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Planning & Communicating Health Care Decisions
& Surrogate Decision-Making

Planning and Communicating Health Care Decisions and Surrogate Decision-Making

As we live longer, we face an increased likelihood of physical or mental disability.  In our last article, we focused on financial management planning alternatives for persons confronted with potential health crises and incapacity.  While financial management is important to assure the resources to carry through life and to pass on to loved ones, planning for nonfinancial issues may have even greater personal impact.  Whatever your resources, they may be ineffective if you don’t properly plan and designate future caretakers who will make the types of personal and health decisions you want made.  In this article, we address how personal health care decisions can be legally and effectively communicated.

Advance Directives for Health Care

Under common law, absent a public interest otherwise, we each have a right to determine who can touch our body or not touch our body at any given time.  For the purposes of deciding among health care alternatives, Maryland law provides that “[a]ny competent individual may, at any time, make a written or electronic advance directive regarding the provision of health care to that individual, or the withholding or withdrawal of health care from that individual.  Notwithstanding any other provision of law, in the absence of [such] a validly executed or witnessed advance directive, any authentic expression made by an individual while competent of the individual’s wishes regarding health care for the individual shall be considered.”  Note however that, for your wishes to be considered when you can no longer communicate, they should be spelled out in writing so that they can be read by health care providers without involvement of a court, or, if court involvement becomes necessary, so that the court has proof upon which to make a decision.

As Justice William Brennan noted in his dissent in the Supreme Court’s landmark 1990 Cruzan decision, “Medical technology has effectively created a twilight zone of suspended animation where death commences while life, in some form, continues.  Some patients, however, want no part of a life sustained only by medical technology.  Instead, they prefer a plan of medical treatment that allows nature to take its course and permits them to die with dignity.”  If you wish to limit or eliminate artificial measures to prolong your life, you will want to execute a type of advance directive called a “Living Will Declaration”.  In effect, a Living Will Declaration is an advance directive that, in certain defined situations, health care should be withheld or withdrawn.  Maryland law facilitates such communication by defining common instances for such decisions in the event that you suffer a “persistent vegetative state”, “end-stage condition”, or “terminal condition” so that health care providers have a common understanding as to what these terms mean.  While you may wish to specify other situations where you don’t want your life prolonged by artificial measures (such as if you become a paraplegic) or you may wish to modify the Maryland definitions (such as to define the word “imminent” in the State’s definition of “terminal condition”), these definitions become a good starting point for expressing your intent about end-of-life treatment in a manner that others will understand.

In addition to living will declarations, Maryland and other states now require health care facilities to maintain a “Medical Order for Life-Sustaining Treatment” (commonly known as a “MOLST”) as a part of a patient’s medical records.  A MOLST is a written medical order signed by a physician, physician’s assistant, or nurse practitioner concerning the use of life-sustaining procedures, use of medical tests, patient transfers from a hospital to a nonhospital setting, and other appropriate treatment matters across various health care settings.  By law, the MOLST is supposed to be consistent with the patient’s known decisions and advance directives (and the decisions of his or her health care agent or surrogate decision maker) so it is important that you provide copies of all of your advance directives for care to your health care facility upon entry.  It is generally a good idea to review and prepare a MOLST form ahead of time to go over the decisions to be made at the health care facility’s MOLST interview.  (You can download one of these forms from our website at http://thewrightfirm.net/forms/.) My experience is that if a competent patient has completed a reasonably contemporaneous MOLST worksheet, that will be the basis of the one ultimately entered at the health care facility.  Such a completed written MOLST worksheet is itself also an effective written advance directive regarding your wishes about your health care or the withholding of health care.

Advance Directives for Surrogate Health Care Decision-Making

Since it is virtually impossible to anticipate all the potential health care decisions that might need to be made were one to become incapacitated, it is important to designate a surrogate to make those decisions in the manner that you would want them to be made.  In this regard, Maryland law authorizes “[a]ny competent individual . . ., at any time, [to] make a written or electronic advance directive appointing an agent to make health care decisions for the individual under the circumstances stated in the advance directive.”  When making an advance directive to appoint a health care surrogate, be sure to designate alternative agents to act in this capacity in case one designated surrogate is unable or unwilling to act.  Both primary and alternative health care agents may be appointed to act together as co-agents, individually by themselves, or consecutively in a line of succession.

Unless otherwise provided in the document, an advance directive by law only becomes effective when the declarant’s attending physician and a second physician certify in writing that the patient is incapable of making an informed decision.  “Incapable of making an informed decision” means the inability of an adult patient to make an informed decision about “the provision, withholding, or withdrawal of a specific medical treatment or course of treatment because the patient is unable to understand the nature, extent, or probable consequences of the proposed treatment or course of treatment, is unable to make a rational evaluation of the burdens, risks, and benefits of the treatment or course of treatment, or is unable to communicate a decision.”  Know therefore that, in naming a health care agent, you are not giving up the right to make your own decisions.  You retain that authority until two doctors determine that you can no longer make informed decisions for yourself or unless you designate other circumstances as to when you want your nomination to become effective.  Should you choose to do so, you may designate persons (such as family members) other than physicians to decide when the designation takes effect.

If you fail to designate who you want to make health care decisions for you when you can no longer make informed decisions and the need for a surrogate arises, Maryland law provides a priority list for who is entitled to be your decision-maker in this order: your guardian, if one has been appointed; your spouse or domestic partner; an adult child; your parent; your adult brother or sister; or another friend or relative who demonstrates specific facts and circumstances that show regular contact and familiarity with your activities, health, and personal beliefs.  Individuals in one particular class may be consulted to make a decision only if all individuals in the next higher priority are unavailable.  Since the first priority class is a guardian appointed by a court, it is generally always better to name who you want to serve in an advance directive rather than to leave such a court appointment to chance.

HIPAA Authorizations for Release of Protected Health Information

In 1996, Congress passed a law entitled the Health Insurance Portability and Accountability Act (“HIPAA”) that limits the use, disclosure, or release of a patient’s “individually identifiable health information”.  While the main purpose of HIPAA was to help consumers maintain health insurance coverage as they changed locations and jobs, Congress was concerned that in doing so, it was increasing the likelihood for inadvertent disclosures of private health information as people moved around.  Congress decided that such disclosures could only be avoided if harsh penalties were imposed on health care providers who released individually identifiable health information without explicit patient authority.  HIPAA’s success and the resulting provider reluctance to release health information to persons other than their actual patient make it important that, in addition to declaring who you want to be your surrogate decision-makers, you authorize them to obtain individually identifiable health information about you.  A written Authorization for Release of Protected Health Information (or “HIPAA Waiver”) is a means to make sure that your designated surrogate can obtain the information necessary to make meaningful decisions.  Very often, the designated surrogate will need to get health care information about you from many different sources, not all of whom know your particular current circumstances.  A HIPAA Waiver is a proactive approach to making sure such health care information will be available to your health care agent from sources who otherwise fear being hit with a large fine for disclosure.  In addition, you may wish to allow family members to have individually identifiable health information about you to provide them with information about inherited health conditions.  Therefore, make sure that your HIPAA Waiver names both your designated health care agents and such family members and that the HIPAA Waiver survives your death.

 

The common thread here is that federal and Maryland law provide for and encourage you to plan and communicate your wishes in advance about how your personal health care decisions should be made if you are incapable of doing so at a later time.  We encourage you to think about and make these decisions now rather than to risk never addressing them.  As you can see, there are many tools available to document your wishes in writing so you can make sure they are available and understood when the need arises.  As always, I will be happy to discuss your future health care wishes with you and how available legal documents can insure that your expectations will be carried out.

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Surrogate Financial Management Planning with Powers of Attorney
and Revocable Trusts

In our last article, we focused on the importance of lifetime planning for Mature Single Individuals and some of the impediments they face in accomplishing such planning.  This article focuses on financial management planning alternatives for persons confronted with potential health crises and incapacity.

The Deceptive Ease of Creating a Power of Attorney

Because it is relatively easy to designate a surrogate to manage and control one’s property by means of a document called a “power of attorney”, a court-supervised guardianship of the property of a disabled person generally means that either the person failed to plan effectively for his incapacity or that he or she had no available potential surrogates from which to choose.  In a power of attorney, a “principal” grants authority to an “agent” or “attorney in fact” to act for the principal.  In the case of a power of attorney for property and/or financial management, the authority granted is to act with respect to the principal’s property for the benefit of the principal.  Under the Maryland General and Limited Power of Attorney Act (“the Act”), the agent has a legal duty to “[a]ct in accordance with the principal’s reasonable expectations to the extent actually known by the agent and, otherwise, act in the best interest of the principal; [to a]ct with care, competence and diligence for the best interest of the principal; and . . . only within the scope of authority granted in the power of attorney.”  Unless otherwise provided in the power of attorney, the agent has a further legal duty to “[a]ct loyally for the principal’s benefit; . . . [and] so as not to create a conflict of interest that impairs the agent’s ability to act impartially in the principal’s best interest; …”

The Act facilitates the designation of naming such an agent by including two statutory forms that can be used for this purpose.  However, when designating a surrogate, it’s extremely important to pay attention to the details of what is provided in the power of attorney document.  Because powers of attorney are such powerful instruments, the Maryland Court of Appeals has long held that it is a “well settled” rule that powers of attorney are “strictly construed as a general rule and [are] held to grant only those powers which are clearly delineated” in the instrument.  One cannot merely designate that his agent has “all the powers that I have” in a simple one-page document without designating specific authorities for specific types of property.  As a result, while they will work in many common situations, one cannot rely on use of just one of Maryland’s statutory form powers of attorney for effective management of all potential situations.  For example, the commonly used “Personal Financial Statutory Form” includes no provisions with regard to dealing with tangible personal property or business assets, and neither statutory form includes effective gifting authority to enable the agent to engage in effective tax or Medicaid planning. Maryland attorneys typically use two property powers of attorney for their clients: one of the statutory forms for ease of enforceability in the common situations an agent is likely to face that are covered in the statutory form and a second, supplemental power of attorney for the special situations that the statutory forms don’t cover.

A problem may occur with regard to when an agent is first allowed to exercise authority.  Under the Act, unless the principal provides in the document that it becomes effective at a future date or on the occurrence of a future event or contingency, a power of attorney is effective when executed.  Such immediate effectiveness can be contrary to the intent of the Mature Single Individual who wants to name a surrogate but, because of the parties’ relationship or lack thereof, does not want to give that person immediate control over her property.  While signing a power of attorney does not relinquish the principal’s rights with regard to property, allowing someone else to have that control as well can be unsettling.  In such cases, the person planning for a surrogate may want to employ a “springing power of attorney” that only becomes effective upon a designated future event or contingency (such as incapacity).

Pitfalls When Utilizing Springing Powers of Attorney

While springing powers of attorney are recognized in Maryland, they are not without problems of their own.  As with any power of attorney, there is always a fear by banks and securities brokers that they may somehow be found liable for giving credence to a power of attorney granted fraudulently or after a disqualifying incapacity has already occurred.  In the case of springing powers, there is an added concern as to whether the event initiating the power of attorney’s effectiveness has actually occurred.  For example, if a power of attorney states that it is not effective unless the principal is incapacitated, how does bank teller know whether this is the case?  When a springing power of attorney is deemed to be appropriate, it is always better to specify an ascertainable contingency such as when two licensed doctors make a specific written certification rather than just defining the springing event as one without requiring tangible evidence conclusively proving that the event has occurred.

A second related problem with springing powers is that they are not recognized under the laws of some states.  In Florida, for example, the banking industry convinced the Florida Legislature in 2011 that dealing with springing powers of attorney was so difficult that it would be better not allowing them at all.  While this situation is probably not enough to preclude a Maryland resident from using a springing power of attorney when nervous about his or her potential agents, the questions involved in using such powers should not be ignored.

One poor alternative when worried about an immediately effective power of attorney while at the same time wishing to avoid the problems of springing powers is that of executing an immediately effective power of attorney but giving all copies of the document to a third person (such as a friend or an attorney) who is to decide when it’s appropriate to provide the agent with the power of attorney document.  In essence, this is creating a fiduciary to decide when to empower a surrogate.  This alternative makes little sense.  Who would want to subject himself to the potential liability of making a wrong decision about a potentially untrustworthy agent?  What does the decision-making fiduciary do if the designated agent declines to serve when the decision is made?  How does a financial institution know whether the principal intended the agent’s authority to be effective if the instrument was dated years before.  Does the designated agent not already have effective powers even though he or she may not know what the document says?

Planning for the Needs of More than One Person

One final problem with using powers of attorney for surrogate property management is that they have historically been used only for managing property and financial assets for the benefit of the principal granting them and not for others as well.  A person might want his or her agent to exercise authority with regard to his or her assets for the benefit of someone else, such a spouse, an elderly parent, or a disabled child.  This problem becomes even more cumbersome if a principal wants his property used for the benefit of both himself and the person he or she designates to serve as his agent.  Without specific language to the contrary in the power of attorney, the agent’s duty of loyalty to the principal in this situation will prohibit him or her from using the principal’s assets for the agent’s benefit.  While a principal may include language making clear what his wishes are and who he wants his assets to benefit, there is little or no law making it clear how a court (or financial institution) will interpret the agent’s authority to share the principal’s property benefits.

In short, financial powers of attorney are relatively easy to implement but not without pitfalls that can minimize their utility.

Using Revocable Trusts for Surrogate Property Management

Revocable trusts have long been touted as desirable to allow a decedent’s family to avoid probate after the decedent’s death.  Mature Single Individuals may not, however, place much value in avoiding probate after their death or, in fact, may welcome probate as a means of making sure their designated Personal Representatives carry out their wishes.  What is often overlooked is the very real utility of revocable trusts for Mature Single Individuals to allow them to maintain control of their assets for as long as possible before giving a fiduciary surrogate authority to manage them in their behalf.  This utility derives from the rich and extensive history of revocable trusts as fiduciary mechanisms for carrying out the wishes of the trustmaker, the nature of trusts as relationships designed to accommodate changing situations over extended periods of time, and courts’ familiarity with the use of trusts to take care of multiple parties.  The shortcomings of powers of attorney noted above are routinely handled using revocable trusts.

By means of a revocable trust, the financial surrogate (i.e., the successor trustee) is not vested with authority unless and until the events designated by the trustmaker occur.  Until that time, the trustmaker can act alone or with a supervised co-trustee.  Financial institutions rarely question how a successor trustee (as surrogate for the original trustmaker/trustee) exercises authority over assets held in trust when they have had ample opportunity to see how the original trustmaker intended that authority to be put to work.  And in those rare case where probate is desired to provide court oversight to assure appropriate postmortem distribution, the trustmaker can provide that the revocable trust be added to her estate to be distributed in accordance with her will.

In conclusion, the importance of making plans for the occurrence of incapacity cannot be overstated.  In addition, it is relatively easy to name a surrogate for management of your property and finances if and when incapacity occurs.  However, this process is not without potential pitfalls and should be guided by an experienced professional.  We welcome the opportunity to serve you in this role.

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Lifetime Planning for Mature Single Individuals

Lifetime Planning for Mature Single Individuals

Estate planning generally addresses three primary goals: keeping the client in control of his or her person and property while he or she is alive and well; taking care of the client and his or her loved ones if the client becomes incapacitated; and carrying out the client’s wishes after death. Clients in different life stages tend to give different priorities to these goals. Younger clients without children seem inclined to favor the first goal over the latter two. For those with a spouse and/or children, effecting post-mortem goals becomes much more important. Older clients tend to be more concerned with incapacity and post-mortem goals because the threats posed by these life stages seem closer at hand. In fact, with lengthening mortality rates, incapacity planning is taking on increasing importance for everyone.

Mature Single Individuals and the Problem of the “Short Bench”

For those who are not married and who have no children (“i.e., Mature Single Individuals”), planning for the disposition of property after death may not be as important as it is for those with closer family ties. The potential costs of such planning often encourage one to delay or avoid such planning. With greater importance attached to the designation of surrogates in the event of incapacity, life planning for the Mature Single Individual can actually be more challenging than for the married couple with children.

The basic problem for Mature Single Individuals in planning for their incapacity (or death) is the recognition that while surrogates are understood to be needed, fewer trusted fiduciary alternatives seem available. In our society, incapacity care tends to be rooted in close familial connections built over lifetimes. Where such close familial connections are not available or are available only to a limited extent, the question becomes how to find suitable surrogates to act for the incapacitated client while assuring fidelity and proper attention to these fiduciary duties. Without close family ties, the goal is often also to postpone the designation and implementation of surrogacy until the last possible moment when it becomes necessary.

Court-Supervised Guardianship – The Default Nobody Wants

In the absence of planning, the State provides a default means of determining such surrogacy. Under Maryland law, a court may appoint a guardian to act for a “disabled person” who is unable to manage his property or unable to provide for the person’s daily needs to protect his health or safety. Once such an appointment is made (following a mandated procedure intended to protect the alleged disabled person from unneeded interference), the court stays involved in the guardianship by supervising the guardian’s activities for as long as the incapacity continues. Such court participation inherently requires use of the disabled person’s resources to pay for this process and the guardians involved.

The choice of who serves as the disabled person’s guardian is made in the court’s discretionary determination of what is best for the disabled person and in accordance with a statutory priority list of possible surrogates ranging from a spouse, parents, or the disabled person’s children to heirs at law or any other person, agency, or corporation nominated by a person caring for the disabled person or otherwise considered appropriate by the court. Importantly, however, the statutory priorities list is topped by a person, agency, or corporation nominated by the disabled person if he had the foresight to do so while he has (or had) sufficient mental capacity to make an intelligent choice. As a result, even if a guardianship is not deemed to be objectionable and regardless of the age of the individual involved and the length of the potential “bench” of potential surrogates, it becomes quite important to address the issue of surrogacy by planning well before the onset of any “physical or mental disability, disease, habitual drunkenness, addiction to drugs, . . . compulsory hospitalization, or disappearance”.

The Importance of Addressing Lifetime Planning Issues

A court-supervised guardianship of a disabled person generally means that either the person failed to plan effectively for his incapacity or that he or she had no available potential surrogates from which to choose. This is unfortunate because it is relatively easy to designate a surrogate by means of two types of documents: financial powers of attorney and revocable trusts for the management of an incapacitated person’s property and money; and health care powers of attorney and advance directives to manage his or her health and personal well-being. (We intend to cover these types of documents in greater detail in upcoming articles.)

The primary point here is that the Mature Single Individual should not put off addressing incapacity issues that may have a great impact on his future quality of life. Inertia should not be allowed to control just because the Mature Single Individual does not particularly care about post-mortem planning or because his “short bench” of potential surrogates makes decisions difficult. Most will not want these issues resolved by the discretion of a disinterested court acting at the request of some distant heir or other person nominated by a care agency or otherwise considered appropriate by the court. “Estate” planning involves both lifetime planning and post-mortem planning. Lower prioritization for one does not preclude the importance of the other. And talking through difficult decisions with an experienced professional will often clarify potential resolutions. The critical step in this process is the first one: picking up the phone to make the initial appointment. Once one begins, the rest is easy.

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The Shifting Role of Taxes in Estate Planning

The Shifting Role of Taxes in Estate Planning

I am often asked if Estate Planning has gotten easier as a result of recent changes in federal and Maryland estate tax law. My response: Estate Planning has not gotten easier, it has just become different. Coupled with other changes in society (e.g., lengthening mortality, volatile securities markets, a lengthy period of extremely low interest rates, and new artificial methods of conception), the need for flexibility in Estate Planning seems to have taken on new importance. This article focuses on how the concerns planners address are evolving in light of recent tax law changes.

 

Generally speaking, if a decedent’s assets are subject to potential estate taxation when he or she dies (and even if available exemptions are present to preclude such estate taxation), the capital gains basis of such “property acquired from a decedent” in the hands of his beneficiaries “steps up” (or “steps down”) to its fair market value at the date of the decedent’s death. Such beneficiaries as a result receive this property without the inherent capital gains income that was realizable before the decedent’s death. (Note, however, that this principle does not apply to property that is “income in respect of decedent” such as IRAs and other retirement plans, annuities, Series E savings bonds, or other property where inherent ordinary income has been earned but not yet taxed when a decedent passes away.)

Because the reduction of potential future capital gains taxes by “step up” requires potential exposure to estate taxation at the time of the decedent’s death, a fundamental tension has long existed in estate planning (especially for married couples) between saving estate taxes and saving capital gains taxes. Do we maximize the amount we can exempt from estate tax by placing the first decedent spouse’s assets after his death in a “credit shelter trust” designed to benefit the surviving spouse without having those assets included in her taxable estate? Or do we expose as much of the couple’s net worth as possible to potential estate tax at the death of the survivor to maximize basis “step-up”? A comparable tension exists in Medicaid planning for single individuals where the question becomes: should the potential Medicaid recipient gift his property to family members (who receive the donor’s cost basis) to “spend down” assets to qualify rather than leaving these assets to beneficiaries at his death with a stepped-up capital gains basis?

For a long time, resolution of this tension was easy. If likely estate taxation would occur at 55% of date of death value for federal purposes and from 8% to 16% of such value for Maryland estate tax purposes, there was no question that avoiding such estate taxation by preserving all available exemptions far outweighed the potential of future 15% income taxation on capital gains. Such easy resolution has, however, become very much more difficult in the recent past for a number of reasons:

First, recent dramatic increases in estate tax exemptions have significantly decreased the number of estates where estate taxation is potential or likely. Where a decedent could once only shelter $600,000 from potential federal and state estate taxes, decedents dying before 2026 can each now shelter some $11.2 million of their asset value from federal and Maryland estate taxation. After 2025, even if the federal law is not changed, decedents will still be able to shelter some $6 million from estate taxation. For persons likely to die before 2026 with less than $11.2 million or afterward with no more than $6 million, estate planning to minimize future capital gains taxes has become obvious because their families will not have to worry about estate taxation.

Second, since 2010, a predeceasing spouse can avoid wasting his estate tax exemption by means of “Portability” without using a credit shelter trust that precludes a step-up in basis at his surviving spouse’s death. Portability allows the executor of a deceased spouse to make an election on the first decedent spouse’s estate tax return to transfer or “port” such deceased spouse’s unused estate tax exemption to the surviving spouse’s estate. For example, if two spouses each have $5 million in assets, prior law would have required the first decedent spouse to use as much of his estate tax exemption as possible for a credit shelter trust to avoid his family’s loss of its benefits. In so doing, no further basis step-up would be available for that trust property when the surviving spouse died. Now, however, the first decedent spouse can leave his entire estate to the surviving spouse to be potentially estate taxed when his surviving spouse dies (and with everything other than income in respect of decedent getting a basis step-up at this later date) when the surviving spouse’s estate will potentially have available exemptions of over $16.2 million until 2026 (i.e., $5 million “ported” from the first decedent spouse plus the survivor’s personal $11.2 million exemption) or some $11 million (i.e., the first decedent’s $5 million and the survivor’s $6 million) thereafter. For married couples with larger estates, it is now possible to leave up to $22.4 million before estate taxes apply, with all such property potentially receiving a stepped-up basis at the second death. With such large exemptions from estate taxation available at the survivor’s death, getting as much capital gains basis step-up as possible at the second death has become the primary priority in many more couples’ estate planning. Note, however, that obtaining the advantages of such Portability requires the time and expense of preparing and filing of a federal estate tax return when the first decedent spouse dies; and, unlike credit shelter trust assets, appreciation of “ported” assets do not escape inclusion in the surviving spouse’s taxable estate.

Finally, the rates of taxation for these two planning alternatives are narrowing. Federal estate taxation is now at 40%, rather than 55%, of fair market value at death. For those assets to which Maryland estate tax applies, the combined federal and state estate tax rate is just under 50%. At the same time, capital gains income tax rates have climbed over the years. In addition to the original 15% federal rate, an additional 3.8% net investment income tax on capital gains now exists for individuals earning more than $200,000 (or $250,000 for married couples filing jointly) and an additional 5% capital gains tax (above the net investment income tax) applies for individuals earning more than $425,800 annually (or $479,000 for married couples filing jointly). In addition, state income taxes on capital gains apply with most taxpayers paying between 7% and 9% of such gains, depending on income and county of residence. Thus, combined federal and state capital gains rates of tax at over 30% has become closer to combined federal and Maryland estate tax rates at just under 50%. This is not to say that the taxes paid for capital gains will be more than the estate tax due because the tax base for each is very different. However, the increased burden of capital gains taxation has taken on new importance when estate taxes (and especially federal estate tax) are no longer a major consideration because of increased exemptions and Portability.

As I noted at the outset, these tax changes have not made Estate Planning easier, just different. We often now focus more on capital gains tax minimization than we do on estate tax minimization. If, as expected, Maryland this year reverses its 2019 recoupling with the federal estate tax exemption (because it doesn’t want the Maryland estate tax exemption to climb to $11.2 million), another level of complexity and an increased need for flexibility will be introduced. As we try to emphasize to all our clients, such law changes and changes in family dynamics make it extremely difficult to plan for more than the next 3 to 5 years. Estate Planning is a process, not a one-time event; and providing flexibility to accommodate change is increasingly critical.

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2018 Estate and Trust Tax Planning

Inflation Adjustments and Initial Observations on the 2017 Tax Act’s Impacts:

In late October, the Internal Revenue Service issued its inflation-adjusted exemptions, exclusions and tax brackets to be used for 2018 federal tax returns. See generally, Internal Revenue Notice 2017-178 and Revenue Procedure 2017-58 issued on October 19, 2017. In the estates and trusts area, the principal adjustments are as follows:

  • An individual’s federal estate, gift, and generation-skipping tax exemptions are increased after December 31, 2017 to $5,600,000. Thus, for decedents dying after December 31st with a gross estate (i.e., a taxable estate at death plus prior adjusted taxable gifts) of less than $5,600,000, there will be no federal estate tax due and no federal estate tax return is required to be filed. In addition, individuals may cumulatively make up to $5,600,000 in taxable lifetime gifts before any federal gift tax is imposed.
  • After years of remaining fixed at $14,000 per year, the federal gift tax exclusion will increase to $15,000. As a result, for calendar year 2018, individuals may make gifts that can be enjoyed immediately totaling $15,000 or less to any number of individuals without those gifts counting as lifetime taxable gifts (and without those gifts requiring the use of the $5,600,000 gift tax exemption mentioned above).
  • Finally, for trusts receiving and retaining taxable income, the federal income tax brackets have changed such that trusts do not reach the 39.6% marginal rate until they have taxable income in excess of $12,700. (Please recall that trusts get “distributable net income” deductions for amounts distributed to trust beneficiaries so that this maximum marginal rate will only be imposed on retained ordinary income above that amount. In turn, the beneficiaries receiving this distributable net income will pay tax on the income received at their personal marginal rates.) Note that the new bracket amount does not affect the Maryland income tax paid by the trust at Maryland rates on top of the federal tax.

Despite the IRS’s October pronouncement, a real question exists as to whether any of these limits will apply in 2018. As I write this article, House of Representatives and Senate conferees in Congress have agreed upon a final version for a bill entitled H.R. 1, “the Tax Cuts and Jobs Act of 2017” (referred to below as “the TCJA”). This “Conference Committee” version of the TCJA will now come before both houses of Congress for separate votes of approval. If, as expected, this Conference Committee report is approved by the House and Senate, the Conference Committee version of the TCJA will become law and generally apply with respect to tax years commencing after December 31, 2017. The Conference Committee approved version of the TCJA will substantially change the applicable 2018 estate and generation-skipping transfer tax exemption numbers already announced by the IRS and will change the income tax brackets for trusts:

  • The Conference Committee version of the TCJA will double the basic federal estate, gift, and generation-skipping tax exemptions from $5,000,000 to $10,000,000. With inflation adjustments back to 2010, the actual exemptions per individual will increase to approximately $11,200,000, and a married couple will be able to shelter over $22,000,000 for their post-mortem beneficiaries before having to worry about paying federal estate tax.
    On January 1, 2019, the Maryland estate tax exemption is scheduled to become “recoupled” with the federal exemption. As of now, were the TCJA to pass with the doubled estate tax exemption, that doubled estate tax exemption will apply for Maryland estate tax purposes as well. Time will tell how Maryland reacts to this substantial decrease in tax revenue.
  • The original House of Representatives’ version of H.R. 1 would have repealed the federal estate and generation-skipping transfer taxes entirely as of January 1, 2025. This repeal, however, is not included in the Conference Committee’s approved final version of the TCJA, and for now such repeal is no longer on the agenda.
    Since neither the House nor the Senate versions of the TCJA (nor the Conference Committee report) repeal or change the federal gift tax exclusion amount, it appears that the federal gift tax exclusion will in fact increase to $15,000 for 2018 and succeeding years (until inflation again requires an adjustment in a $1,000 increment).
  • Under the Conference Committee version of the TCJA, the brackets for trust taxable income will be changed as follows:
    • Retained trust income up to $2,550 would be taxed at 10% (a rate below the current 15% tax on such income);
    • From $2,550 to $9,150, retained trust income would be taxed at 24% (a rate also below that mandated by current law);
    • From $9,150 to $12,500, retained trust income would be taxed at 35% (a rate higher than that mandated by current law); and
    • Above $12,500, retained trust income would be taxed at the maximum 37% (a rate that is 2.6% less than that mandated by current law).

    Thus, under the Conference Committee’s version of the TCJA, the maximum bracket for federal income tax on retained trust income will apply at an amount slightly below that projected by the IRS in October, but the rate itself would be 2.6% lower.

  • Because estates and trusts are generally subject to the same rules for calculating taxable income as individuals and because the TCJA suspends most individual itemized deductions until December 31, 2025, estates and trusts will be subject to the same TCJA provisions as individuals with respect to the loss or limitation of itemized income tax deductions (e.g., a $10,000 limit on the deductibility of state and local property and income taxes, limits on the deductibility of home mortgage interest, and loss of the deduction for preparation of tax returns). In particular, trusts and estates will no longer be able to claim as deductions expenses that previously were allowable if they exceeded 2% of taxpayer’s adjusted gross income. However, trusts and estates will now be eligible for a new complicated deduction for certain “qualified business income” received for the taxable year with respect to pass-through business entities.
  • Since individual beneficiaries will not be able to make itemized deductions for these pass-throughs (at least until after December 31, 2025), residuary beneficiaries of estates and trusts will no longer be eligible to benefit from unused excess deductions for estate and trust administration expenses after termination of an estate or trust.
  • The TCJA does not change the “stepped-up” basis provisions of current law with respect to capital gains on inherited assets. As such, beneficiaries will continue to inherit capital assets with the date of death fair market value of the assets as their respective bases for capital gains purposes and without the potential of realizing income taxation on pre-mortem appreciation (or losses) in value.

To learn about how The Wright Firm can help you make adjustments to your estate planning, please contact us at (410) 224-7800, or shines@thewrightfirm.net.

All of this will make wonderful fun for the IRS’s tax return designers over the Holidays. Here’s hoping that your Holidays are merrier than theirs and that we all have a Happy New Year.

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Saving State Income Taxes with Moveable Trusts

We recently reviewed and extolled the benefits of Inheritance Trusts in three blog posts on this website. Two of the principal benefits of such trusts are to provide creditor and divorce protection for beneficiaries on accumulated trust income and to immunize such accumulated trust income and capital gains from future estate taxation.

Inheritance Trusts can be created for beneficiaries using either wills or revocable trusts. One of the underappreciated benefits of revocable trust estate planning is the potential revocable trusts allow for saving future state income taxes on accumulated Inheritance Trust income. In this post, we discuss moveable trusts and how Inheritance Trusts created under revocable trust planning can reduce or avoid state income taxation on accumulated trust income.

Moveable Trusts

Trusts are moveable in three aspects: They are moveable with regard to the state law that controls the construction and interpretation of trust provisions. They are moveable as to the law governing how the trust is required to be administered. They are also, and separately, moveable with regard to the jurisdictions to which they are required to pay taxes.

Construction and Interpretation of Trust Provisions

In general, a trust settlor (“Trustmaker”) is free to select what state law governs the meaning and effect of the terms of his or her trust. The jurisdiction selected need not have any other connection to the trust, and the Trustmaker is free to select the governing law regardless of where the trust property may be physically located, whether it consists of real or personal property, and whether the trust was created by will or during the Trustmaker’s lifetime. The only limitations to this freedom of choice is that a court of equity will be reluctant to give effect to trust action based on the law of a state that is contrary to the declared public policy of the state in which the court sits.

If a Trustmaker fails to designate the law that is to control his or her trust, the meaning and effect of a trust’s terms are determined by the law of the jurisdiction having the most significant relationship to the matter at issue. In this situation, a court would consider such factors as the place of the trust’s creation, the actual physical location of trust property, and the residence of the Trustmaker, the trustee, or the trust’s beneficiaries.

If a Trustmaker has expressly chosen the state law intended to govern his or her trust, that choice may be changed in the future by the trustee or the trust beneficiaries. Trustmakers realize that information about one state’s laws may not be readily available to future trustees and/or beneficiaries, so most trusts include provisions specifying precisely how such changes in governing law may occur. Even absent such express authorization, Maryland trustees and beneficiaries (and those of many other states) can change the originally designated governing law by court action to modify the otherwise express terms of the trust by a showing that the modification is not inconsistent with a material purpose of the trust.

Where a Trustmaker has failed to designate the law that is to control his or her trust, the circumstances of the trust may also force a change in the governing state law. The location of the trust’s principal place of administration, assets, or the residence of the trustee or the trust’s beneficiaries may change, and thereby change the jurisdiction having the most significant relationship to a given matter at issue. Finally, the Maryland Trust Act specifies a procedure by which a trustee may change the principal place of a trust’s administration with acquiescence of qualified beneficiaries. (Following this procedure is not mandatory if, as is often the case, the Trustmaker has provided an easier alternative for the trustee or a “trust protector” to change the trust’s principal place of administration.)

Trust Administration

Usually, the law of the principal place where the trust is administered will govern administrative matters, and the law of the place of trust creation will govern a trust’s dispositive provisions. Since the cardinal rule of trust administration is to give effect to the intent of the Trustmaker, the Trustmaker can influence the governing law of trust administration and disposition by stating his or her intent in this regard. However, with regard to administration and disposition, a connection (or “nexus”) is required between the jurisdiction of choice and the activities of the trust itself. For example, if a Trustmaker chooses Maryland law to govern administration and disposition, something must occur in Maryland to connect the State to the trust, e.g., ownership of land in Maryland, carrying on a Maryland business, trustee residence or location in Maryland, or the occurrence of actual trust investment and/or accounting activities in Maryland. Here again, this choice of applicable law can be changed either by a change in trust circumstances or, so long as a connection exists with the new jurisdiction, by a formal change of the trust’s designated principal place of administration.

Trust State Income Taxation

With regard to what state can tax the income of a trust, the focus shifts from what the Trustmaker wanted (after all, what Trustmaker actually wishes for state income taxation?!) to whether a state has a sufficient connection to the trust and its income to allow it to tax that trust income. For example, regardless of a trust’s principal place of administration, Maryland (and most other states that have a state income tax) taxes a fiduciary who “is required to file a federal income tax return” and who receives “income . . . derived from a business, occupation, profession, or trade carried on in Maryland”. Absent a direct investment in a Maryland business enterprise or income derived in Maryland from “a business, occupation, profession, or trade”, however, the question becomes: what makes a trust sufficiently connected to the state to allow Maryland to tax its undistributed income?

Maryland answers this question by declaring that it has a sufficient connection to the trustee to tax non-Maryland source trust income if the “fiduciary” is a resident of Maryland. For purposes of Maryland income tax, that means the state can tax the income of “a fiduciary . .  . of a trust if:

  1. the trust was created, or consists of property transferred, by the will of a decedent who was domiciled in the State on the date of the decedent’s death;
  2. the creator or grantor of the trust is a current resident of the State; or
  3. the trust is principally administered in the State.”

In the case of an Inheritance Trust, the trust does not occur unless and until the Trustmaker dies, so the creator of grantor of the trust can no longer be a current resident of Maryland. Thus, whether or not the income of the trust can be taxed by Maryland comes down to whether “the trust was created, or consists of property transferred, by the will of a decedent who was domiciled in the State on the date of the decedent’s death” and whether “the trust is principally administered in the State”. The benefit of revocable trust estate planning is that Inheritance Trusts are not created by the will of a Maryland decedent. With regard to the income taxation of non-Maryland source income of an Inheritance Trust created under a revocable trust, the question thus comes down to where the trust is principally administered.

Moving the Inheritance Trust’s Principal Place of Administration

As noted above, a trust’s principal place of administration can be changed either under the terms prescribed by the Trustmaker in the trust instrument or by complying with Maryland’s statutory procedure. Often, such a change need only require notice to the trust’s qualified beneficiaries specifying:

(i)     The name of the jurisdiction to which the principal place of administration is to be transferred;

(ii)    the address and telephone number at the new location at which the trustee can be contacted;

(iii)   An explanation of the reasons for the proposed transfer;

(iv)   The date on which the proposed transfer is anticipated to occur; and

(v)    the date, not less than 60 days after the giving of the notice, by which the qualified beneficiary must notify the trustee of an objection to the proposed transfer.

If no qualified beneficiary objects to the change, the trustee then merely goes ahead with the change. Where previously authorized by the Trustmaker, even this notice and objection procedure may not be required because the notice procedure specified above is not mandatory if the Trustmaker deems otherwise.

Over the lifetime of a trust, such a change in principal place of administration can have a substantial financial impact, especially if an Inheritance Trust has a trustee who resides in Florida or another state that does not have a state income tax or whose income tax is lower than Maryland’s relatively expensive rates. Even where this may not be the case, it may be possible to add a co-trustee who “resides” in such a state and to whom the administration of the trust may be delegated. In the case of a corporate trustee located in such a state, the immunity from state income tax may offset the cost of paying a commission to the nonresident trustee.

As such, creating an Inheritance Trust under a revocable trust (rather than a will) plus the moveability of the trust can give rise to significant potential savings in future state income taxes on accumulated Inheritance Trust income.

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Transferring Motor Vehicles To Living Trusts

Motor Vehicle Transfers to Maryland Revocable Living Trusts

A question often arises when funding a new or existing revocable living trust (“living trust”) whether the trustmaker should retitle his or her motor vehicles to the trust. Two recently enacted Maryland laws have added clarity to this issue but no definitive answer.

Chapter 663 of the 2017 Laws of Maryland as of July 1, 2017 makes it clear that a trustmaker may retitle his or her motor vehicle to a living trust without having to worry that a Maryland 6% excise tax or certificate of title fee will be due when the trustmaker transfers the vehicle to the Trustee or when the Trustee subsequently transfers the vehicle to certain family members of the trustmaker (e.g., upon the death or disability of the trustmaker). Chapter 684 of the 2017 Laws of Maryland will not be effective until October 1, 2017, but on and after that date, a vehicle owner may avoid probate for the vehicle after his death by registering the vehicle with a designated transfer-on-death beneficiary.

Why transfer a motor vehicle to a living trust?

As with most of a trustmaker’s non-qualified plan property, the funding issue boils down the costs and benefits of creating a living trust in the first place. Among their principal virtues are the facts that living trusts avoid post-mortem probate for assets owned by the Trustee at the decedent trustmaker’s death and that they provide one of the best vehicles for managing pre-mortem assets during the trustmaker’s incapacity. With regard to funding motor vehicles, the question becomes whether these benefits are worth the costs of the retitling, especially when the inherent aging process of vehicles may make it unlikely that a particular vehicle will continue to be owned by the trust when the trustmaker dies or becomes incapacitated. In addition, even if individual ownership of the vehicle is retained by the owner at death, the value of his or her probate estate may be less than the $50,000 jurisdictional limit for expedited small probate estates.

Heretofore, a principal cost of transferring a vehicle to a Trustee was the potentially steep cost of ultimate transfer to a family member after death or the disabling event. Since transfers from the probate process were already exempt from such transfer taxes and fees, this author suggested the legislation that became Chapter 663 for the benefit of client trustmakers owning expensive “family heirloom” classic vehicles. As a result of Chapter 663, that steep cost should no longer be an impediment to transferring a vehicle to a living trust. However, what complicates the analysis is that Chapter 684 will now provide an alternative, relatively easy, and inexpensive means to avoiding probate inclusion for a vehicle intended to be transferred after the death of its owner.

Arguments Against Transferring Vehicles to a Living Trust

If probate avoidance and incapacity management remain desirable reasons to place a vehicle in trust, what are the arguments that deciding not to do so makes more sense? Two of these arguments can be dismissed at the outset: First, although some argue that placing a vehicle in trust opens up other trust assets to claims by creditors injured by operation of the vehicle, in point of fact a living trust provides no immunity for the claims of such creditors even if the vehicle is not placed in trust. Section 14.5-508(a)(1) and (5) of the Maryland Trust Act make it clear that, in Maryland,

“During the lifetime of the settlor, the property of a revocable trust is subject to claims of the creditors of the settlor; … and [a]fter the death of a settlor, and subject to [certain statutory provisions providing for a shortened post-mortem limitations period for such claims and the right of the settlor to direct the source from which liabilities are to be paid] the property of a trust that was revocable at the death of the settlor is subject to claims of the creditors of the settlor.”

Second, some commentators argue that placing a vehicle in trust makes it more difficult to obtain casualty and liability insurance for the vehicle. That has not been the experience of this writer. Federal law provides that moving a vehicle to a trust does not affect the insurance on that vehicle, and this writer has found that insurers will readily add a trust as an additional insured on the policy of the transferring trustmaker without additional cost. (Adding the trust as an additional insured is important because, after transfer, the insurable interest for casualty and negligent entrustment is now held by the trust.)

In some states, transferring a motor vehicle to a living trust involves payment of a sales tax or transfer fee. Chapter 663 now makes it clear that as of July 1, 2017, those are not applicable in Maryland. However, minimal (less than $30) re-registration fees do still exist here.

In addition, some states require new vehicle safety inspections when transferring a vehicle to a trust. The excellent Maryland Motor Vehicle Administration (“MVA”) website article on Titling – Placing a Vehicle into a Trust, found heremakes it clear however that transferring a Maryland titled vehicle into a trust in which the current owner of the vehicle is the primary beneficiary of the trust requires no such new safety inspection.

If the existing title to the vehicle reflects a lien for money borrowed to buy the vehicle, the MVA will require a trustmaker requesting transfer to supply a statement from the lien holder on the lien holder’s stationery authorizing the lien to be transferred to the new trustee title. Lien holders may not be cooperative in supplying such statements, so this may be one insurmountable impediment to transferring a vehicle to trust.

Absent such a lien with a difficult lien holder, the real arguments against placing the vehicle in trust are (1) the available alternatives to the benefits of doing so and (2) the potential likelihood that the vehicle may no longer remain in the trust when incapacity or death occurs. Argument (2) will always involve depreciation rate and actuarial guesses. As to argument (1), Chapter 684 will make it relatively easy to use a transfer-on-death beneficiary designation to avoid probate (albeit with the payment of a re-registration fee), but this alternative fails to provide management in the event of incapacity. However, if a vehicle owner is willing to give this management authority to a surrogate in a power of attorney, the MVA has readily available procedures for using that power of attorney when incapacity occurs.

Conclusion

Whether to fund motor vehicles into living trusts has always been a difficult decision. Because Chapter 663 of the 2017 Laws of Maryland relieves most worries about potential down-the-road excise taxes and certificate of title fees, we now encourage our clients to take the guessing out of the equation by transferring their motor vehicles to their new living trusts. If nothing else, doing so avoids potential probate hassles with regard to the vehicles. We recognize however that this is still a close cost-to-value judgment and that many clients will decide to act alternatively. If they do, Chapter 684 will provide clients another means by which to avoid probate inclusion if and when that becomes more important.

If you would like to learn more about this topic or would like to set up a consultation to discuss your options, please feel free to contact Richard T. Wright at The Wright Firm by phone at (410) 224-7800 or contact us through our website’s Contact Page.

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Securing Your Family’s Future Using Inheritance Trusts: Part 1

PART 1: Inheritance Trusts and How They Work

The key to estate planning is understanding clients’ goals for the process. Generally, as a primary overarching goal, clients cite their desire to maintain their assets for as long as possible as a safety net protecting themselves and their loved ones from both anticipated and unforeseen threats and challenges. Nothing worries parents more than a creditor or divorcing spouse depriving their loved ones of the assets they worked so hard to pass on. Given this goal, it shouldn’t be any surprise that in our practice, once clients understand how Inheritance Trusts work, they choose to leave their estates to their loved ones by such trusts over 90% of the time.

Inheritance trusts have been with us for many years, primarily to manage funds for minors and others who would otherwise have trouble maintaining them. The basic idea was originally to separate management from benefit to protect the benefits for as long as necessary. The modern “wrinkle” has been the recognition that, by making the capable beneficiary the manager (i.e., the trustee) and by maintaining the trust in place, the protections and safety net remain in place for as long as possible without significant loss of beneficiary control or enjoyment.

In this installment, we describe Inheritance Trusts and explain how they work. To do so, however, we first have to review some basics:

The Law Underpinning our Use of Trusts

Trust law has developed over hundreds of years as an outgrowth of our laws of property and judicial support of fundamental fairness (equity). Under our law of property, the bundle of rights held by an owner includes the right to transfer his property in the manner he chooses. The law of equity will support and enforce such transfer as long as the transfer does not violate a paramount principle of public policy. In particular, the law grants primacy to the intent of the transferor in transferring his property, regardless of whether he transfers his entire bundle of rights in the property to one or more persons or whether he chooses to parcel out different rights in the property to different persons. Such differing rights could include the right to control how and/or how long property is used in a particular fashion, the right to receive the benefits of the property as so utilized, and the rights to transfer the property in the future and to administer the proceeds of such future transfer. This potential, indeed likelihood, for court enforcement of the transferor’s intent is the fundamental “glue” that underpins the use of trusts.

A trust is really nothing more than a transfer of property that separates the owner’s bundle of rights in the property at the time of transfer. In the case of an Inheritance Trust, that separation generally occurs after someone’s death, most likely, when a beneficiary might otherwise have inherited the property outright from the decedent.

What is a trust?

A trust is a court enforceable relationship established by a property owner when he transfers property to someone who will thereafter own and use the property according to a set of instructions that binds the new “owner” as to what he can or cannot do with the assets subject to those instructions. This relationship generally involves three types of parties: the original owner who is called a “settlor” or “Trustmaker”, a “Trustee” who will thereafter own the property and put it to use, and a “Beneficiary” who will now or at some time in the future enjoy the benefits of the property while it is owned by the Trustee. (Please note that although the words, “Trustmaker”, “Trustee”, and “Beneficiary”, are used here in the singular, there may be more than one Trustmaker, Trustee, and/or Beneficiary; and a person may simultaneously hold one or more of these capacities with respect to any trust.)

The Trustmaker is the party who establishes the trust by transferring property to the Trustee and by creating the instructions (i.e., in a will or trust agreement) that control that property in the Trustee’s hands. The Trustee is the party who actually has title to the trust property and who carries out the instructions. As the name suggests, the Beneficiary is the person who is intended to benefit from the trust assets and the Trustmaker’s instructions. It is the Trustee’s legal fiduciary duty to carry out the Trustmaker’s instructions for the benefit of the Beneficiary. If he or she fails to do so, the Trustee’s personal wealth is subject to court order to rectify any breaches of the terms of the trust (i.e., the Trustmaker’s intent).

If the Trustmaker retains the right to take back the property initially transferred to the Trustee or to change the instructions that control that property in the Trustee’s hands, the trust is called a “revocable trust”. If the Trustmaker expressly fails to retain or no longer has such rights (e.g. by reason of his death), the trust is called an “irrevocable trust”. Additional distinctions exist depending on when the trust is created: If the owner/Trustmaker establishes a trust during his lifetime, the trust is called a “lifetime”, “living”, or “inter vivos” trust. If the trust is created after the owner/Trustmaker’s death (e.g., a trust created under the Trustmaker’s will), the trust is generally styled as a “testamentary” trust. Absent express language in the trust document to the contrary, a Maryland lifetime or living trust is deemed to be a revocable trust. Since the Trustmaker is no longer alive to change his instructions, a testamentary trust will be irrevocable unless a court finds that the Trustmaker’s instructions (intent) have become impossible to achieve or that a unanimously agreed upon modification of trust terms is not inconsistent with a material purpose of the trust.

Examples Of Inheritance Trusts

Let’s say you and your spouse would like to establish Inheritance Trusts for your two daughters after both your deaths. You and your spouse will first create a will or living trust as a Trustmaker. Each of these documents will contain instructions to establish trusts for your daughters together or for each of them and will transfer your property to the Trustees of those trusts after both of you have passed.

You believe your oldest daughter is already prepared to manage the assets transferred to her trust, so you name her as the trustee of her trust so that she can control that property and you give her discretion as to when she can distribute property income (or the trust property itself) to herself or her descendants.

You would like to see your younger daughter grow into her future role as Trustee, so you name her as a Co-Trustee of the trust (with her sister or another trusted family member or friend as the other Co-Trustee) until your younger daughter reaches a certain age (e.g., 30). At that time, the trust instructions say that she will become her trust’s sole Trustee. While your younger daughter serves as a Co-Trustee with the consent of her Co-Trustee required to make decisions, your trust instructions require the Co-Trustees to distribute certain amounts to her annually so that she can count on receiving those annual benefits.

Once each daughter becomes sole Trustee of her respective trust, each will act as caretaker of the inheritances and manage their investment until they are ready to pass them on to their own children and/or more remote descendants.

In the meantime, while her trust remains in existence, you state in the trust document for each daughter that no right to benefit from the trust may be transferred by any beneficiary as such, and no creditor of a beneficiary may attach trust property or any trust interest. Trust property will remain transferrable by the Trustee, but under Maryland law, “[a] creditor may not . . . reach or otherwise compel distribution of the beneficial interest of a beneficiary that is a trustee or the sole trustee of the trust, . . . except to the extent that the interest would be subject to the claim of the creditor were the beneficiary not acting as cotrustee or sole trustee of the trust.” Subject to certain limited public policy exceptions for unpaid taxes, child support, and alimony, each daughter’s interest in the trust and the trust property itself is therefore protected from claims by potential creditors.

Stay tuned for future installments

In future installments of this series about Inheritance Trusts, we will explain these and other benefits of using Inheritance Trusts in your planning. We will also explain the process of receiving an inheritance in trust, as well as titling trust assets, setting up trust accounts, and the obligations of Trustee-beneficiaries to their other or future beneficiaries.

If in the meantime you would like to speak with us about securing your own plans for the future, please give us a call at (410) 224-7800.

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Securing Your Family’s Future Using Inheritance Trusts: Part 2

PART 2: The Benefits of Using Inheritance Trusts

In part 1 of this series, we described Inheritance Trusts and how they can achieve clients’ desires to maintain their assets for as long as possible as a safety net protecting themselves and their loved ones from both anticipated and unforeseen threats and challenges. In this installment, we go over the particular benefits they offer at relatively little cost.

Benefits of Receiving Your Inheritance in Trust

There are three significant benefits to receiving your inheritance in trust rather than outright: (1) asset and creditor protection, (2) transfer (i.e., estate, gift, and GST) tax minimization, and (3) disability planning.

Asset Protection

As we discussed in Part 1 of this series, inheritances held in Inheritance Trusts are typically what are commonly referred to as “spendthrift” trusts. This term comes from the trust provisions that prevent a beneficiary from being able to pledge, assign, or otherwise anticipate their interest in the trust before he or she actually receives it. Because the beneficiary has no right to receive trust distributions ahead of the time when the Trustee (who may be the beneficiary himself but who acts in a fiduciary, as opposed to an individual, capacity) actually distributes them to him, the beneficiary’s creditors similarly cannot reach his trust interest until it is actually in his possession. As a result, his individual judgment creditors will not be able to reach the assets owned by the beneficiary’s Inheritance Trust unless they are creditors of the trustee (in his or her separate role as trustee) or creditors of a beneficiary with respect to alimony, child support, or taxes. In other words, the Inheritance Trusts’ assets are protected from lawsuit judgments against the beneficiary (or the beneficiary’s descendants or siblings).

Asset protection is important in a litigious society where the divorce rate hovers around 50%. The value of trust asset protection cannot be emphasized enough, especially since public policy generally makes it impossible for an individual to obtain this level of asset protection with respect to his or her personal assets. Spendthift trust creditor protection is made possible by the law’s view that, as long as he does not violate some important public policy in doing so, the manner in which a Trustmaker ties up his assets after death is his business and an entitlement resulting from his ownership of these assets in the first place. Spendthrift trusts are not deemed to be violative of public policy.

Future Transfer Tax Minimization

Inheritance Trusts also implement important estate and generation-skipping transfer tax planning. Under this type of planning, the assets in an Inheritance Trust will not be included in the beneficiary’s gross estate for federal or state estate tax purposes, no matter how much they grow in value. While the beneficiary can control the trust as its Trustee and has powers in this regard that are quite broad, those Trustee powers are by design insufficient under federal and state law to make them the functional equivalent of outright ownership. The same is true as to inherited rights as a trust beneficiary. As a result, while retained in the Inheritance Trust, the trust assets are not taxed for estate tax purposes as a part of beneficiaries’ respective taxable estates, and they can be passed on to the next generation (i.e., the Trustmaker’s descendants) without being subjected to estate tax.

An Inheritance Trust can be passed on to the next generation tax-free because it is exempt for the federal generation-skipping transfer tax (“GST Tax”). This is a tax equal to the federal estate tax that becomes payable when trust assets are distributed to beneficiaries more than one generation below the person in whose taxable estate the trust assets were last included. In essence, the federal GST Tax is designed to capture the estate tax that would have been payable from a generation where estate tax on trust assets is skipped. To limit the reach of this GST Tax on “smaller” estates, Congress allows an exemption from GST Tax for each individual taxpayer. Inheritance Trusts can be specifically designed to take advantage of all of the GST Tax exemptions of both the Trustmaker and the Trustmaker’s spouse. (The current GST Tax exemption available to a decedent is $5,450,000, but this amount will be indexed for future inflation. In the case of spouses, those exemptions can be doubled with careful planning). Unfortunately, unused GST Tax exemptions are not portable from a prior spouse to his survivor, so each spouse will need to use an estate plan utilizing Inheritance Trusts to take advantage of his or her GST Tax exemption.

Beneficiary Disability Planning

While a beneficiary is alive and able to manage his finances, he can serve as Trustee of the Inheritance Trust set up for his benefit. In addition, Inheritance Trusts often authorize the beneficiary to determine who will succeed him as Trustee when he is no longer willing or able to serve. To do so, the beneficiary will have to nominate a person, persons, or entity as Successor Trustee in a written document executed with the level of formality required in the trust instructions. If the beneficiary fails to nominate a successor trustee, the Trustee of the Inheritance Trust will be as the Trustmaker originally nominated in the trust by default. Please note that if a beneficiary wants his spouse to serve as Trustee of his Inheritance Trust if he cannot do so, he will usually need to create a writing that specifically makes this designation. To avoid complications of any potential divorce, a spouse is not generally otherwise named as a part of a line of succession.

In any event, if the beneficiary becomes disabled, management of his trust assets for his benefit is assured without court appointment of a guardian of his property or the ambiguities of enforcing a power of attorney.

 

In the final installment of this series about Inheritance Trusts, we will explain the process of receiving an inheritance in trust, as well as titling trust assets, setting up trust accounts, and the obligations of Trustee-beneficiaries to their other or future beneficiaries.

If in the meantime you would like to speak with us about securing your own plans for the future, please give us a call at (410) 224-7800.

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Securing Your Family’s Future Using Inheritance Trusts: Part 3

The Logistics of Inheritance Trusts

In parts 1 and 2 of this series, we described Inheritance Trusts and how they can achieve clients’ desires to maintain their assets for as long as possible as a safety net protecting themselves and their loved ones from both anticipated and unforeseen threats and challenges. In this installment, we go over the mechanics of setting up and operating an Inheritance Trust.

Titling Trust Assets and Setting Up Trust Accounts

When an Inheritance Trust is established, its Trustee (and in particular, a Trustee who is also a beneficiary of the trust) will need to keep inherited assets (as well as assets acquired in the future using the proceeds of these inherited assets) segregated from his personal assets. He does so by the titling of trust property and by using a separate trust taxpayer identification number.

Title to all newly inherited trust assets (and the proceeds of these inherited assets) should be kept in the name of the Inheritance Trust at all times. We prefer the following format for titling assets in the name of an Inheritance Trust:

“Gloria Sample Jones, Trustee of the Gloria Sample Jones Inheritance Trust under Article Twelve of the John Sample Living Trust dated December 24, 2008”

Obviously, each beneficiary Trustee would insert his or her name in this language and the particulars of the source document when titling inherited assets to his trust. However, to avoid future problems with banks and financial houses, it is important to use a title that references the document that states the authority for the trust, the trust administration provisions, as well as the source for Trustee powers and succession provisions.

Merging Separate Inheritance Trusts from Each Parent

Often, children of the same parents will technically receive an Inheritance Trust from each parent. To avoid having multiple trusts, the source document will generally have a merger clause allowing the Trustee to merge multiple trusts with the same beneficiaries and trust provisions. As such, the substantially identical trusts set up by each parent can be merged by having the Trustees sign what is known as a Trust Merger Agreement. Thus, two separate Inheritance Trusts (i.e., one received each parent) are consolidated into a single Inheritance Trust for the beneficiaries involved.

Utilizing the Assets of An Inheritance Trust

In order to provide the asset protection and tax benefits described in Part 2 of this series, there need to exist certain technical restrictions on beneficiary Trustee access to an Inheritance Trust’s property. However, beneficiary Trustees need not feel particularly limited by these restrictions because these provisions are purposefully drafted to be as expansive as possible without causing tax effect. The beneficiary Trustee will generally have complete authority as to the investment of trust property and broad authority as to when to make distributions.

A Trustee of an Inheritance Trust may make distributions of trust property to trust beneficiaries (including himself) for their education, health, maintenance or support. These terms have very broad meanings as demonstrated below:

Education

Includes payments for tuition, fees, books, supplies, living expenses, travel and reasonable spending money related to private pre-school, kindergarten, elementary school, middle school, college preparatory high school, undergraduate college, graduate college, and vocational, professional, or other specialized training

Health

Includes payments for medical services, prescription/over-the-counter drugs, and/or medical equipment, and, in general, anything directly promotive of the good health of trust beneficiaries

Maintenance or Support

Includes payments to keep the beneficiaries living in the manner that is reasonable given the amount of funds which can be devoted to this purpose, i.e., anything reasonably required to maintain the beneficiary’s lifestyle. (In addition, Trustees are often given the discretion when and whether to take the beneficiary’s other resources into consideration in making such lifestyle maintenance distributions.)

The principal limitation here is that Inheritance Trust assets may not be used to benefit persons or entities other than those persons who are currently the beneficiaries designated by the Trustmaker.

Types of Property an Inheritance Trusts Can Own

In general and unless otherwise specified in the Trustmaker’s instructions, Inheritance Trusts may own any type of property that is readily available to the public, such as: real estate, farming/ranching businesses, stocks, bonds, commodities, options, metals, partnership interests, limited liability company interests, and other types of closely-held business interests. The limitations here are that the Trustee is obligated to the beneficiaries to invest prudently and to avoid self-dealing.

Inheritance Trusts may also own life insurance or annuity products. However, you should consult with an estate planning attorney prior to purchasing a life insurance or annuity product with an Inheritance Trust. Notwithstanding trust provisions, if the Trustee of a trust owns life insurance on his own life, that life insurance can be made taxable as a part of his estate.

Other Ongoing Trustee Duties

In addition to the duties discussed above, Trustees of Inheritance Trusts need to remember that they now have fiduciary duties to others to be responsible for many of the same tasks they would have been doing if they owned the property in their own name (rather than as Trustee of the Inheritance Trust), such as:

Insuring trust property against potential hazards/casualties;
Keeping records of the trust’s financial history; and
Filing annual federal and state income tax returns for the trust on April 15th of every year.

It is important to note that Inheritance Trusts will each be separate income taxpayers and will require their own respective income tax returns. To this end, Trustees need to use separate federal tax identification numbers for their trusts. Because trusts pay federal income tax based on very compressed tax brackets (in 2017, a trust’s undistributed income is taxed at 39.6% once that income totals only $12,500), Trustees will probably want to do some distribution planning to make sure that as much of this income as possible is taxed at lower rates available to trust beneficiaries.

Trusts currently written as a Maryland trust are also subject to Maryland income tax. However, beneficiary Trustees who reside outside of Maryland may change the taxing state if the trust is being administered outside of Maryland and was not created under the will of a Maryland resident. One of the first administrative activities a beneficiary Trustee might want to consider undertaking is an examination with a local accountant or attorney as to where it makes the most sense to have the trust taxed.

Finding Assistance

Much of this may seem new to you, but it is not “rocket science”. We are in business to help our clients plan their Inheritance Trusts and to help with their implementation and administration. If you would like to speak with us about achieving your goals for the future, please give us a call at (410) 224-7800.

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