In addition, "community property" is not automatically transferred, but its transfer to the survivor must be confirmed through a probate proceeding or "spousal property petition."
Life Insurance
My understanding is that currently, neither of you has any life insurance. I strongly recommend that you consult with a financial planner and/or life insurance agent and discuss the benefits and cost of obtaining life insurance. I am quite concerned that in the event either of you died, there would be a substantial impairment of your family's lifestyle. If John died, I assume that virtually all income would be lost; if Mary died, there would be substantial expenses for child care, combined with a loss of income as John spent less time at work.
If you do buy life insurance, I would generally recommend that Mary own any insurance on John's life, and John should own any insurance on Mary's life, to prevent life insurance proceeds from being included in the estate subject to federal estate taxes at the second death.
Business Issues
You indicated that you maintain your corporate records carefully and that you have been involved with a number of attorneys as a result of business-related lawsuits. As you know, it is extremely important that you maintain "corporate formalities," such as holding meetings and electing officers, in order to maintain the protections offered by the corporate structure.
When I do estate-planning work for a client who owns a closely-held business, I usually request that they bring me your corporate minute book or "binder" so that I may briefly review it and make any suggestions and comments. While I do not assist clients in maintaining corporate records or other business legal work, I do believe it appropriate to review the corporate binder so I may know whether I should recommend that you consult with a business attorney for any reason.
At this time, I strongly recommend that John and the co-owner of the businesses consider whether to prepare and implement a corporate "buy-sell" agreement that would require or permit either owner to buy out the other's widow in the event of death. Such an agreement could be funded with life insurance, or could be designed to specify a long-term stock repurchase plan. In addition, you should evaluate whether either or both owners should maintain long-term disability insurance or other insurance to address the long-term corporate consequences of the disability of either co-owner.
Summary and Recommendations
It seems likely that your estate would be subject to federal estate taxes after you both die, but that these taxes can be reduced, deferred, and probably completely eliminated by establishing an "exemption trust" at the first death. I recommend that you retain me to draft documents that will leave all property to the surviving spouse at the first death, with an added provision that any "disclaimed" property would pass instead to an "exemption trust" to reduce the taxes that would otherwise be owed at the survivor's later death.
You also face substantial probate fees and delays at the second death (and at the first death, if an "exemption trust" is created), unless you create and implement a revocable "living trust" or some other technique to avoid probate. However, because you are young and healthy and expect many more changes in your life, I do not recommend that you prepare and implement a revocable living trust at this time.
At this time, I recommend that you retain me to prepare wills, durable powers of attorney, and health care powers of attorney. My fee for this work would be ${fee}. This fee would include my work on the following tasks:
Please review the enclosed "Attorney's Engagement Agreement" and "Memorandum Regarding Joint Representation." If you have any questions or comments regarding these documents or this letter, please call me at your earliest convenience. If you are satisfied with these documents, please sign them and return one copy of each with your check, and I will then prepare and send you a draft of the new trust and wills.
If you have any questions about the matters we discussed in our meeting, or any issues raised in this letter, or any other estate-planning issues, please contact me at your earliest convenience.
Sincerely yours,
Mark J. Welch