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Wednesday, July 16, 2014

Duty of Executor to Defend a Will Against a Will Contest in Pennsylvania

In most states, when a person is named as an executor in the Will, the executor has an affirmative duty to defend the Will from Will contests.  For example, if mom dies testate leaving her entire estate to child one, cutting out child number two, and child number two sues to say the Will is result of undue influence, the executor would be obligated to defend the validity of the Will and could hire an attorney using estate assets to aid in the defense.  Unless the executor caused the undue influence, he would not be personally liable to the estate for the cost in defending the validity of the Will.

Pennsylvania law is quite different from most other states in that while an executor is a necessary party to a contest involving the Will, the executor is generally not a party in interest who has standing to instigate a contest or to appeal a decree of distribution. (In re Estate of Fleigle, 664 A.2d 612, 444 Pa Super. 632 (1995))  An executor who has not been surcharged or is not required to distribute an amount larger than the total assets of the estate has no standing to except to an adjudication of the auditing judge regarding payment of claims against an estate unless the executor is also a residuary beneficiary of the estate.  (Appeal of Gannon, 428 Pa. Super. 349, 360-61, 631 A. 2d 176, 181 (1993))  The executor is entitled to notice and may then elect whether to become a party (Royer’s Ap. 13 Pa. 569; Yardley v. Cuthbertson, 108 Pa. 395, 445-448), although if he does become a party his costs and counsel fees must be paid by him or those who authorize him, not by the estate.  (Faust Estate, 364 Pa. 529 (1950))

The Faust case is extremely important because it shifts the burden for payment of legal fees from the estate to the executor personally if the executor decides to insert himself or herself into a Will contest.  Additionally, if executors engage in an act that is beyond their scope as representatives of an estate, they risk losing their executor's commission.

Pennsylvania law does have a few exceptions for when an executor can get involved in a Will contest.  An exception exists where a testator directs or imposes a duty on the executor to defend the Will against contests.  (Bennett Estate, 366 Pa. 232 (1951); See also:  Tutelea Estate, 4 Pa. D. & C. 3d 199 (1974))  Another exception to the Pennsylvania rule is where the executor is also a trustee and is required to defend the trust.  (Fetter's Est., 151 Pa.Super. 32, 29 A.2d 361 (1942)).

We also need to differentiate cases where an executor is being sued for his services as executor.  (Browarsky Estate, 437 Pa. 282 (1970))  Because the executor is placed in the position to be sued because of duties he had performs for the estate, it would be unjust to require him personally to bear the reasonable costs of the defense of suits brought against them solely by reason of their positions as executors. "It is well established that whenever there is an unsuccessful attempt by a beneficiary to surcharge a fiduciary, the latter is entitled to an allowance out of the estate to pay for counsel fees and necessary expenditures in defending himself against the attack [citing cases]." Wormley Estate, 359 Pa. 295, 300-01, 59 A.2d 98, 100 (1948). Accord: Coulter Estate, 379 Pa. 209, 108 A.2d 681 (1954).

Finally, there is very old case that stands for the proposition that: “The executor propounding a Will for probate, acting in good faith, is entitled to costs out of the estate, whether probate is granted or refused.”  (Ammon’s Appeal, 31 Pa. 311).  I note that I can’t find the case, only a cite in a treatise, but I believe this to still be good law if the executor does not get involved in a Will contest.

If an executor uses estate assets to pay for legal fees related to a lawsuit against himself or because the executor impermissibly got himself involved in a Will contest, a judge can surcharge counsel of an estate or counsel for an executor. (Faust)

The rationale behind the Pennsylvania case law is that a Will contest is between the testamentary beneficiary and the heirs or next of kin, therefore the executor should not waste estate assets on their dispute.  The rationale behind the rules in most other states presumes that the testator wrote the Will the way he or she wanted it and the executor should try to uphold the testator's intent.

From a practical point of view of estate administration attorneys, we need to consider three things.  One, we need to understand the source of the money from which we are getting paid and keep track of it. If we are paid from the estate for a Will contest or for an objection to an accounting, we may be required to give the money back to the estate.  Personally, we always ask for a retainer from a proposed executor before they have qualified executor.  Accordingly, they are paying me with their own money and getting reimbursed from the estate later.  Also, attorneys should put language in their retainer agreements stating that the proposed executor is personally liable for the legal work if he cannot qualify as executor or if we wind up doing work for the executor in an individual capacity.

Second, in the event of a Will contest or an objection to an accounting, attorneys should track their time separately.  Time spent on the Will contest or an objection to an accounting should be differentiated from time spent administering the estate.

Finally, attorneys should consider whether they want to draft their estate planning documents in a way to change the default rules regarding an executor's duty to defend the Will.  Personally, I think that it makes more sense for an executor to use estate assets to defend the integrity of a Will and that the executor shouldn't be personally liable absent gross negligence, willful misconduct or bad faith. After all, some beneficiaries might not have the resources or the mental capacity to act in their own best interests.
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Thanks to Pierson W. Backes, Esq. for his help with this article.

Wednesday, July 2, 2014

Nice Article on the Basics of ILITs

A colleague of mine, David Saltzman, has written a nice article on the Basics of Irrevocable Life Insurance Trusts.  As he points out, setting up a life insurance trust is a great way to minimize your estate tax liability and it can be especially important in New Jersey.

Dave is a great resource and knows a lot about insurance.  Feel free to contact him regarding any insurance questions you may have.

Monday, May 26, 2014

Pennsylvania Same Sex Married Couples No Longer Have to Pay Inheritance Tax

On May 20, 2014, U.S. District Court Judge John Jones III declared that Pennsylvania's laws banning same sex marriage was unconstitutional.  Besides the practical implication that same sex couples in Pennsylvania may now get married, it also means that when one spouse dies, the survivor can now inherit tax free.  

Previously, only a heterosexual surviving spouse could inherit assets of the deceased spouse tax free.  Additionally, for same sex couples, if one partner left money to another, that would be taxed at a 15% rate - the same as if the person were a total stranger.

If you are in a same sex marriage (that was licensed in another state) you may wish to consider revising your estate planning documents as a result of this ruling.  Additionally, if you have recently lost a same sex spouse, you may wish to consider amending the Pennsylvania inheritance tax return to request a refund.   

Thursday, May 22, 2014

Change in New York Estate Tax Law

Effective April 1, 2014, the State of New York made numerous changes to its tax law.  Most dramatically, New York is increasing its estate tax exemption amount from $1,000,000 to match the federal estate tax exemption amount.

New York's New Estate Tax Exemption Amount
Until March 31, 2015, the new estate tax amount will be $2,062,500.
From April 1, 2015-March 31, 2016, the exemption amount will be $3,125,000.
From April 1, 2016-March 31, 2017, the exemption amount will be $4,187,500.
From April 1, 2017-December 31, 2018, the exemption amount will be $5,250,000.
From January 1, 2019 on, the exemption amount will be indexed to the federal estate tax exemption amount.

However, New York has created a devastating Estate Tax "Cliff" by phasing out the benefit of the New York Exclusion Amount for estates that exceed 100% - 105% of the exclusion amount.

The practical implication of the "Cliff" is that for estates under the NY estate tax exemption amount, there will be no tax.  For estates just above the threshhold, there will be an effect tax rate of as high as 252% (Source www.jdsupra.com).  For estates above 105%, there is a flat 16% tax on all assets owned by the decedent, not just the amount above the exemption limit.

Addition of a Three Year Look Back Provision
New York has also added a three year look back provision for gifts made within three years of death.  This provision only applies for gifts made between April 1, 2014 and January 1, 2019.  The lookback will not apply if the gifts were made when the decedent wasn't a New York resident or if the gift is otherwise includible in the decedent's taxable estate.

Other Important Changes to NY Estate Tax
Other major changes made by the new law are to:
1)  repeal New York's generations skipping transfer tax; and
2)  allow a marital deduction for non-citizen spouses.

New Law Regarding Income Taxation of NY Resident Trusts
Finally, the new law aggressively pursues an income tax on trusts for the benefit of New York residents.  The bill is going after two types of trusts.  The first one being one that a wealthy New York resident sets up for his own benefit, retaining a discretionary interest in the trust.  The second one being any trust for the benefit of a New York resident.

With respect to the first type of trust, for years, wealthy individuals have set up "incomplete gift non-grantor trusts" to avoid the New York income tax.  The idea was that if you created a trust in another jurisdiction (with the assets and trustees outside of NY) then New York would not have the right to tax the income earned in that trust to the extent income was retained in the trust.

With respect to all other trusts, New York will now tax the distributions of accumulated income to New York residents.  However, the State will offer a credit to the extent a tax is paid to another jurisdiction.

Important Items That Were Considered But Not Changed
1)  New York has not adopted the concept of portability of the estate tax exemption; and
2)  New York had considered a maximum 10% tax rate, but decided to keep it at 16%.

Friday, March 14, 2014

Excellent Guide on International Estate and Inheritance Taxes

While I have not had a chance to review it thoroughly to confirm its accuracy, I note that the accounting firm, Ernst & Young, has posted a detailed analysis of the estate and inheritance tax laws of almost every country in this brochure.

For those of you who have assets in multiple jurisdictions or are citizens living abroad, you should familiarize yourselves with these laws and hire competent counsel to asset you in minimizing your taxes.

Monday, March 10, 2014

Calculating Trustee Commissions in NJ

From time to time, people ask me how executor's commissions and trustee's commissions should be calculated.  I have already written a post on calculating executor and administrator commissions, so this post will focus on Trustee commissions. 

New Jersey statutes on trustee commissions are very difficult to interpret because they use the term fiduciary to apply to executors, administrators, trustees, guardians and conservators.  This would not be a problem if the fees were calculated the same, but they are not.  Additionally, there are different rules for testamentary trusts (trusts created under a Will) and intervivos trusts (a trust created while the Grantor was alive).  Going forward, if a particular rule applies to everyone, I will call that person a fiduciary.

To start, the Grantor of a Trust can specifically provide for a trustee commission.  However, for testamentary trusts, if the commission is higher than the amount allowed under the New Jersey statutes, the Will must specifically state that the testator is aware of the commissions allowed under the New Jersey statutes and expressly authorize payment in excess thereof.  N.J.S.A. 3B: 18-31.

Failure to expressly authorize a commission in excess of the NJ statutory limit or failure to state whether or not a trustee is even entitled to commission will result in the trustee being able to take a fee as provided in New Jersey Statutes 3B:18-23 through 3B:18-29.  These statutes also apply to Guardians and Conservators.


So how is the trustee's fee actually calculated?


Unlike an executor who typically takes a one time fee, Trustees are more likely to take annual commissions, especially if the trust goes on for a long time. 

The fee is comprised of both an income commission and a corpus commission.  A trustee is entitled to annual income commissions of 6% without prior court approval. N.J.S.A. 3B: 18-24.



The corpus commission is a bit more complicated to calculate:. Normally an executor will take a one time commission as follows:
  1. 0.5% on the first $400,000 of all corpus received by the executor; plus
  2. 0.3% on the excess over $400,000.  (N.J.S.A. 3B: 18-25)
If there is more than one trustee, an additional 1/5 of all the commissions allowed above is authorized, provided that no one trustee shall be entitled to any greater commission than that which would be allowed if there were but one trustee involved.   (N.J.S.A. 3B:18-25.1)

A trustee is entitled to a minimum fee of at least $100 per year and corporate trustees may set their own rates.   

Upon the termination of a trust, the trustee is entitled to a termination fee in addition to the annual fees he or she may have taken.  3B:18-28.  The termination commission is as follows:
  1. If the distribution of corpus occurs within 5 years of the date when the corpus is received by the fiduciary, an amount equal to the annual commissions on corpus authorized pursuant to N.J.S. 3B:18-25, but not actually taken by the fiduciary, plus an amount equal to 2% of the value of the corpus distributed
  2. If distribution of the corpus occurs between 5 and 10 years of the date when the corpus is received by the fiduciary, an amount equal to the annual commissions on corpus authorized pursuant to N.J.S. 3B:18-25, but not actually received by the fiduciary, plus an amount equal to 1 1/2 % of the value of the corpus distributed;
  3. If the distribution of corpus occurs more than 10 years after the date the corpus is received by the fiduciary, an amount equal to the annual commissions on corpus authorized pursuant to N.J.S. 3B:18-25, but not actually received by the fiduciary, plus an amount equal to 1% of the value of the corpus distributed; and
  4.  If there are two or more fiduciaries, their corpus commissions shall be the same as for a single fiduciary plus an additional amount of one-fifth of the commissions for each additional fiduciary.
An illustration of how to calculate the annual trustee commission

Let's presume the following facts:  Trust owns a house worth $500,000, a $1,400,000 in stocks and bonds, and $100,000 worth of cash. This is the value at the end of the previous year.

Let's also presume that there is only one trustee and in the year in question the stocks and bonds gave off $56,000 of income. 

Accordingly, the calculation would be as follows:

0.5% on the first $400,000 would be $2,000
3.5% on the next $1,600,000 would be $4,800
6% on the $56,000 of income would be $3,360
So the trustee would be entitled to a total commission of $10,160 for the previous year.


Final thoughts about trustee's commissions

Any commission that a trustee takes will be subject to an income tax.  As a result, if the trustee is also a beneficiary, he or she may not want to take a commission.  Additionally, many times relatives do not appreciate the amount of work involved and will become upset at a trustee if he or she takes a commission. You should think about the dynamics of your family before taking one.

A trustee that does extraordinary work can apply to the court for a commission in excess of the statutory fee.  A trustee needs to prepare an annual accounting, and one that fails to adequately communicate with the beneficiary or otherwise behaves badly can be removed by the court.  If a trustee is removed from office, he or she may be required by a judge to forfeit his commissions.  This is not automatic though.

Finally, as discussed in back in May of 2013, an attorney who is serving as a trustee may be entitled to a fee for legal services AND a commission.

Friday, March 7, 2014

Calculating NJ Executor Commissions

From time to time, people ask me about executor's commissions and trustee's commissions in New Jersey.  Because it is a bit complex, I have broken it down into two posts and I will focus on commissions for executors and administrators today.

To start, a Will can specifically provide for an executor's commission.  In that absence of expressly authorizing a commission an executor will be entitled to take an executor's fee as provided in New Jersey Statutes 3B:18-12 through 3B:18-17. These same statutes also provide that if a person dies intestate (dies without a Will), the administrator of the estate may also take a fee.  Since the fees for an executor and administrator are the same, I will use the term interchangeably for purposes of this post.

New Jersey statutes are very difficult to interpret because they use the term fiduciary to apply to executors, administrators, trustees, guardians and conservators.  This would not be a problem if the fees were calculated the same, but they are not. 

So how is the executor's fee actually calculated?

First, an executor is entitled to annual income commissions of 6% without prior court approval. (N.J.S.A. 3B:18-13)

Second is the calculation of the corpus (or principal) commission.  This is a bit more of a complicated formula. Normally an executor will take a one time commission as follows:
  1. 5% on the first $200,000 of all corpus received by the executor;
  2. 3.5% on the excess over $200,000 up to $1,000,000;
  3. 2% on the excess over $1,000,000;
  4. and 1% of all corpus for each additional executor provided that no one executor shall be entitled to any greater commission than that which would be allowed if there were but one executor involved.   (N.J.S.A. 3B:18-14)
Sometimes an estate administration goes on for a lengthy period of time.  Under such circumstances, an executor can also receive an annual commission equal to 1/5 of 1% (or 0.2%) of the corpus.  However, this commission is not that frequently taken and a court may disallow it if it is in excess of  N.J.S.A. 3B:18-14.

What assets are part of the corpus when determining the executor's commission?
The corpus of an estate is generally defined to mean any asset that has come into the hands of the executor.

Examples of assets that come into the hands of the executor are:  Bank accounts, automobiles, tax refunds, business interests, an interest in a lawsuit or litigation, life insurance payable to the estate, retirement accounts with no beneficiary and real estate that were owned by the decedent. 

Examples of assets that do not come into the hands of the executor and are not subject to the commission include: Life insurance (if there is a beneficiary other than the estate), retirement accounts where a beneficiary other than the estate is named, property that is held as joint tenancy by the entirety or joint tenants with rights of survivorship.

What about mortgaged property - do I use the net value or the gross value?

While it may be unfair if the estate is heavily leveraged, the commission is taken on the gross estate, not the net.  If the result is too onerous, a beneficiary may wish to seek judicial relief.

An illustration of how to calculate the executor commission
Let's presume the following facts:  Decedent owned a vacation house worth $500,000 and a mortgage of $100,000, a primary residence owned with his wife as tenancy by the entirety worth $1,000,000 and a mortgage of $300,000, a $400,000 IRA payable to his wife, $200,000 in stocks and bonds, a $200,000 life insurance policy payable to his children, and $100,000 worth of insurance with no beneficiary. 

Let's also presume that there is only one executor and during the administration, the $200,000 of stocks and bonds gave off $5000 of income. 

Included for purposes of calculating the commission are:  the $500,000 house, the $200,000 in stocks and bonds and the $100,000 life insurance policy with no beneficiary (for a total of $800,000).  There is no deduction for the the $100,000 mortgage.  The primary residence, the IRA and the $200,000 life insurance policy are excluded.

5% on the first $200,000 would be $10,000
3.5% on the next $600,000 would be $21,000
6% on the $5000 of income would be $300
So the executor would be entitled to a total commission of $31,300.


Final thoughts about executors commissions

Any commission that an executor takes will be subject to an income tax.  As a result, if the executor is also a beneficiary, he or she may not want to take a commission.  Additionally, many times relatives do not appreciate the amount of work involved and will become upset at an executor if he or she takes a commission. You should think about the dynamics of your family before taking one.

An executor that does extraordinary work can apply to the court for a commission in excess of the statutory fee.  An executor that behaves badly can be removed by the court.  If an executor or administrator is removed from office, he or she may be required by a judge to forfeit his commissions.  This is not automatic though.

Finally, as discussed in back in May of 2013, an attorney who is serving as an executor may be entitled to a fee for legal services AND a commission.