- Less costly to set up (does not require "Funding" or much decision-making)
- Allows for tax planning (but requires setting up costly Testamentary Trusts after probate)
- Filed with Courthouse: Financial and Asset information available to the public
- Only takes effect after you are dead
- No incapacity planning: Judge decides who makes living, financial and medical decisions for you
- Requires probate
- Requires Court or Judge oversight and approval
- More expensive to administer
- Takes longer to administer through court process
- May be easier to contest than a Trust
Many clients who come to me say their estate is simple, their assets are few, and all they need is a "simple" Will. It is then that we start to discuss what a Will is, how it works, when it takes effect, who it affects, and whether we actually need at Will at all. I find that people are usually surprised at the answers to those questions when they start to learn the facts and we apply them to their particular home and family circumstances.
A Will is only good after the Will-maker, or Testator, is dead. A Will requires a probate. Probate is the process by which title and ownership of assets that are in the person's name at the time of their death is transferred to someone else. In other words, a Will is basically a letter to the probate court or probate judge explaining what you wanted to have happen to your assets after you are gone.
The Probate process takes place in your local State courthouse with a probate court judge. Thus, all the documentation of your assets, net worth, and the contents of your Will are all available to the public for inspection. This means that a prior employer, an ex-spouse, or business competitors can come into the courthouse after you are gone, and without reason or explanation, review the court documents recording the disposition of your assets. You do not need to be a lawyer or a family member to review a person's probate file. Many people are not concerned about other people reviewing and reading about your personal wishes and gifts in your Will. However, people get curious about the other court documents showing your cash accounts, investments, debts, creditors, equipment lists, insurance policies, and all the other assets we accumulate and hope to pass on to our children and other loved ones.
You may have gifted much assets to one of your children while you were alive, and then not given that child any assets after you are gone. Why should people in the community speculate why you may have given everything to your other children and nothing to the one child? They do not have the whole story, but just what is contained in the courthouse records...
Since your Will only takes effect after you are gone, there is no opportunity to provide for your wishes regarding your health care, where you should live, or how your money should be spent if you become mentally disabled or incapacitated. Thus, even with a Will, if you were injured in a car accident or simply slipped on the ice and hit your head and became unable to make decisions for yourself, your family members will be left to hire lawyers and go to the courthouse to have a judge decide who should be your Guardian or Conservator. A Guardian is generally the person who makes lifestyle and daily living decisions for you, the "ward" (e.g., to live at home, assisted living, or nursing home). Generally speaking, a Conservator is a person who makes financial decisions for you, the protected person (e.g., keep paying life insurance premiums, whether to pay taxes on IRA money, or whether to try to gift assets for protection from the nursing home).
If you are incapacitated, the result is that instead of staying in control of who decides where you live, how you live, and how your money is spent, the probate court and the judge make those decisions for you. In order to make those decisions, the judge will want to know your actual mental capacity. The judge will order that you be evaluated by a doctor who will likely spend 1/2 hour analyzing you, and another 1/2 hour dictating a report. You will pay for that evaluation. Instead of family members who actually know you making the decision whether you are incapacitated, some court-ordered physician will do so. You have lost control.
The judge will also want to exactly of what your estate consists. This means a formal inventory will have to be completed, and the judge will likely require an annual report of your assets and available funds. This will require hiring an accountant to file the report and requires the judge's approval. Now you have lost control of who gets to decide your competency, who decides how your money is spent, or who decides where you will live and be treated.
Most people experience a process of decrease towards the end of their life. Unless there is a traumatic event like a heart attack, stroke, or accident, most people will slowly decline in their ability to care for themselves and will move through stages of in-home care, assisted living care, nursing home care, and possibly hospice. Often during this time, one of the children or other family members is left responsible to provide one-on-one assistance to you. That leaves the other family members to question whether the primary caregiver has influenced you in your last days. They may feel slighted or unfairly treated since you may have been influenced by the caregiver.
Since a Will is only administered or acknowledged after a person is gone and can no longer speak for themselves, it is easier much easier for other family members to contest a Will. Compare this to a Revocable Living Trust, where you are alive and well and able to make decisions concerning the ultimate disposition of your assets. Thus a Revocable Living Trust leaves much less room for family members to contest your wishes. The Trust may bring a level of peace and family harmony that is available through the Will probate process.
Administration of your Will takes place after your death. Again, that leaves your children or other loved ones behind to act as your Executor (or Personal Representative as they are now commonly called). The Personal Representative is responsible to locate and hire an attorney, if they choose, and to appear in the courthouse in front of the probate judge to open the probate claim and then complete the disposition of your assets. This includes reviewing all the assets, dealing with all other family members, and fulfilling your wishes. The Personal Representative is responsible to sign all forms and documents, and to appear in court whenever the judge needs the Personal Representative to in person. The Personal Representative will also have to appear in the courthouse to sign the closing documents in order to complete the probate claim.
The probate process requires publication of the probate claim in your local newspaper for two weeks, and then requires a four-month waiting period for any potential creditors to be notified and to have an opportunity to file a claim to repayment from your estate. There have even been news articles describing how some unscrupulous individuals have monitored the probate publications and have filed untruthful claims against estates because they know it is cheaper to pay off nuisance claims than it is to pay a lawyer to defend against paying them.
In the end, in can take upwards of 9 - 18 or even 24 months for the entire probate claim to be settled. In Minnesota, lawyers are not allowed to charge by percentage of the total estate value. Lawyers must bill by the hour. However, review of the total costs for lawyers to probate your estate demonstrates total fees in excess of 2% - 5% of the total estate. Thus, administering a Will can become very costly through the administration process.
Some attorneys like to sell "simple" Wills because they are less expensive to set up than a Trust. However, the administration cost is where the probate attorneys are able to make up their fees.
If your and your spouse's assets exceed Minnesota's State Estate Tax exemption amount of $1million, we can draft tax-saving language into the Will in order to create Trusts after you are gone ("Testamentary Trusts"). This type of Will is called a "complex" Will. However, the reality is that you have to pay for the Will up front, then pay a lawyer to administer your Will through the probate process, and then pay the lawyer to set up the Trusts! This is about the worst possible cost scenario for those with taxable estates!
"But I Already Have a Will..."
Most often I find that families who have a Will or other estate planning documents truly care about what happens to their things and to their family after they are gone. That is why I feel so badly when I review those documents and find that they are either no longer current with the laws, or the family has grown and changed and is no longer provided for. Our State and Federal laws change all the time. With expanding local and national debt, our government is constantly looking for ways to increase revenues. We do not know from one year to the next what our State or Federal Estate tax exemption limits might be.
Further, newest statistics are showing a trend in divorce rates to exceed 50%. While this is a sad truth about our society, family structures are changing as quickly as the laws. It is more and more common to find family divorces, remarriages, adoptions, step-children, ex-spouses, and blended families with "yours, mine and ours" children. This might include pre-marital assets like the family farm. It is common for our planning to include protection of blood-line assets and property.
Family values, short and long-term goals, and even the family structure change over time. What used to be important when the kids were little and the bank owned your house and farm change when the kids are married and we are looking at expanding the family business or farming operation to accommodate the growing numbers of people to support. What might have been a good plan back then is likely not going to achieve your goals for today and in the future.
It is for these reason s and many others that I strongly encourage you to call to set up your free consultation. I will work with you to identify your goals, identify your assets, and will work steadfast to find the best solutions to your estate planning needs!
"But I Don't Have a Spouse or Children..."
This is a familiar situation for those who may have been too busy with the farm or the business to get involved in a marriage or have children, or maybe you have lost your loved ones before your time. In any event, there are options for those who do not have readily identifiable heirs or beneficiaries picked out. You should still protect your assets and yourself by ensuring you have your living will, health care directive and power of attorney prepared for you in the event of your own incapacity.
Rather than wasting assets and resources in the court systems having a judge who does not know you try to appoint someone as your Guardian or Conservator, let me help you ensure that you know Who is going to care for you, What you will receive for care, Where you will live, and How your money will be spent. Ensuring your disability documents are in order will provide you with peace of mind knowing you will be cared for and your asserts will be used for your benefit.
Considering the uncertainty of the financial and medical providers actually honoring an otherwise perfectly legal Power of Attorney, you may consider Trust planning. In a Trust, you retain the power to control your assets and finances as you see fit as long as you are alive and competent. You also appoint the person or persons who you trust will act in your best interests if you cannot act for yourself. In the unfortunate event you become disabled (which is as easy as a slip and fall, car accident or stroke), your appointed Trustee will ensure your care needs are met. You will not have to worry about the hospital, the bank or other medical or financial institution refusing to honor your power of attorney.
Many people feel blessed to be able to give to charitable causes after they are gone. I can work with you to ensure you receive the full benefit of your money and assets during your lifetime, but also that your legacy lives on through charitable giving. I can suggest ways of producing tax savings in the present, maintaining income through your lifetime, and then benefiting those in need after you are gone. Let your legacy live on after you are gone in the minds and in the hearts and prayers of those you have helped...
- Begins working immediately.
- Private. Only between you and your lawyer.
- Not filed or published in the courthouse.
- Does not require Probate.
- Does not require Court or Judge oversight or approval.
- Provides protection in the event of your incapacity or disability.
- Easier to administer after death.
- Easier to protect assets in protective trust shares to the kids.
- Provides asset protection from new spouse, or from the kids' bankruptcy, divorce or lawsuits
- Allows for specific gifting of specific land or assets to particular individuals
- Allows for tax planning
- Allows for generation skipping (from you directly to the grandkids or great-grandkids)
- Not as easily contested as a Will
- Easier to administer after death: Less cost and less time to administer
- More work and expense to set up (you have to make decisions up front)
- Requires "Funding" or changing title and ownership of assets in order to work
What is a Trust
In contrast to the simple Will, a Trust is a legal document that will hold title to your assets. You are the maker of the Trust (also called the "Trustmaker" or "Grantor"). As the Grantor, you assign a person or persons to control and administer your assets. That person or persons are called the Trustee. Often, the Grantor is also the Trustee of his/her own Trust. Thus, as long as you are alive and mentally competent, you maintain full control over all your assets as the Trustee over your own Trust. You will also assign successor Trustees or Co-Trustees to help you administer your assets with you or for you if you become unable.
Think of a Trust like your own personal Fort Knox. Just as Fort Knox is used to safely and securely store a large portion of United States official gold reserves, your Trust safely protects title and ownership of your assets. Just as the federal government controls and directs the use, distribution, purchase and sale of the Unites States' gold reserve, your Trust enables you to control the use and disposition of your assets if you become mentally disabled by selecting successor Trustees you trust to make good decisions for you if you are no longer able.
The most common type of Trust we would likely use in your estate plan is the Revocable Living Trust. This means that as long you are alive and competent, you retain full control of your assets. There is no difference in your taxes or tax returns and you do not need a Tax ID number for your Trust. Your income and tax liability are reported on your personal tax return just like they always have been. You reserve the right to control and direct the use of your assets, and you retain the right to amend, restate or revoke your trust. Such Trusts are also called "Grantor" Trusts, because the Trustmaker retains all rights to his/her assets. It is "business as usual."
Effective Immediately, During Your Lifetime
A Revocable Living Trust, or "RLT," is good immediately upon signing. You do not have to wait until you are dead before the Trust starts working. It provides its protection to right away. However, in order for your RLT to work properly, it must actually "own" title to your assets. The process of transferring title and ownership of your assets to the Trust is known as "Funding."
Funding / Fueling Your Trust
The Funding process is vital and necessary to the effective implementation of your Trust. Think of the Trust as an engine and your assets as the fuel. An engine cannot run without fuel. Likewise, neither your Trust nor your Trustees can protect or control your assets if the assets are not placed inside or Funded into the Trust. One of the biggest mistakes people make is to have a lawyer draft a Trust for them, but then fail to Fund the Trust! The Trust may be perfectly legal and valid, but remains utterly worthless to you if your assets are not properly funded.
Some attorneys and law firms choose not to take the time to ensure proper funding of your Trust. I believe that good quality estate planning service begins with a lawyer who will ensure your Trust works properly by assisting you with the Funding of your Trust.
At Legal Estate Planning Solutions, I provide the written instructions for the proper Funding of your financial accounts and CDs, investments, life insurance policies, business interests, vehicles, personal property, real estate (deeds), and other assets. There are some assets that you do not want to Fund into your Trust. For example, an IRA (an individual retirement account) cannot be owned by your Trust. Such a transfer would be considered a "cashing out" of the account which would trigger any penalties and taxes due on your qualified IRA monies. There are also special rules for how your insurance policies should be owned so you avoid possible double taxation at your and your spouse's deaths. I am always available to answer questions, make suggestions, and assist you to properly Fund your Trust.
Trusts are Not Public Documents
Remember that a Will is a public document along with the other financial information that becomes part of a probate file. Unlike the Will, a Trust is a private document between you and your attorney. It does not get filed with the State or the County or at the courthouse, it does not require probate, nor does it require court or judge oversight or approval.
Since your Trust takes effect immediately after you sign it (and after you properly Fund it), the terms of the Trust will control the use and disposition of your assets should you become mentally incapacitated or disabled. Remember that a Will only takes effect after you are gone, so there is no option to ensure proper use and investment of your assets if you hit your head in a car accident or slip on the ice and are no longer capable of making financial or health care decisions.
Further, you get to choose who decides when you are incapacitated. You can name a Disability Panel which is comprised of the people you trust to decide when you are no longer capable of making good decisions concerning your assets. Your Disability Panel usually consists of your spouse and/or your children, and usually someone from the medical community (e.g., your attending physician). Your Disability Panel can also include parents, siblings, nieces, nephews, or trusted friends. With a Trust, if you become incapacitated, you will know that it is the people you trust who will decide your competency, not a judge you have never met or a doctor who does not know you or treat you.
If you become incapacitated and your Disability Panel agrees, then your successor Trustees that you named will begin administering your Trust according to the terms that you had previously set forth. With a Trust, even if you become incapacitated, you have already decided what is important to you, and who you trust to carry out your wishes. This is not possible under a Will.
Due to the additional planning and decision-making that comes with making a trust, and due to the Funding requirements, Trusts are more expensive to set up. However, not every person needs a Trust, and not every person needs to go through the work or expense of establishing a Trust. That is decision that each individual client will have to decide for themselves. I simply inform and empower clients to be able to make that decision.
The Trust agreement can be administered by anyone who is competent to do so. That means that even if I draft and Fund a Trust for you, you may take that Trust to another attorney or other competent person to administer. The Trust is good wherever you go.
Trusts Do Not Require Probate To Administer
Trusts do not require probate to administer. Unlike a Will that requires your personal representative to appear in Court and publish notice of the probate and the creditor claim waiting period and the signing of any letters testamentary and the closing of the probate claim, a Trust is much simpler to administer. It generally requires a meeting with the Trustee to ensure proper distribution of the assets. The attorney may only be required to assist the Trustee in obtaining a Tax ID number for the Trust after the Grantor has died, and provide the Trustee with a Certificate and/or an Affidavit of Trust evidencing the Trustee's right to act on behalf of the deceased Grantor's Trust.
Trusts Cost Less to Administer
In contrast to the Will (which requires probate and costs between 2%-5% or more of the total probate estate to administer), the Trust may only cost a few hundred dollars for the attorney's time and assistance. Of course every case will differ according to its facts, but Trusts are overwhelmingly significantly less expensive to administer, generally costing less than 1% of the total Trust estate.
Trusts Take Less Time to Administer
In contrast to the Will (which requires probate to administer, including the publication and creditor notice period), the Trust should take weeks, not months to administer. This is so because the Trust already dictates how the assets should be administered, and the Trustee is responsible to transfer the assets according to the terms of the Trust.
Trusts May Be Less Contested Than Wills
Since the Grantor is alive and well while the Trust is in effect, there is much less chance of family members raising undue influence claims or that the Trustmaker did not intend the distributions he made. It is much easier for family members to raise such claims after the person has died and the Will is being administered because there may have been opportunities for the primary caregiver to have exerted undue influence against the person who made the Will before they died.
Probate Avoidance and the Transfer on Death Deed (TODD)
- Used to Avoid Probate Process
- Uses Beneficiary Designations, POD and TOD designations instead of Will
- Keeps your Financial and Asset documents out of public view in the courthouse
- Does not create a present gift or penalty period for Medical Assistance
- Less costly than Probate
- Does not protect home or assets from Nursing Home
- Does not provide for Incapacity or Disability Planning
- Must be used in conjunction with POA, HCD & HIPAA
Another option to consider that may be very effective and very inexpensive is the Transfer on Death Deed. Since 2008, the state of Minnesota has authorized use of the Transfer on Death Deed, or TODD. This allows the owner of land or other real estate, like your house, to transfer ownership of the real property by filing and recording a TODD with the county. The TODD does not transfer any immediate interest in the property because it only takes effect after the owner is deceased. Thus there is no "gifting" issue or period of ineligibility for Medical Assistance purposes.
The TODD is revocable, so it can be changed at any time the owner is still alive and competent. All you need to do is file a revocation of the TODD in the county where you recorded the TODD, file another TODD transferring equal or greater interest in the property, or simply transfer the property by gift or sale to someone else. In other words, as long as the owner is alive and well, they may revoke or change the beneficiary designations however they would like.
Since the TODD transfers ownership of the property at the death of the owner (or at the second death of joint owners), there is no need to go through probate or use a Will to transfer ownership of the property.
If you couple the TODD with Joint Ownership and with Payable on Death (POD) and Transfer on Death (TOD) and beneficiary designations, you may avoid probate altogether. Generally I recommend you place POD or TOD designations on your cash accounts, investment accounts, CDs, money market accounts, and your investment accounts. For your IRAs, 401k, 403b, SEP, SIMPLE, or Keogh plans (your qualified, pretax money) and your life insurance policies, I recommend you ensure your primary beneficiary is designated as your spouse, and then name your kids as contingent beneficiaries. You may want to check that your kids know where your safe deposit box key is located, and that they are listed on the bank's forms to be able to access the Safe deposit box after you are gone.
Please contact me with any questions regarding the TODD or beneficiary designations.
- Provides Liability Limitation and Asset Protection
- Good for Ease of Ownership of multiple assets
- Provides for Ease of Transferring Wealth
- Easier and more efficient for Gifting Strategies
- Retains control over business and assets
- May provide for adequate income after Retirement
- May Reduce Estate Tax, Income Tax, and/or Self-Employment Tax
- Enables "Discounting" of the value of underlying assets
- Ease of Succession Planning after death
- Enables continuity of the Business after death
- Additional expense to set up
- Additional bookkeeping requirements to maintain
- Likely requires annual renewal and update filings
There are many reasons you may be considering forming a business entity to hold title and operate your assets. These might include liability segregation and protection; ease of ownership; ease of transferring wealth; gifting strategies; keeping control over assets for as long as possible; ease of transferring ownership at retirement or death; ensuring adequate retirement income from your assets; reducing estate, income and/or self-employment taxes; and other reasons that fit your particular facts and circumstances.
The primary business types include:
- Sole Proprietorship
- General Partnership (GP)
- Limited Partnership (LP)
- Limited Liability Partnership (LLP)
- Limited Liability Limited Partnership (LLLP)
- Limited Liability Company (LLC)
- C Corporation
- S Corporation
There are numerous reasons for choosing the differing types of business entities including treatment of income tax, capital gains tax, self-employment tax, limitations of liability, whether you have employees, whether you require all the income generate from your business, how you will acquire capital investments, how you wish the income to be distributed, and many other reasons. A full discussion of all those reasons lies beyond the scope of this overview. However, some important points need to be understood in the context of estate planning.
Many clients with whom I work are business owners or farmers. There are often considerable personal assets and business interests involved in the entire estate. Therefore, we must be conscientious whether we want our personal assets (e.g., our vehicles, cash / CDs / money market accounts, land, other real estate, boats / trailers / snowmobiles / ATVs, rental properties) subject to an accident or mistake that may happen at our business.
A good example is the farmer who may have a row crop component and a hog component as part of his total farm operation. He may own his house, a couple personal vehicles, a family lake cabin, a time share, Recreational Vehicles, and a park model in Arizona. Suppose the farmer or one of his employees is driving a load of hogs or grain down the county road and the air brakes hiss and he accidentally pull through the intersection and hits another vehicle. Farmer is suddenly liable for any injuries and damages and wrongful death that may have been caused by the unintentional accident.
Since the farmer owns all his assets (personal accounts, home, toys, vehicles, cabin, time share, park model, RV) and all his business interests (land, equipment, trucks / trailers, hogs, buildings / barns / sheds) all in his own name, ALL of his assets may become subject to the liability.
"But I already have insurance..."
Many clients tell me they are not concerned about the liability issue because they have insurance plus and umbrella policy. My response is always: "Insurance is your first line of defense in the event of an unforeseen incident." However, you are only covered up to the limits of the policy. So even if we have two million in coverage over the farm and another million umbrella policy, we still may have a problem. For instance, suppose the vehicle that was hit contained husband, wife, and three kids (fairly common example). Husband and wife are mid-thirties with thirty years of earning potential. If either of them is badly injured and disabled, they may be entitled to medical expenses, lost earnings, lost earning potential over their lifetime, pain and suffering, and emotional distress. If one or both parents are killed, there will likely be a wrongful death action. If any or all of the four children requires special care or treatment, their medical expenses over their lifetime will be at issue. Imagine the cost of nursing home care for the life expectancy of a 12 year old girl considering the cost of care and inflation.
Suddenly, without any intentional wrongdoing, the farmer's entire holdings may become subject to a liability that he may not have even directly caused. While he may have insurance coverage totaling three million, he likely does not have enough to cover the entire cost of care and medical expenses for the lives of the family that were affected by the accident. Once the liability exceeds the policy limits, the court and the judge start looking at the farmer's or business owner's personal assets to satisfy whatever liability judgment was determined. After the Sheriff sells the machinery and equipment, the hogs and the trucks, the barns and sheds, he may come after the family lake cabin, the toys, the park model, and potentially some of the land to satisfy the judgment. This would be a terrible result.
The solution may be to segregate or separate the liability of the hog operation from the land from the farmer's personal assets.
We could file Articles of Organization for a Limited Liability Company to hold the hogs, equipment, grain, and machinery. These are the hottest items that are most likely to cause damage or injury to someone else, especially where trucks are hauling livestock or grain on state or county highways. The injuries that may occur in such an accident are likely to be very serious and cause significant damages. We could limit any liability from any of these sources to only the assets within the organization. Thus, even if we exceeded our policy limits and the court came after our machinery and livestock, farmer would still have his land and personal assets protected. Although devastating, he could still rent the land and would have his home and personal belongings enough to get back on his feet. He did not lose everything, even though his insurance was insufficient to cover the damages.
We may also place his land into a Family Limited Partnership. Doing so provides many benefits. By definition, a Limited Partnership includes two types of Partners: General Partner's and Limited Partners. The General Partners have the authority to decide: who may become partners; who will be excluded; decide rental of Partnership assets (who may rent, at what rate, for how long); determine sale, purchase, encumbrance, transfer or mortgaging of Partnership assets; and other operational aspects of the business. The Limited Partners do not share in any of the decision-making authority held by the General Partners. The Limited Partners possess only the right to collect their pro-rate share of the profits according to their percentage ownership of the Partnership Interests.
If Farmer and wife are each 2% General Partners, and each 48% Limited Partners, the land asset inside the Family Limited Partnership (FLP) is now owned by the FLP. Farmer and wife no longer own acres of land, but rather own Partnership Interests. Since Farmer and wife are the only General Partners, they continue making all decisions regarding the land, including who else can become a Partner, if they will rent the land, to whom they will rent, at what rate, and for how long. Farmer and wife, as General Partners, also control the purchase of additional land or the sale of any of the land inside the Partnership. In other words, it is business as usual. However, the FLP will have to collect any rents and will have to pay the property taxes and insurance.
Since there are restrictions on the Limited Partners' ability to accept new Partners, to rent or sell the land, or the mortgage the land, there are very few buyers who would desire to purchase any of the Partnership Interest. The lack of control and lack of marketability of the land due to the Partnership Agreement terms means that while the value of the land itself continues to be Fair Market Value, the value of the restricted Limited Partnership Interests is reduced or "Discounted." The amount of the discount is determined by an appraiser who is certified to appraise the value of business interests. Usually we can expect a 25 - 35% discount for a Minnesota FLP.
The Discount produces two beneficial results. First, if your estate is over $1 million, then you are taxable under the Minnesota State Estate Tax. By placing your land into the FLP, you will receive a 25-35% Discount which may reduce the value of your taxable estate to below the $1 million exemption limit and may eliminate (or at least reduce) your estate tax.
Another major benefit is with Gifting. In order to qualify for Medical Assistance or to reduce your taxable estate, some families begin Gifting strategies to transfer some of their wealth to their kids during their lifetime. There is no Minnesota state Gift tax. There is a Federal Gift Tax of 35%, but there is an annual exemption of $13,000 per year per person. This means Farmer and wife can each gift up to $13,000 worth of cash or assets (for a total of $26,000) to each of their kids without filing an additional paperwork or paying any gift tax. Any gift that exceeds $13,000 per year per person must be recorded on IRS Form 709 Gift Tax Return. However, no Gift tax is due unless the gift exceeds $5 million.
Imagine that you want to reduce your total estate tax bill by gifting some of the land to kids during your lifetime. How difficult is it for Farmer and wife to appraise their land every year, then survey off $13,000 worth of acres (1.3 acres?), and then gift the partial acres to the kids each year. That would be hugely expensive, time consuming, and probably causes more trouble than it is worth. However, if you do not own acres, but own Partnership Interests, it is much easier to transfer or gift $13,000 worth of Partnership Interests than it is to transfer actual acres. Remember, the land is discounted by 25-35%. So, instead of only gifting $13,000 worth of acres, Farmer and wife could gift up to $17, 550 (13,000 x 1.35% = 17,550) worth of land to the kids each year (or a total of $35,100 per year per child from both mom and dad).
Careful of the Capital Gains...
Thus, it is much easier and much more efficient to gift Partnership Interests than it is to gift actual acres. However, there is one major caveat: that being Capital Gains tax. When a person Gifts an asset, the tax basis of the asset follows the gift. For example, if Farmer and wife own land they purchased at $1,000 per acre, but it is now worth $6,000 per acre, they have a capital gain of $5,000 per acre. The long term capital gain rate is about 23% (15% federal, 7.85% Minnesota). If Farmer and wife decided to sell their land, they would pay 23% of the $5,000 capital gain per acre sold, or $1,150 per acre.
The same holds true for gifts of Partnership Interests: the basis you gift will be the basis received by the recipient. In addition, if you accept the benefit of the Discount by placing your land in an FLP and then you accept the Discounted value of the land at your death to save estate taxes, your heirs will get a Step Up in basis, but will only Step Up to the Discounted value of the land.
You need to be careful when forming an entity so that you fully understand the implications. For every action, there is a reaction. If you obtain the benefit of the Discount for estate tax purposes, your heirs may pay the Capital Gains if they ever try to sell the land later.
Ease of Ownership & Transfer
Another benefit using an FLP is that you will own all your land parcels in one place. This may make it easier to dividing the land among your loved ones after you are gone. Instead of trying to divide particular parcels or acres equally between your kids (which is inherently unequal because no two pieces of land are exactly the same), you can easily divide your Partnership Interests among your children in whatever distribution percentages you like. It is very easy to value what each Partnership Interest is worth, and then divide the Interests among the children or other beneficiaries however you please.
Maintain Adequate Retirement Income
An FLP also enables you to ensure that mom and dad retain adequate retirement income and maintain control over the Partnership, even while they gift Limited Partnership Interests to their kids. In essence, the all the Partners in the Partnership are entitled to receive their portion of the Partnership profits according to the percentage ownership of Interests. In our example above, where mom and dad are each 2% General Partners and 48% Limited Partners, mom is entitled to receive 50% of the profits (2% + 48%), and dad is entitled to receive 50% (2% + 48%) of the profits.
When you gift a Partnership Interest, you are entitling the recipient to collect their pro-rata share of the profits according to percentage ownership. For example, if mom and dad decide to gift 10% of the Limited Partnership shares to each of their two kids, mom will be a 2% GP and a 38% LP, dad will be a 2% GP and a 38% LP, Child 1 will be a 10% LP, and Child 2 will be a 10% LP. Thus, mom and dad will each be entitled to collect 40% of the profits, and each child 10% of the profits.
Maintain Control Over the Farm / Assets
Remember, only the General Partners get to make decisions regarding the Partnership assets. So, as long as mom and dad retain majority ownership of the Partnership Interests, they maintain control of the farm! In addition, if mom and dad desire to gift Partnership Interests to reduce their taxable estate, but they wish to preserve the income from the Partnership for themselves, we can draft the Partnership Agreement to authorize only enough profit distribution to cover the taxes owed on each Partners Interests. That way we can reserve the additional income from the land to ensure adequate income for mom and dad's retirement.
Reduce Your Self-Employment Taxes
Let us assume our Farmer again. Farmer raises and sells his grain for earned income and is taxed at his marginal tax rate or tax bracket. He files an IRS Form 1040 income tax return. He also files a Schedule F (or, in the case of a sole proprietor, a schedule C). As a sole proprietor or a Farmer, his income is subject to the Federal, State, and Self-Employment (SE) Tax. Note: the Self-Employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance). So, our Farmer is paying 15.3% SE tax on his earnings, up to $110,100, after which only the Medicare portion of the SE tax is owed.
Let us assume also that we have taken Farmer's land and placed it into a FLP. Farmer now owns Partnership Interests, not acres. Farmer can now set a lease agreement to rent his land from his own FLP. Rent payments are deemed "passive" income and are therefore not subject to the SE tax. The result is that the Farmer saves the 15.3% SE tax on whatever amount he pays his FLP (himself). Stated another way, the Farmer's earned income (subject to Federal, State and the 15.3%$ SE tax) reduces by the amount he pays his FLP in Rent. The Farmer's FLP balance sheet increases by the amount of the rent payment, but that money is no longer subject to the 15.3% SE tax.
For example, let us assume that Farmer places 500 acres into his FLP. Then let us assume he charges a "reasonable" rental rate per acre of $200 per acre. The amount of the rent payment equals $100,000. Farmer would have paid Federal, State, and 15.3% SE taxes on his earned income. However, because he reduced his earned income by $100,000, and instead earned $100,000 in passive rental income via his FLP, he saved the 15.3% of SE tax. Farmer saved $15,300 in SE taxes in the first year of his FLP! And, he continues to save the SE tax for every subsequent year he continues to farm!
Of course the amounts and figures will vary from one client o the next, but this overview should provide a general idea of how entity planning can reduce your SE tax burden.
There are very many options when it comes to business entity planning. You will need to find an experienced attorney who is willing to engage you with enough time to adequately identify and clarify your needs, wants and goals. Only then can you develop an estate plan solution that solves all your concerns and desires.
Deal with owning real property by converting it to intangible property...
INCAPACITY / DISABILITY PLANNING
- Power of Attorney
- Durable vs. Non-Durable
- Immediate vs. Springing
- Common Law vs. Statutory Short Form
- Health Care Directive
- Appoints a Health Care Agent
- Living Will
- Provides Health Care Agent with your preferences concerning Health, Medical, Emergency and End-of-Life Options
- HIPAA Authorization
- Authorizes your Health Care Agent to access your confidential medical records and discuss your treatment, services, medications, diagnosis and prognosis with your doctor
There are certain documents that will be completed regardless of which type of planning you choose (Will or Trust planning). In the event of your mental incapacity or disability, every person over 18 years old needs certain documents to ensure access to proper health and medical care. I call these "Ancillary" documents as they accompany and are in addition to the other planning documents.
I. Health Care Directive
Your Health Care Directive is the document that appoints a Health Care Agent to speak for you if you become unable to speak for yourself concerning medical treatment. Your agent can be your spouse, your children, parents, siblings, nieces or nephews, or other trusted friends, or any combination of the above. You can require that any one of your Health Care Agents can make decisions for you on their own, or that all your selected Health Care Agents must agree.
I will work with you to empower you to decide who your Health Care Agent(s) should be, and who your successor agents should be. I always want to see successor agents named in the event your first named Agent dies or become incapacitated before you do. I frequently meet clients who believe they have appropriate documents and paperwork, but then I find that there are no successor agents listed. I also find that even attorneys or law firms fail to meet the formal document execution requirements of being signed, dated, and either properly notarized or witnessed.
Consequences Of Not Having HCD
Should you become incapacitated due to stroke or accident, and you do not have anyone appointed to make healthcare decisions for you, your family members will be left to hire lawyers and go into court seeking appointment of a Guardianship over your person. This is a completely preventable outcome by simply having hour Health Care Directive in order. This will likely save you the $3,000 to $5,000 or more expense of attorney's fees in pursuing a court-ordered Guardianship.
II. HIPAA Authorization
HIPAA is the acronym for the federal Health Information Portability and Accountability Act of 1996. This is the law that requires proper authorization for third parties to access your protected health care information. Minnesota law historically restricted the HIPAA authorization to only one year. Another issue I frequently encounter is that of not providing for successor HIPAA agents. Generally, you will assign your HIPAA agents to be the same as your Health Care Agents. This way the people you have asked to make health care decisions for you will also have access to the medical records and treatment notes, and will be able to discuss your case with your treating physician.
Consequences of Not Having HIPAA Authorization
Thus, clients have described the situation where their spouse was in critical care at their local hospital, but upon arrival, the spouse was not allowed access to either the medical records or to speak with the doctor about the spouse's medical care because either the HIPAA had expired or a HIPAA Authorization had never been executed.
This is a must-have document for every person over 18 years old.
III. Common Law Power of Attorney
The Power of Attorney is the document that allows you, the Principal, to appoint a third party to act as your financial manager if you are unable to do so. The document indicating your appointment is called the Power of Attorney (POA). The person or persons whom you appoint are called your Attorney-In-Fact. There are several types of POA including General or Limited, Durable or Non-Durable, and Immediate or Springing. Here is a little regarding each of these options:
Durable vs. Non-Durable
A Durable POA is one that remains in effect even in the event of your disability or incapacity. This is actually the main reason we have POAs - to ensure we have someone we trust to take over our financial matters if we are unable. However, there may be some circumstances where you may want to authorize a person to make financial decisions while you are able to monitor their actions on your behalf, but that power ceases once you become incapacitated and cannot longer monitor your Attorney-In-Fact's actions. Generally, you will sign a Durable POA because we want to appoint an Attorney-In-Fact who can act on your behalf especially after you become incapable of doing so on your own.
General vs. Limited
A General POA is one that places no restrictions on the actions your Attorney-In-Fact can take on your behalf. Thus, a General POA allows your Attorney-In-Fact to do anything with your real estate, finances, investments, Life Insurance, IRAs, and other assets to the same extent as you would have been able. A Limited POA is one that simply places restrictions on the actions your Attorney-In-Fact can take. For example, you may want to allow your Attorney-In-Fact to sell or mortgage or gift your farmland or lake house, but do not want to allow your Attorney-In-Fact to sell, mortgage or gift your homestead.
Thus you could limit your Attorney-In-Fact to having authority over all your real estate except for the home-place. You could also allow your Attorney-In-Fact to deal with or dispose of your cash assets, CDs, Money Market accounts, and Investments, but not to deal with or dispose of your Life Insurance or IRAs. Or you could allow your Attorney-In-Fact to deal with your financial matters, but not your real estate, or handle your personal finances, but not your business matters.
There is any number of combinations that could be implemented depending upon your particular facts and circumstances. This is where finding a lawyer you are comfortable dealing with and talking to can make the estate planning process much easier and much more effective for your particular circumstances. I am happy to discuss your facts and circumstances and provide you with recommendations for you to consider in order to make decisions.
Springing vs. Immediate
An Immediate POA is one that takes effect immediately upon signing. In other words, your Attorney-In-Fact can take whatever actions you have authorized starting the moment the POA is signed. There is no contingency or event that must occur before the Attorney-In-Fact may act.
A Springing POA is one that requires a condition or event to occur before the POA becomes effective and before the Attorney-In-Fact may act. Usually this option is selected when you wish to retain full and sole control of your assets and finances for as long as you are able.
There is an ongoing debate about which type of POA you should sign. There is certainly reason for concern in authorizing your Attorney-In-Fact to dispose, buy, sell or trade your money or property before there is an actual need. Most of us wish to retain sole control over our assets for as long as possible. That way we know our money and property will be available to us to with as we wish. If we give an immediate POA to our Attorney-In-Fact, he/she would have legal authority to sell or transfer or encumber our assets, even though we remain fully capable of making decision s for ourselves. You must really trust your Attorney-In-Fact before you authorize them to dispose of your money and property to the same extent that you could.
The argument in favor of signing and immediate POA is predicated upon the difficulty in obtaining a physician's opinion stating that your loved one is no longer competent to make decisions concerning assets and finances. Doctors and psychologist are reluctant to declare a person incapacitated without having ample opportunity to meet, interview, test and evaluate the person. Therefore, it can become very time consuming and expensive to actually have a medical professional declare a person incapacitate before the Attorney-In-Fact is able to take actions on your behalf. There could be some expensive and very stressful consequences if bills need to be paid, or a tax-saving gifting strategy is to be employed while you are waiting for confirmation from a physician that your loved one is no longer capable of making decisions for yourself. Thus, it may be better to have an Immediate POA so the Attorney-In-Fact is empowered to take whatever actions are necessary to protect your best interests.
IV. Statutory Short Form Power of Attorney
There is another option that is not favored, but worth mention: that being the Minnesota Statutory Short form POA. This is a form POA listed in the Minnesota Statutes. It is as its name implies: short and concise, generally filling one page, front and back. It is a check-the-box form used to indicate which powers you are authorizing to your Attorney-In-Fact, whether it is a Durable POA, whether the Attorney-In-Fact can transfer your property to himself/herself, and how frequently the Attorney-In-Fact must produce an accounting.
While the Statutory Short Form POA is better than nothing, it poses several drawbacks. First, according to the terms of the statute, the Attorney-In-Fact is restricted from making any gifts to himself/herself or to any of their dependents in excess of $10,000 in the aggregate in any given year. This may result in your inability to adequately plan for protecting your assets from the Nursing Home or from the County Estate Recovery process.
My Common Law POA authorizes the Attorney-In-Fact to take whatever actions are necessary and prudent to best protect the Principal's interests. This would likely include gifting in excess of the statutory $10,000 limit. In addition, my Common Law POA both expands the authority of the Attorney-In-Fact to take actions in your best interest, but also places additional accountability requirements on the Principal. Thus, we get the best of both worlds: we get the benefits of full and expanded powers, but we also get the benefit of increased accountability.