Death Bed Estate Planning Fire Drill – When a client walks into your office and informs you they have only a very short time to live, time is short and your planning options are more limited.
General Review of Client Situation
The first thing to do is what you would normally do in your periodic client review. The Trust Review Checklist is attached as Exhibit 1. In particular, ask if there is anything specific which brought the client to your office. They may have something particular in mind. More generally, review their existing documents, if any, and see what changes, if any, they want to make. Have the client’s wishes, circumstances, or assets changed significantly? Make sure beneficiary designations are as intended.
Clearly, some items will be of less importance (general durable power of attorney which ceases at death) while other items will be more important than usual (organ donation, burial instructions, etc.).
Many advanced planning strategies will no longer be appropriate to initiate, especially those focused on getting asset appreciation out of the estate. Starting an appreciation-focused strategy on the death bed is relatively worthless given the low likelihood of appreciation prior to death. Further, strategies that rely on actuarial values, such as a CRT for life, SCIN, etc., will be of very reduced value because you can no longer rely on the actuarial tables when the client is terminal (greater than 50% chance of not surviving 1 year). However, a review, including a death bed review, can be a good time to look at existing advanced planning strategies to make sure they are being implemented as anticipated. In particular, if there is an existing FLP/LLC, is the client respecting the entity? Are the filings current? Is the client using the FLP as his/her personal slush fund? While it is too late to remove all the sins, you can significantly improve the client’s chances of having a respected FLP if you can correct these issues.
However, there are many strategies that you can initiate even at the last moment.
Annual Exclusion Gifting
Perhaps the easiest and most obvious way to do deathbed planning is fully utilize any unused gift tax annual exclusions for the current year. Gifts excluded under Section 2503(b) are not brought back into the estate merely because they happened in close proximity to death.
Example: Grandma has made no gifts for the year of her death. She has 5 children, 25 grandchildren, and 10 great-grandchildren. In addition, 10 of these descendants are married. That totals 50 potential annual exclusions. 50 x $11,000 = $550,000. If Grandma died in 2004 with $2,050,000 she would have owed $249,000 in estate tax. After the annual exclusion gifting, her estate is reduced to $1,500,000, which is equal to her applicable exclusion amount. Accordingly, no tax is due.
Often, the client may not wish to benefit the descendants in exactly the distribution pattern that annual exclusion gifting would require. In the above example, Grandma may want to benefit each child’s per stirpital line equally. However, one child may have no descendants while another may have many. All of the descendants are still better off if Grandma reduces her estate and the corresponding estate tax payable. The trust or other estate planning documents can be modified to equalize for this lifetime gifting. Of course, the method of equalization will need careful consideration.
In order to utilize an annual exclusion and remove the assets from the estate of the client, the gift must become complete during the donor’s lifetime. This can be particularly problematic when the donor is on his or her deathbed. If the donor (or his or her agent with gifting powers) writes a check to make the gift, the gift is not deemed complete until the check clears. If the donor is still alive when the check clears, the gift completion relates back to the date of the gift. However, if the donor dies prior to the check clearing, the assets are included in the estate.
Example: Grandma, of Irish heritage, writes $11,000 checks to all of her descendants for St. Patrick’s Day. Grandma dies March 31. Only those checks which cleared between March 17 (St. Patrick’s Day) and March 31will carry funds out of the taxable estate.
With deeds, delivery of the deed to the donee or his or her agent results in completion of the gift. Recordation is not necessary for the gift to be complete.
Structuring Fractional Interests
At the death bed, it is typically too late to try to do FLP or FLLC entity planning. Numerous cases have held that the proximity to death is one factor tending to show that an FLP should not be respected. Recent attacks on FLPs, in cases such as Strangi and Kimbell have added uncertainty to an already perilous strategy.
In this situation, doing a death bed FLP may be worse than doing nothing at all. If the Service is successful in challenging the FLP, the full value of the underlying assets including any appreciation would be brought back into the estate. Due to the original discounting, you could actually be worse off.
A safer, cleaner approach is to fractionalize interests in property. For example, take the family farm and gift a portion to the descendants. This will qualify the gift and the remaining portion for discounts on the gift tax return and estate tax return, respectively. Note, because the fractional interest is a present interest, not a remainder interest, it will qualify for the annual exclusion if the gift is completed during life. While discounts typically are lower than with an FLP, lower-risk discounts of 10-25% are a good result.
Further, it is not necessary to make gifts to descendants to fractionalize an asset. A couple can fractionalize a property between themselves, each owning ½ the property. Also, a property could be divided with a Family Trust. Note, a gain transaction between a surviving spouse and a Family Trust will normally be a recognition event. Income tax consequences will have to be weighed against estate tax savings of fractionalization.
Example: Mary died and left $1,000,000 in a Family Trust. John is now on his death bed and has $2,000,000 all (conveniently) in a single asset, a tract of land. If he did nothing, he would pay $225,000 in estate tax after factoring in his $1,500,000 applicable exclusion remaining. John could sell an undivided ½ interest in the tract of land to the Family Trust for a 20% discount, or $800,000. Now, John has $800,000 and a ½ interest in the land, worth another $800,000. Now, John’s taxable estate is $1,600,000, resulting in a tax of only $45,000 after utilization of the applicable exclusion. This results in a savings of $180,000 in estate taxes. Note, this may be partially offset by the built-in capital gain for John’s estate and for the Family Trust due to the discounting. However, this $400,000 in built-in gain, at the 15% capital gain rate, results in $60,000 in tax. Also, this tax will not be paid until or unless there is a future recognition event. Even assuming an immediate sale of the property, there is still a net savings of $120,000 in taxes.
Charitable giving
If charitable gifting is in the client’s plans, they can get more bang for their buck if they do the gifting during life. A charitable gift will qualify for the gift tax charitable deduction, just as it would have for the estate tax charitable deduction. However, in addition, the lifetime charitable gift will qualify for an income tax charitable deduction.
Example: Grandpa has a $1,700,000 estate and wants to bequeath $200,000 to charity, resulting in no estate tax. Grandpa makes a gift of $200,000 to charity immediately prior to his death. Grandpa now has an estate of $1,500,000 and still owes no tax. However, Grandpa will now have an income tax deduction of $200,000, which he can take against his income, subject to the percentage limitations of section 170. This could save Grandpa $80,000 in income taxes, assuming a 40% combined state and federal marginal tax rate. Of course, the reduction in income taxes will result in more money being in the estate, potentially increasing estate taxes by $36,000. Even assuming the applicability of estate taxes, this still results in a net tax savings of $44,000.
Gifting for Decoupled States
Federal estate tax is based upon the taxable estate, and adjusting for gifts made before death, including bringing back into the estate any gift taxes paid during the three years prior to death. Thus, from a federal perspective, disregarding annual exclusion gifting, there is no advantage to death bed gifting.
However, states base their tax on the adjusted taxable estate, i.e. the gross estate without adjustment for prior taxable gifts or payment of gift tax. Thus, if the decedent gifts everything the instant before death, excepting the amount needed to pay the gift tax on that transfer, they can avoid state estate taxation on all but the funds retained to pay the gift tax. This can result in substantial savings of over 10% of the amount of the death bed gift.
Example of Tax Savings | ||
Estate Tax Calculation – Death in 2004 | Without Deathbed Gifts | With Deathbed Gifts |
Estate Assets | $12,000,000 | $ 160 |
Estate Deductions | 0 | 0 |
Gift Tax Paid on Gifts Within 3 Years of Death | 0 | 3,891,840 |
Taxable Estate | 12,000,000 | 3,892,000 |
Prior Taxable Gifts (Assumed Made in 2001 and 2004) | 2,000,000 | 10,108,000 |
Total Tax Base for Federal Tax | 14,000,000 | 14,000,000 |
Tentative Federal Estate Tax Before Credits | 6,540,800 | 6,540,800 |
State Estate Tax (Calculated on Taxable Estate Less $60,000) | 1,386,800 | 269,168 |
Tentative Combined State & Federal Estate Tax | 7,927,600 | 6,809,968 |
Less State Tax Credit | -346,700 | -67,292 |
Less Unified Credit | -555,800 | -555,800 |
Less Gift Tax Paid on All Prior Gifts | -435,000 | -4,326,840 |
Total Combined State & Federal Estate Tax | 6,590,100 | 1,860,036 |
Total Gifts Tax on Deathbed Gifts Made in 2004 | 0 | 3,891,840 |
6,590,100 | 5,751,876 | |
Federal Estate Tax | 5,203,300 | 1,590,868 |
State Estate Tax | 1,386,800 | 269,168 |
Gift Tax (From Deathbed Gifts) | 0 | 3,891,840 |
Total Estate & Gift Tax | $6,590,100 | $5,751,876 |
Savings From Deathbed Gift | $838,224 | |
Income Tax Basis Issues
It is important to consider the income tax basis of various assets. If there are assets which have a loss, the client may wish to recognize the loss to offset other income. If the loss asset is in his or her estate at death, of course the basis will be stepped-down to fair market value. Further, if the loss asset is gifted, the donee’s basis for loss purposes is the fair market value as of the date of the gift, i.e. the loss will not benefit them. The donee’s basis for purposes of gain remains the donor’s basis. This is the worst of both worlds.
Appreciated assets should be avoided when choosing assets to be gifted for annual exclusions and other gifting. These appreciated assets should be left in the client’s taxable estate so that they get a step up in basis at the client’s death. Cash or other assets with basis at or near fair market value make ideal assets for gifting. If the client does not have a sufficient amount of such assets, the client may be able to recognize enough losses and gains to offset each other, thereby generating sufficient cash for gifting.
Example: Client has $2,050,000 and wants to make $550,000 in annual exclusion gifts to 50 beneficiaries. Assets include WorldCom stock with basis of $351,000 and fair market value of $1,000, Wal-Mart stock with basis of $1,000 and fair market value of $351,000, $200,000 in cash, and various other illiquid assets such as closely-held businesses. The client could sell WorldCom and Wal-Mart shares to raise $352,000 without income tax consequences due to the offsetting of losses and gains. The client could then use the cash on hand and the cash generated from the sale to make death bed gifts. As a result the client would avoid estate taxation without negative income taxation consequences.
Roth IRA
If the client’s adjusted gross income for the year will not exceed $100,000, the client can elect to convert a traditional IRA to a ROTH IRA. If the client has a taxable estate, this can be an excellent way to remove from the estate the income tax liability on the IRA.
Example: Mary is single and has adjusted gross income of $90,000. She has an IRA worth $500,000 and other assets worth $1,300,000, for a total estate of $1.8 million. Let’s assume debts and expenses of $121,000 for a net estate of $1,679,000. If Mary did nothing, she would have an estate tax of $80,550. If Mary converts her IRA to a ROTH IRA, she will have debt equal to the income tax liability on the IRA conversion. Without the conversion, Mary would have an income tax liability of about $15,000 assuming $15,000 in deductions and a typical profile. If she converts the IRA, she will owe approximately $194,000 in tax, an increase of $179,000. That $179,000 increase in tax will deplete the estate, resulting in a net estate of $1,500,000 and no estate tax. Of course, now Mary’s descendants will make withdrawals income tax free over their life expectancies. This strategy is particularly useful when the recipients are in high income tax brackets and will not be able to do a spousal rollover.
Exhibit 1 | ||||||||||||
TRUST REVIEW CHECKLIST | ||||||||||||
Reviewing Attorney: | Date: | |||||||||||
Client: | ||||||||||||
Trust Name/Date: | ||||||||||||
Prepared By: | ||||||||||||
Amendment(s)/Date(s): | ||||||||||||
Prepared By: | ||||||||||||
Estate Size: | Areas of Concern: | |||||||||||
Husband Citizenship: | U.S. | Resident Alien | Non-Resident Alien | QDOT | ||||||||
Wife Citizenship: | U.S. | Resident Alien | Non-Resident Alien | QDOT | ||||||||
Previous Marriage: | H | Children | W | Children | ||||||||
CLIENT DESIRES | ||||||||||||
1. | Change of Trustees / POA Agents: | Yes | No | |||||||||
a. | ||||||||||||
b. | ||||||||||||
c. | ||||||||||||
2. | Births / Deaths Since Trust Drafted: | Yes | No | |||||||||
a. | ||||||||||||
b. | ||||||||||||
c. | ||||||||||||
3. | Changes to Beneficiary Distribution Patterns: | Yes | No | |||||||||
4. | Special Need Child(ren): | Yes | No | |||||||||
a. | ||||||||||||
b. | ||||||||||||
c. | ||||||||||||
TRUST REVIEW CHECKLIST, CONTINUED | ||||
5. | Spendthrift Child(ren): | Yes | No | |
a. | ||||
b. | ||||
c. | ||||
6. | Asset Protection Issues: | |||
a. | Possible Divorce of Child(ren): | Yes | No | |
b. | Creditor Protection Issues: | |||
c. | General Creditors | Yes | No | |
Tax Liens | Yes | No | ||
Judgement Creditors | Yes | No | ||
7. | GST Issues: | |||
a. | Is Client Expecting Large Inheritance: | Yes | No | |
GST Issues for Client | Yes | No | ||
GST Issues for H’s Parents | Yes | No | ||
GST Issues for W’s Parents | Yes | No | ||
b. | Is Client’s Child(ren) Independently Wealthy | Yes | No | |
GST Issues for Client | Yes | No | ||
GST Issues for Child(ren) | Yes | No | ||
i | GST Child #1 Name: | |||
ii | GST Child #2 Name: | |||
iii | GST Child #3 Name: | |||
8. | Long Term Care Concerns | |||
a. | Is H a Medicaid Candidate | Yes | No | |
b. | Is W a Medicaid Candidate | Yes | No | |
c. | Is H a Candidate for Long Term Care Insurance | Yes | No | |
d. | Is W a Candidate for Long Term Care Insurance | Yes | No |
TRUST REVIEW CHECKLIST, CONTINUED | |||||
SUMMARY OF EXISTING TRUST | |||||
Trust Description | |||||
1. | Current Beneficiary Distribution Pattern | ||||
Beneficiary Name | Outright | Staggered / In Trust to Age ____ | Special Needs / Spendthrift | Pot Trust (GST or Non-GST) / GST Sep. Shares | |
a. | |||||
b. | |||||
c. | |||||
d. | |||||
e. | |||||
2. | Type of Trust: | ||||
a. | Single | Subtrusts: | |||
b. | Married Separate: | Non-Tax | Disclaimer | GPOA | QTIP |
c. | Married Joint: | Non-Tax | Disclaimer | GPOA | QTIP |
3. | Beneficiary Lapses: | ||||
Lapses in Specific Devises | Yes | No | |||
a. | |||||
b. | |||||
c. | |||||
Lapses with Residual Beneficiaries | Yes | No | |||
a. | |||||
b. | |||||
c. | |||||
4. | Funding Formula: | ||||
a. | Pecuniary: | Family | Marital | True Worth | Fairly Representative |
b. | Fractional: | Family | Marital | Prorata | Pick and Choose |
c. | IRC 2057 QFOBI Business / Farm / Real Estate | IRC 2032A Farm / Real Estate |
TRUST REVIEW CHECKLIST, CONTINUED | ||||||
5. | Distributions to Surviving Spouse | |||||
a. | Family Trust | Income | Income / HEMS | TRU | Fully Discretionary | |
b. | Marital (QTIP) | Income | Income / HEMS | TRU (or Income, if Greater) | Fully Discretionary | |
c. | HEMS from Family Trust for Dependents | Yes | Yes, Limited By Surviving Trustor’s Assets | No | No HEMS for Marital / QTIP | |
d. | 5 x 5 Power | Family | Marital (QTIP) | |||
e. | LPOA | Family | Marital (QTIP) Testamentary | |||
6. | Tax Allocation Language: | |||||
a. | Hubert Language: Pay Transmission Expenses from Trust Income | 12/1999 – 1/2000 | Yes | No | ||
b. | Estate Taxes Paid by Residue | Yes | No | |||
c. | Estate Taxes Paid by Specific Devises | Yes | No | |||
d. | Prohibition Against the Use of Trust Retirement Assets to Pay Estate Tax | Yes | No | |||
e. | IRC 2207A – QTIP Right of Recovery | Provision in Will | Yes | No | ||
7. | Other Trust Retirement Asset / Annuity / IRD Issues: | |||||
a. | Retirement Assets / Annuity / IRD Assets Needed to Fully Fund Family Trust | Yes | No | |||
b. | Fractional Funding Formula: | Yes | No | |||
c. | IRD Allocation Language | Yes | No | |||
d. | Income and Principle Defined | UPIA/RUPIA | Yes | No | ||
8. | GST Provisions: | |||||
a. | GST Authorizing Language | Yes | No | |||
b. | GST Allocations Specified | Yes | No | |||
TRUST REVIEW CHECKLIST, CONTINUED | |||||||
9. | Trustee Provisions: | ||||||
a. | Disability Trustees | Yes | No | ||||
b. | Trustor Comeback Provision | Usually Contained in the Definition of Incapacity | Yes | No | |||
c. | Separate Trustee or Co-Trustee Named for the Family Trust and/or Marital Trust | Note: Issue with Children from Previous Marriage | Yes 1. Separate 2. Co-Trustee | No | |||
d. | Provisions for Trustee Removal | 1. Any Reason 2. For Cause Only | Yes | No | |||
e. | Provisions for Replacement | 1. Limited to Corporate Trustee 2. Exclude Beneficiaries | Yes Yes | No No | |||
f. | Special Co-Trustee Provisions | Gifting / Life Insurance | Yes | No | |||
10 | Trustee Powers | ||||||
a. | Either Trustor-Trustees Can Act Alone or Must Act Together | 1. Act Alone 2. Act Together | Yes Yes | No No | |||
b. | Power to Amend / Revoke | ||||||
After Trustor’s Disability | Yes | No | |||||
After First Trustor’s Death | Family / Marital Survivor’s Trust | Yes Yes | No No | ||||
c. | Medicaid Planning | 1. Remove Assets from Trust 2. Segregate Community Spouse Resource Allowance (CSRA) to Subtrust | Yes Yes | No No | |||
d. | Gifting Powers GPOA Issue if Gifting Power is in Excess of 5 x 5 Power Without Special Gifting Co-Trustee | 1. 5 x 5 Powers 2. Continue Existing Gifting Program in Excess of 5 x 5 3. Special Co-Trustee to Gift to Acting Trustee | Yes Yes Yes | No No No | |||
e. | Change Trust Situs | Will Become Increasingly Important | Yes | No | |||
f. | Lend / Borrow / Exchange / Deal With Estate of Trustor(s) or Trustees of Trustor(s)’s Other Trusts | Crucial Provision for Dealing with ILITs | Yes | No | |||
TRUST REVIEW CHECKLIST, CONTINUED | |||||||
11. | Other Trust Provisions | ||||||
a. | Prudent Person Rule | 1.Trustor 2. Related Trustee 3. Unrelated / Corporate Trustee | Yes Yes Yes | No No No | |||
b. | Prudent Investor Rule | 1. Trustor 2. Related Trustee 3. Unrelated / Corporate Trustee | Yes Yes Yes | No No No | |||
c. | Retain Existing Trust Assets | Yes | No | ||||
d. | Hold-Back Provision | Yes | No | ||||
e. | CERCLA | Yes | No | ||||
12. | Other Estate Planning Documents | ||||||
a. | Current Durable Power of Attorney for Property | Yes | No | ||||
i. | Medicaid Planning Powers | Yes | No | ||||
ii. | Gifting Powers | ||||||
Limited to 5 x 5 Power | Yes | No | |||||
Continue Existing Gifting Program in Excess of 5 x 5 | Yes | No | |||||
Special Co-Trustee | Yes | No | |||||
b. | Pour-Over Will | Yes | No | ||||
i. | Guardians for Minor Children | Yes | No | ||||
ii. | IRC 2207A – QTIP Right of Recovery | Yes | No | ||||
iii. | Coordinated With Trust Amendment(s) | Yes | No | ||||
c. | Property Agreement (Separate or Community) | Yes | No | ||||
i. | Prenuptial Agreement in Effect | Yes | No | ||||
ii. | Agreement Properly Balances Estate | Yes | No | ||||
iii. | Has Step-Up in Basis Been Discussed | Yes | No | ||||
iv. | Has Client Moved From Community Property to Common Law State or Common Law to Community Property State | Yes | No | ||||
d. | Health Care Durable Power of Attorney Current | Yes | No | ||||
e. | Living Will / Advance Directive Current | Yes | No | ||||
TRUST REVIEW CHECKLIST, CONTINUED | |||
13. | Retirement / Annuity Plan Documents: | ||
a. | IRA Plan Document Reviewed | Yes | No |
i. | Beneficiary Designation Correct | Yes | No |
ii. | Recalculation Automatic | Yes | No |
b. | Retirement Plan Document Reviewed | Yes | No |
i. | Beneficiary Designation Correct | Yes | No |
ii. | Recalculation Automatic | Yes | No |
iii. | Payment to Trust Permitted | Yes | No |
iv. | Terminates at Death | Yes | No |
c. | Annuity Contracts Reviewed | Yes | No |
i. | Annuity Ownership Correct | Yes | No |
ii. | Annuitant / Beneficiary Correct | Yes | No |
iii. | Can Non-Owner Spouse Continue Income Tax Deferral at Death of Owner Spouse | Yes | No |
TRUST REVIEW CHECKLIST, CONTINUED | |||
14. | Candidate for Advanced Estate Planning | ||
a. | Intervivos QTIP Trust | Yes | No |
b. | Annual Gifting ($10,000 per Non-Spouse Donee) ($100,000 Non-Citizen Spouse) (Unlimited Citizen Spouse) | Yes | No |
c. | Children’s / Grandchildren’s Trust | Yes | No |
d. | Business Buy / Sell Agreement | Yes | No |
e. | Irrevocable Life Insurance Trust (ILIT) – Separate (1) (2) – Joint | Yes | No |
f. | Combine ILIT with Split Dollar | Yes | No |
g. | Qualified Personal Residence Trust (QPRT) Single – Split | Yes | No |
h. | Split Purchase of Property | Yes | No |
i. | Charitable Remainder Uni-Trust (CRUT) – Net Income Charitable Remainder Uni-Trust (NIMCRUT) – FLIP Uni-Trust (FLIPCRUT) Intervivos – Testamentary | Yes | No |
j. | Family Limited Partnership (FLP) / Family Limited Liability Company (FLLC) | Yes | No |
k. | Sale to Defective Grantor Trust (SIDGT) | Yes | No |
l. | Grantor Retained Annuity Trust (GRAT) / Grantor Retained Uni-Trust (GRUT) | Yes | No |
m. | Grantor Retained Income Trust (GRIT) (nephews / domestic partners) | Yes | No |
n. | Self Canceled Installment Note (SCIN) (shortened life expectancy) | Yes | No |
o. | Charitable Lead Annuity Trust (CLAT) (shortened life expectancy) Intervivos – Testamentary | Yes | No |
p. | Private Foundation Intervivos – Testamentary | Yes | No |
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Did you enjoy, Death Bed Estate Planning Fire Drill?
Did you enjoy, Death Bed Estate Planning Fire Drill?
Did you enjoy, Death Bed Estate Planning Fire Drill?
Did you enjoy, Death Bed Estate Planning Fire Drill?
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