Estate Planning and Divorce in New Jersey

Men and women who are contemplating a separation or divorce have unique needs. Some divorces are very friendly and you can still count on your soon-to-be ex, but in most other situations, you may find that you rethink many aspects of your life, including where you wish your assets to go should something happen and who you can trust. 

Accordingly, it is essential to update your estate planning documents.  This should be done:

1. To ensure that someone trust-worthy will be able to make medical and financial decisions for you in the event that you are incapacitated; 
2. To prevent your soon-to-be-former spouse from receiving all of your assets; and 
3. To give you as much control as legally possible over how your children or any embryos created during infertility treatments will be taken care of and provided for in the event that you pass away.

The less trust-worthy your spouse is, the more important it will be that you take action to protect yourself (and your children). To help you get safely through this time of transition, you should consider creating:   

1. A Will. If you are married and die without a Will, your spouse would generally be entitled to 100% of your estate. However, if even if you are still married you are generally permitted to leave your assets to whomever you wish if you write a Will.  Most people think that your spouse may still be entitled to a third of your estate (the “elective share” under N.J.S.A. 3B:8-1), but the statute contains many exceptions which typically allow you to completely cut out your soon to be ex. This is because the elective share statute requires that at the time of death the decedent and the surviving spouse must not have been living separate and apart in different habitations, they must still been cohabiting as spouses and not under circumstances which would have given rise to a cause of action for divorce or nullity of marriage to a decedent prior to the decedent's death.
2. An Advance Directive for Health Care/Health Care Power of Attorney. This will allow you to control who will make medical decisions for you if you are unable to make them for yourself, helping to ensure that your wishes will be achieved. For example: would you want the person you are divorcing to be able to make decisions about your medical care and whether or not to remove life support, or would you want this decision to be made by a relative or close friend?
3. A Financial Power of Attorney. This will allow your agent to use your money to pay for your medical bills, attorney fees connected to your divorce, and potentially take action to do anything else needed for your benefit. Depending on how this document is structured, it can take effect as soon as you sign it, so that a trusted friend, relative, or financial services professional can help you through this stressful period. The divorce process is a stressful one and often brings with it a slew of new responsibilities and challenges. This document can allow you to outsource emotionally-difficult tasks such as selling your marital home and managing the transition of your assets from joint to separate accounts while you focus on making the big decisions, attending court, and adjust to life as a single parent. This document can also prove invaluable if symptoms of anxiety and depression (which can often be triggered by major life events) set in and you become unable to manage your affairs. Being proactive and creating a plan for dealing with your responsibilities can help make your daily life easier and more manageable during this difficult time. 

Speaking with an estate planning attorney can help you better understand your options and create the best possible plan when preparing for challenging circumstances.  

Written by: Jessica J. Sauer, Esq. & Kevin A. Pollock, Esq., LL.M. 

Helpful Estate Planning Hints for Divorce Attorneys

A. Have your client do pre-divorce estate planning (especially if the split is partially the result of financial matters)

1. Most clients are not aware that if they die during the pendency of their divorce that their soon to be ex may still inherit everything. This can be particularly important if it is likely that the ex will remarry or has kids from another relationship.

2. Generally, your client cannot write a new Will completely cutting out the soon to be ex out due to NJ's elective share statute.

a. Exceptions:

1) The soon to be ex can be cut out if your client and the soon to be ex are separated and not living together.

2) The soon to be ex can be cut out if your client and the soon to be ex have ceased cohabitating as husband and wife.

b. If one of the exceptions does not apply and your client dies before the divorce is final, the soon to be ex can elect to receive up to 1/3 of the augmented estate.

1) In a simplistic way, the augmented estate can be estimated by looking at the net estate (the value of the estate minus the bills that must be paid).

2) Do not factor in estate taxes at this point.

3) Do add back gifts made by the decedent within two years of death.

4) Do add in retained interests held by decedent at the time of death.

5) See N.J.S.A. 3B:8-3 for a true definition.

3. If your client is wealthy, he may wish to consider putting the soon to be ex's 1/3 share in a fairly restrictive trust for the soon to be ex with the remainder going to your client's children.

B. When drafting agreements between the divorcing parties, don't just say that money should be held "in trust" for the benefit of your client's children in the event one of the two die. This agreement can potentially override the terms of any will or trust agreement, so think a bit about some of the terms:

1. Typical terms include:

a. Having the children receive the money in two tiers (1/2 at age 25 and the balance at age 30 is usually good). If there is a lot of money, you can even do three tiers.

b. You should have your client think for a few minutes about who should be trustee. Better the two parties agree than have to get the court involved to appoint one.

2. Do any of the children have special needs and should special provisions be incorporated?

3. How important is it to guarantee that the ex put a provision in his/her Will stating that a certain percentage of his/her estate must go to their children? This can be contractually agreed to.

C. Don't just require that your client's ex purchase $X amount of life insurance on the ex's life.

1. Demand that your client's ex agree to pay for the policy, but have your client actually buy it. This accomplishes multiple goals:

a. It ensures that the policy is in fact in place;

b. In the event the ex runs into financial trouble, your client can continue the payments;

c. It can save a huge amount in taxes;

1) Typically if the ex owns and maintains the life insurance on his life, then regardless of who the beneficiary is, it will be subject to the Federal and State Estate tax upon his death;

2) If your client or an irrevocable life insurance trust (an "ILIT") owns the policy, then it will not be subject to estate taxes upon the ex's death (provided it was not transferred to your client or the ILIT within 3 years of the ex's death).

3) To give an example of real life savings, let's assume that ex is worth $2 million and is required to buy a $1 Million life insurance policy. That policy will cause ex's estate to be subject to approximately a $500,000 tax. This is particularly problematic if most of that is going to your client's children. By having your client or an ILIT own the policy, this estate would completely escape federal estate taxes and only be subject to minimal NJ estate taxes.

D. Do not forget about retirement assets, pension plans and life insurance

1. Most divorce attorneys remember to put a provision in the divorce and separation agreements which will require that their clients receive a portion of the ex's estate, but some forget to require/request that their client receive a portion of the ex's retirement assets or life insurance upon the ex's death. The general trend is to deal with this through a QDRO and let the chips fall where they may upon the ex's death.

2. Moreover, many divorce attorneys forget to include the client's children in this part of the planning. It is imperative for attorneys with clients who's wealth is tied up in retirement accounts deal with where these retirement accounts go on the death of the ex.

3. A common example of the above may be illustrated as follows. H and W, who have 2children, get a divorce. H has a 401(k) worth $1,000,000. The two do a QDRO and split this evenly. H should insist of W, and W should insist of H, that their children be named as the beneficiaries of this 401(k) (AND any IRA that this gets rolled into). Otherwise, if W gets remarried, the new husband could legitimately be named as the new beneficiary of this retirement account. NOTE: They attorneys should leave this open for the clients to amend in an amicable way in the event one of the children should not be named as a beneficiary due to drugs, alcohol or any other legitimate reason.

E. What about possible inheritances?

1. Except to the extent that the parties agree, you should always get the soon to be ex to disclaim all interests that he/she may have in your client's estate, non-probate assets and joint assets.

2. Many times your client's parents will include the ex as a beneficiary of their estates. You should think about trying to get the soon to be ex to disclaim these interests as state law may not always treat the ex as dying on the date of the divorce.

F. Dividing Joint Assets

1. Transfers of property incident to divorce are not treated as taxable gifts for federal gift tax purposes. To qualify, the property must generally be transferred within one year from the date the marriage ends. (Transfers made within 6 years of the date of divorce can qualify if the transfer is made puruant to a divorce or separation agreement. This time frame may be further extended for cause such as litigation surrounding the transfer of a business interest.)

a. Exceptions:

1) Transfers to a non-citizen former spouse;

2) Transfers to a trust for the benefit of the transferee former spouse of property on which liabilities exceed the transferor's basis for the property; and

3) Transfers to a trust for the benefit of the transferee former spouse of installment obligations.

b. If one of these exceptions apply, the transferor spouse may recognize gain or loss.

c. If the transfer is deemed as a transfer incident to divorce, the transferee spouse takes the property with a basis in the property equal to the basis of the transferor spouse. This is known as a carryover basis.

d. Divorce attorneys should be careful in agreeing to take property that has high built in gains as result of this carryover basis.

e. Your client may be required by the settlement agreement to transfer an insurance policy on his or her life to the ex and continue paying the premiums on the policy. It is important to know that the transferor can only deduct those premium payments as alimony (taxable to the recipient) if the transferor makes the transferee both the owner and irrevocable beneficiary of the policy.

2. In NJ there is no gift tax, but in order to avoid the real estate transfer tax for transfers incident to divorce (or the dissolution of a civil union partnership) the property must be transferred no later than 90 days after the date the divorce or dissolution decree is entered. See: http://www.state.nj.us/treasury/taxation/pdf/other_forms/lpt/rtfexempt.pdf

Business Succession Planning

Some of you may have seen these scary statistics:

According to the U.S. Small Business Administration, 90 percent of the 21 million small businesses in the U.S. are family-owned, but less than one-third of family-run companies succeed into the second generation, while only half of that make it to the third. Most often, the lack of a proper succession planning is to blame.

Proper business succession planning is particularly vital in the Northeast where taxes are so high.

Let's assume that an unmarried NJ decedent (Jane) has a company worth $5,000,000 at the time of her death. Without looking at Jane's other assets, I can tell you that her heirs have a potential federal estate tax liability of close to $1,350,000 plus a NJ Estate Tax liability of almost $400,000 for a total tax liability of close to $1,750,000. If she had no issue or parents living, this would also be subject to a $750,000 New Jersey inheritance tax. These taxes could decimate a small company at a time when the key person involved is not around.

The benefits of proper planning are countless.At a minimum, proper strategy will help you minimize taxes, maximize control and provide a clear path for continuity of the business. Planning an exit strategy is important as soon as you go into a business. This includes planning for death, divorce or a sale upon retirement.

Some popular planning techniques include:

1. Setting up an entity structure (LLC, C Corporation, S Corporation, Partnerships, etc.);
2. Purchasing Life Insurance (combined with Buy-Sell Agreements);
3. Creating agreements limiting control of potential takers to the business;
4. The use of promissory notes;
5. Selling or gifting ownership in the business to family members; and
6. Selling or gifting ownership in the business to other entities or trusts that will benefit family members.

Valuation Discounts

One of the most important aspects of proper planning is gaining the ability to maximize the amount that you can pass down to your heirs through the use of Valuation Discounts.

When a person has a small business, it is often difficult to sell. The IRS recognizes this lack of marketability. Additionally, as many small business owners get on in years, they are not as involved in running the business. The IRS also recognizes this lack of control.

It is not uncommon to have restrictive agreements in place that will allow an owner to pass on his or her interest with a one-third discount for lack of marketability PLUS another one-third discount for lack of control. Discounts are very specific to each business and a proper appraisal is a MUST.

So how does it work?

Let's go back to our example above. Let's assume that Jane has one child, Dave, who is 35 years old and has shown some interest in the business. Ten years ago, Jane sets up an entity, let's say an LLC, with a restrictive operating agreement. As a result, the appraisal comes back and states that there is a 1/3 discount for lack of marketability. Jane can transfer Dave $1,012,000 of this company without any out of pocket gift tax consequences. Without the appraisal, this would result in a transfer of 20% of the company. With the appraisal, Jane could transfer as much as $1,518,000 of the LLC (a little over 30%) without gift taxes. Additionally, Dave could buy another 20% of the company with a promissory note at the lowest rate available for tax purposes. Let's say a ten year note of $666,666 at 6% interest. Finally, Jane is in good health, so for the next 10 years she uses her annual exclusion amount to gift Dave another $12,000 worth of the company annually. (Since annual appraisals would be expensive, let's assume we don't discount this.)

The result is that upon Jane's death 10 years later, her 100% interest in the company, which started at $5,000,000 company, has been reduced as follows:
1) Through the lifetime gift to Dave, her interest is reduced to a 70% interest, worth $3,500,000;
2) Through the promissory note, her interest is reduced just under 50%, with a value of just under $2,500,000.
3) Through the annual gifting, her interest in the business is reduced to $2,380,000.

Upon Jane's death her $2,380,000 interest will receive a 1/3 discount for lack of marketability and another 1/3 discount for lack of control. This will result in a tax valuation of approximately $1,060,000. After we add back in the $666,666 that she received for the 20 interest plus another $220,000 for interest payments, she will pass with a taxable estate of about $1,950,000.

Accordingly, upon Jane's death, her estate will not be subject to any federal estate tax liability. Additionally, the NJ Estate tax liability will be reduced to $96,000. This is a tax savings of over $1,600,000 - which far outweighs the costs involved in such preparation.

Obviously, there are many different ways to structure this type of transaction, but they are usually based upon the same methodology. The numbers and techniques involved will depend upon the individual needs of the client. For example, if Dave were not responsible or had no interest in running the business, Jane could give him his shares in trust. If Jane had a business partner, this structure could be done for each partner and combined with a buy-sell agreement funded by life insurance.

Estate Planning When Contemplating Divorce

Once a divorce is final, your former spouse, and relatives of your former spouse, are generally not entitled to inherit any money from you upon your death. But what should you do during the lengthy time of your separation leading up to your divorce?

Ripping up a Will that gave everything to your surviving spouse does not solve your problems. New Jersey’s newest probate law (N.J.S.A. 3B:5-3), enacted in 2005, states that you are married and die without a Will a large portion of your assets, possibly all your assets, will pass to your surviving spouse. Accordingly, if you die before your divorce is final, your surviving spouse may still be entitled to all your assets (marital and non-marital). Additionally, your surviving spouse will be entitled to be the Administrator of your estate. This may be completely contrary to your real wishes.

If you do not want the person you are divorcing to receive all your assets, creating a new Will gives you greater control over where your assets go and allows you to pick your own Executor.

When drafting a new Will, keep in mind that any persons that you name under your Will to act as trustee or guardian for your children might be affected by your divorce. Accordingly, if you name a relative of your former spouse as a trustee, he or she may be ineligible to serve as a trustee of any trusts for your children unless clear instructions are given. You should also revisit your guardianship designations to make sure they are still appropriate given your current circumstances.

However, even with a new Will, you usually cannot completely cut out your spouse. Depending upon how far along you are in the process of your divorce, New Jersey’s Elective Share Statute may allow your surviving spouse to claim up to 1/3 of your estate. However, even if your surviving spouse is unable to collect his or her elective share, the Court may intervene if it thinks it would be inequitable to completely cut out your surviving spouse. In 1990, the New Jersey Supreme Court utilized its equitable powers to grant a surviving spouse an equitable share of the marital assets.

In addition to writing a new Will, to further protect yourself, your divorce attorney should consider provisions in your separation agreement whereby you and your spouse waive your right to claim the elective share of your spouse. Your divorce attorney may also wish to consider submitting a motion to the Court to prevent your spouse from making beneficiary changes to his or her life insurance, retirement plans and educational savings accounts.

Finally, do not forget to speak with your parents and siblings about their estate planning documents. If they have money passing to your spouse under the terms of their Wills, or if you or your spouse is named as a guardian, they may wish to update their Wills as well.