Joint Trusts - A Great Planning Opportunity for Non-Traditional Couples and Blended Families

Creating an estate plan for clients who are in non-traditional relationships or are part of a blended family can be very tricky.
  

Why is Estate Planning for Non-Traditional Couples So Tricky?

Let's assume a hypothetical fact situation where you have a women (Jane) with $4M in assets.  She is a widow and has 2 children.  Now let's also assume that she is in a committed relationship with a person (Alex) who has $2M in assets, and Alex has three children.  Finally, let's assume that they agreed to set up a joint bank account and that they want to buy a house together worth about $1M, with Jane putting up three-quarters of the money for the house.  

Typically, the clients in this scenario will want to take care of each other, but they also want to ensure that a certain amount of their assets go to their respective children.  Let's assume the specific goal for Jane and Alex is that the surviving partner can have the joint bank account and use the house for the rest of their life, but everything else goes to their respective children.  To accomplish this, they buy the house as joint tenants with rights of survivorship and create Wills leaving everything else to their respective children.

In this hypothetical, if Jane dies first, the house and the joint bank account go to Alex because they are joint assets and supersede the Will.  When Alex dies, his $2M plus the house goes to his children.  This is not necessarily a far result for Jane's children.  Alternatively, if Alex dies first, the house and the bank account goes to Jane, and then upon her death, it all goes to her children, cutting out Alex's descendants with respect to the joint assets.  As you can see, the problem with this traditional plan is that one partner dies and the survivor takes the house and bank account and it cuts out the descendants of the first client to die with respect to the joint assets.

Why a Joint Trust Can Be an Important Estate Planning Tool for Non-Traditional Couples

One of the best ways to handle a situation like this is for Jane and Alex to set up a joint trust.  The trust could be funded with the house and cash (in whatever amount they like).  While Jane and Alex are alive, the trust could be revocable and they could have complete control over it to do whatever they like.  The trust becomes really powerful when the first partner dies (or becomes incapacitated), because we can then make the trust Irrevocable.  While we can customize these types of trusts in many ways, most people want to guarantee that the survivor can: live in the house for the rest of their lifetime, sell it and buy other real estate, or sell it and have an income stream to live off of.  

The main benefit to this type of trust planning is that we can provide a much safer way of ensuring that ALL of Jane and Alex's descendants receive whatever is left over when the survivor dies.  Moreover, we can make sure that their descendants receive money in a way that is more fair based upon need or based upon how Jane and Alex contributed funds towards the trust.  In this example, since Jane is putting up $750,000 towards the house, the trust can say that, following the deaths of both Jane and Alex, the remainder of the trust assets go 3/4 to Jane's children and 1/4 to Alex's children.  

Initially, Jane and Alex could be in control of the Trust (making them the Trustees).  We can also have a system in place so that one of Jane's children steps up as co-trustee if something happens to Jane and one of Alex's children steps up as co-trustee if something happens to Alex.  If Jane's children and Alex's children can't work together, we can also have a neutral trustee appointed. 

Can Anyone Create a Joint Trust?

Anyone can create a joint trust.  The type of trust I am describing in this post works for unmarried or married couples. 

Are There Any Downsides to Creating a Joint Trust?

When creating any estate plan, one of the downsides is the cost to create the plan.  Creating a custom plan like this will certainly cost more than simply titling assets in joint name.  However, the more money over which you are trying to control the disposition, the more it is worth setting up this type of trust.

Another potential downside to creating a joint trust is that, depending upon its structure, the trust may need a tax identification number and a tax return will need to be filed for the trust for any income earned.  

It should also be pointed out though that if the couple is unmarried and they live in a jurisdiction with an inheritance tax (like New Jersey or Pennsylvania), this structure would trigger the inheritance tax on both the first to die and likely the second to die.  However, for unmarried couples, this tax would be incurred on the first to die regardless of whether or not a joint trust was utilized.  In New Jersey, the inheritance tax could be avoided if the couple agrees to enter into a NJ Domestic Partnership agreement.

How Do I Create a Joint Trust?

If you would like to know more about estate planning for non-traditional couples or setting up a joint trust, we would happy to speak with you to so that it could be properly customized to meet your needs.  Kevin A. Pollock, Esq., LL.M. is an attorney licensed to practice in NJ, NY, PA and FL.  Kevin Pollock meets with clients in Lawrenceville, NJ and in Boca Raton, FL by appointment only.  Kevin may be reached at (609) 818-1555.  

Why Repeal of the NJ Estate Tax Means Married Couples Should Update Their Wills

Effective January 1, 2018, New Jersey repealed its estate tax.  The question then become how does this affect you and do you need to do anything about it?  For most people the change is a positive one because it means their heirs pay less taxes and they do not need to do anything to update their documents.

Generally, You are Unaffected by the Repeal of the NJ Estate Tax If...

1. You do not have children and plan on leaving money to siblings, nieces, nephews, friends or charity.
2. You are NOT married but have surviving descendants.
3. You are married couples with children and you plan to leave everything outright to your surviving spouse on the first to die.

In all three situations above, the repeal of the New Jersey estate tax should not affect you and you generally will not need to update your Will or Revocable Living Trust.*  In the first situation, if you are leaving money to siblings, nieces, nephews and friend, be aware that NJ did NOT repeal its inheritance tax, so you still are affected by that.

For married couples who have a Disclaimer Trust plan, your documents are also generally unaffected.

Repeal of the NJ Estate Tax Can Dramatically Affect Married Couples Who Set up a Trust for the Surviving Spouse

To understand why the repeal of the New Jersey Estate Tax can adversely affect married couples who set up a trust for the surviving spouse, I will take a step back to discuss why we often recommend a trust be created for a surviving spouse.

Reasons to Create a Trust for a Surviving Spouse

1. The first spouse to die wants to ensure that if the surviving spouse gets remarried, the children are protected from future spouse and still receive an inheritance.
2. You have children from a previous relationship and want to ensure that upon the death of your spouse, your children receive whatever is left over.
3. The surviving spouse isn't good with money and needs assistance managing the wealth.
4. Estate Tax Efficiency - Prior to 2017, New Jersey had a ‘use it or lose it’ state estate tax exemption of $675,000.  

Why Was It Tax Efficient to Create a Trust for a Surviving Spouse

Protecting money for the benefit of the your children or from a spendthrift spouse are still very valid reasons to set up a trust, so I will spend the rest of the article talking about how trusts for a surviving spouse in older Wills and Revocable Trusts are usually no longer tax efficient.  

Let's presume it's 2016 and we have a married couple with $1,350,000 of assets.  One spouse dies leaving everything to survivor outright.  The surviving spouse then dies shortly after leaving everything to the children.  In this scenario, we would lose the NJ estate tax exemption of the first spouse to die and the children would only benefit from the $675,000 NJ estate tax exemption of the Surviving Spouse.  Assuming no growth in assets, the children inherit the full $1.35M, but $675,000 would be subject to a tax of almost $55,000.

To minimize the NJ estate tax, attorneys would advise clients to set up a trust for the surviving spouse instead of having funds go outright.  So, in the example above, when one spouse dies, he could leave everything to a trust for the survivor.  The surviving spouse then dies shortly after leaving everything to the children.  In this scenario, by funding a trust for the surviving spouse, we are utilizing each spouse's NJ estate tax exemption.  Upon the death of the surviving spouse, children would receive $675,000 from the trust tax free and the other $675,000 from the surviving spouse tax free.  This type of planning could easily save $55,000 in NJ estate taxes.

Funding a Trust for the Surviving Spouse May Be Tax Inefficient after the Repeal of the NJ Estate Tax.

Now that you know why it was advisable to set up a trust for a spouse and why it was tax efficient, you need to know why most older trusts should be amended.  Basically, now we can make it even MORE tax efficient.  This time, however, we are not talking about estate tax efficiency - now we are trying to make the trusts more efficient for income tax and capital gains tax purposes.  Let me give you two examples again:

Let's presume it's 2010 and we have a married couple with $1,350,000 of assets.  Dad dies leaving everything to Mom.  Mom lives another 20 years before dying and leaving everything to the children.  Since Mom lived another 20 years, let's presume the assets grew by $1M and were now worth $2,350,000. We do not have to worry about the NJ estate tax anymore, so the assets would go to the children completely free tax.  Additionally, when the children receive their inheritance, it is eligible for a step-up in basis.  This means that the children can effectively sell their inheritance the day after Mom dies and pay no capital gains tax on the $1M+ of appreciation.  (Please read this post to better understanding basis.)  

Now, let's presume the same facts as above except that when Dad died, he left $675,000 to Mom in trust.  Let's also presume that the trust received the benefit of all the appreciation, so that when Mom died, she had $675,000 in her own name and $1,675,000 in trust.  The children would still receive a step-up in basis from the $675,000 in assets that came from Mom, but the basis in the trust fund assets would only be $675,000 (the value on Dad's date of death).  So when the children sold the assets that were in the trust, there would be a capital gains tax (up to 23%) on the $1M.  

Most older Wills and Revocable Trusts used this formula for a trust for a surviving spouse, so hopefully it is easy to see why it is no longer tax efficient to continue using it.

Do I Need to Update My Estate Planning Documents?

If you have a Will or Trust created prior to 2017 leaving money in trust to a surviving spouse, the short answer is probably yes.  The one major exception to this is if you have a Disclaimer Trust plan.  If money goes outright to the surviving spouse, and the survivor has to make an affirmative election to fund a trust, then the plan most likely is fine the way it is written.

How You Can Fix Your Older Trusts

If you have an estate plan that automatically leaves money in trust for the surviving spouse, there are two easy ways you can fix it so that it is more tax efficient. 

1. Option one is to get rid of the trust for the surviving spouse and leave everything to the survivor outright.  This is an easy solution when the estate isn't very large or complex.  However if you are in a second marriage situation or if you are concerned about the surviving spouse getting remarried or spending away the children's inheritance, then you should consider the second option.
2. Option two is to revise the formulas in the Will or Trust so that it gets a step-up in basis when the surviving spouse dies.  (There are hundreds of ways to do this which are far beyond the scope of this post.)

To further complicate things, most tax attorneys like me will also build in a fail-safe so that if the NJ estate tax comes back, we can have the option of funding an old-style trust.

Conclusion 

If you have an older Will or trust that leaves money to a surviving spouse in trust - have it looked at.

* Regardless of whether you have a trust for a surviving spouse, always have your own estate planning documents reviewed by your attorney just to be sure it matches your wishes and still complies with state law.  The purpose of this blog post is to discuss who is most likely to be affected by the repeal of the New Jersey estate tax.

Growing Problem of Banks refusing to Honor a Financial Power of Attorney

Please be advised that more and more banks are refusing to accept any financial power of attorney other than their own form.  This may not be a huge problem if you are still competent, but if you become incapacitated later and have not sign the "Bank approved form", it could make life very difficult for your agent to act on your behalf.

I recently ran in to this problem with a client and it took a long time to straighten out.  Also, I just came across this excellent article in the New York Times written by Paula Span on the topic. I strongly suggest reading it as it details how widespread the problem is and offers some helpful solutions.

I do note that, to date, the banks have tended to back down if you approach the managers and legal department.   Unfortunately, hiring an attorney to fight that fight may cost the client a fair amount in legal fees.  Another approach, if you are politically connected, is to get your ombudsman involved.

As a result of these news, I tend to be advocating Revocable Living Trusts even more.  Unfortunately, that won't help if the client has an IRA or other retirement account.  I'm interested in hearing how others are dealing with this problem.

One Does Not Simply Inherit Assets in New York

I am in the midst of one my of my more difficult estate administrations in New York, and I thought it would be worthwhile to remind everyone how important it can be to set up a revocable trust in situations where you are leaving your estate to someone other than your next of kin.

In the matter I am working on now, the decedent (let's call her Jane) passed away leaving everything to her long time boyfriend and one other person.  Jane was not married and had no children, but she did have many siblings and nieces and nephews.  Even though Jane had a Will, the State of New York is requiring that we get each of Jane's surviving siblings to sign an affidavit approving of the probate of the Will. (This is known as a Waiver of Process; Consent to Probate Form.) 

Jane also had one sibling (Fred) who died before her.  So we have to get this form signed by all of Fred's children as well.  Should I bother mentioning that everyone has lost contact with one of Fred's sons?

Unless EVERY one of Jane's next of kin signs this form, the proposed executor has to go through extra steps to start his or her job.  This means the bills don't get paid, real estate can't get sold, and money can't be transferred to the people named in Jane's Will.

The need to have this form signed will wind up costing the estate a lot of time and money as the Executor must make diligent effort to track down this missing nephew.  It will also complicate matters if any of Jane's siblings or Fred's children does not sign and notarize the form required by New York.  Other than doing the right thing, none of Jane's relatives has any incentive to sign this form.  In fact, if any of Jane's relatives believe that Jane's boyfriend shouldn't inherit, they can certainly make it a difficult and expensive process.

If Jane had properly titled her assets in the name of a revocable trust and named beneficiaries on her IRA and life insurance policies, she could have helped her loved ones avoid the probate process.  By avoiding probate, all of these steps become unnecessary and would have saved everyone time, trouble and money.

A Trust can Qualify for a Section 121 Deduction (For Sale of a Personal Residence)

Typically, people take it for granted that there will not be any tax when they sell their personal residence.  Technically, there is a tax, but the government also offers a limited exclusion under Section 121 of the Internal Revenue Code.

For individuals who sell their primary residence, you can exclude the first $250,000 of gain.  After that, it is subject to a capital gains tax.  For married couples, you can exclude the first $500,000 of gain.

In order to qualify for the exclusion, you must have OWNED and USED the residence as your principal residence for 2 of the last 5 years ending with the date of sale (it does not have to be consecutively). If the home was previously used as a rental property, in a business or for another non-qualified use, there may be longer holding requirements or a reduced exemption amount.

One common estate planning tool that many attorneys create is a revocable living trust.  A revocable living trust, also known as just a Living Trust, is device to manage a person’s assets during life and after death. While the Grantor is alive, the Grantor can manage his or her trust funds as the Grantor wishes. When the Grantor passes, it acts like a Will but with the added benefit of avoiding probate.  If a person sets up a revocable trust, it is highly recommended to transfer all real estate into this trust, including the primary residence.

Another common estate planning tool, particularly for individuals doing Medicaid planning or VA benefit planning, is to move the primary house to an irrevocable trust, which is set up as an intentionally defective grantor trust (IDGT).  An IDGT is a type of trust that is outside a Grantor’s estate for estate tax purposes while simultaneously requiring the Grantor to be taxed on the income earned in the Trust.

Under Internal Revenue Code Treasury Regulation 1.121-1(c)(3)(i), if a residence is owned by a trust, for the period that a taxpayer is treated under sections 671 through 679 (relating to the treatment of grantors and others as substantial owners) as the owner of the trust or the portion of the trust that includes the residence, the taxpayer will be treated as owning the residence for purposes of satisfying the 2-year ownership requirement of section 121, and the sale or exchange by the trust will be treated as if made by the taxpayer.

So, the long winded answer to the question is, yes, if a trust owns a primary residence and it is set up correctly, it can qualify for the Capital Gains Tax Exclusion under Section 121 of the Code.

Using Revocable Trusts to Prevent Elder Fraud

There are many schools of thoughts on the use of Revocable Trusts, also know as Living Trusts or Grantor Trusts. Some attorneys love them as a way to avoid probate; others, including myself, are more hesitant to recommend them. My hesitancy in using them stems from the fact that in New Jersey probate is usually not that difficult or expensive. (I always recommend them for my clients with property in Florida, New York or in multiple states.)

I also find that many attorneys create Revocable Trusts, but do not help their clients fund them. Unless these trusts are fully funded BEFORE you die, you have to go through probate anyway. This can double or triple the costs involved because you pay more on the front end AND when you die.

Despite my general reluctance in setting up Revocable Trusts, I can offer another good reason for setting one up - to prevent Elder Fraud. You probably see stories all the time about how a carekeeper, neighbor or other stranger is hired to look after an elderly person and then unwittingly gives away thousands of dollars for reasons that they can no longer recall.

In a worst case scenario, the elderly individuals become convinced that their children have abandoned them and change their estate planning documents to cut out their children. Occasionally, the bad caretaker, neighbor or stranger also becomes the new Power of Attorney and proceeds to spend all of the elderly person's assets.

A way to prevent these events from happening is to create a Revocable Trust naming a trusted relative as Trustee (or as co-Trustee with the elderly individual). With a trusted relative named as Trustee or co-Trustee, money cannot be spent or given away without the trusted relative knowing about it. Moreover, the trust cannot be modified without the trusted relative becoming aware of the situation.

Even without naming a trusted relative as Trustee or co-Trustee the trust can be structured to make it more difficult to modify to change than a Will or a Power of Attorney. For example, you can have a provision in the Revocable Trust that requires certain individuals to be notified before any modifications are made. That is not the case with a Will or Power of Attorney, which can be changed on a whim and without any notice requirements.

Another way a Revocable Trust can prevent Elder Fraud is because it is just more cumbersome to deal with. So, while many attorneys, and non-attorneys, feel that they can write a Will or Power of Attorney, far fewer people want to mess with a Revocable Trust. Sometimes, there is no better way to stop a thief than to make them have to jump through some legal hoops.

Revocable Inter Vivos Trust (a/k/a the Grantor Trust)

The Revocable Grantor Trust is a favorite of practitioners who wish to help their clients avoid probate. The other advantage to the trust is that for individuals who wish to keep their family secrets out of the public domain, it provides a means to keep their estate planning wishes private.

1. The major benefit of the Grantor Trust is that it provides a method for managing the Grantor’s assets, which is particularly useful in the event of incapacity.
2. It is valuable for clients who are not sure if they plan to stay domiciled in New Jersey and may move to a part of the country where avoiding probate is of utmost importance.
3. Planning considerations

a. When transferring real property into any trust, there is a cost associated with the transfer. Additionally, there may be real estate transfer fees and if there is a mortgage on the property, the mortgage company may have an issue with the transfer.
b. Under Revenue Ruling 85-45, the sale of a person’s principal residence held in trust qualified for the I.R.C. §121 capital gains tax exclusion provided the person and trust otherwise qualified for the exclusion.
c. Probate of property in New Jersey is not as expensive or time consuming as in other jurisdictions, so the cost of establishing the trust may not always be justified.

4. Tax aspects

a. While the Grantor is alive, this trust will be ignored for tax purposes and taxed to the Grantor. The trust may also use the Grantor’s social security number until this time.
b. Upon the death of the Grantor, the taxation of the trust will be dependent upon the terms of the trust. A new tax ID number will usually be appropriate.

5. Administration

a. During the life of the Grantor.

1) The administration of Grantor trusts is quite simple while the Grantor is alive as the Grantor who acts as his own Trustee generally has complete control over all the assets as if he owned the assets outright.
2) At any time a Grantor may terminate (or revoke) the trust and receive all of his assets back. This may be especially useful if there is a third party Trustee who is not doing what the Grantor wants.
3) All bank accounts and titling of assets should be made as follows: “[Trustee Name], as Trustee of the [Trust Name]”.
4) To avoid confusion, a Trustee should always indicate when he or she is acting on behalf of the trust rather than in an individual capacity. Accordingly, checks, letters and any other documents should be signed as Trustee.

b. Upon the death of the grantor, the trust turns into an irrevocable trust. The administration will be dependent upon the actual terms of the trust instrument.

1) Unlike trusts created under a Will, the Trustee does not need to acquire Letters of Trusteeship from the Surrogate. This is both a time saver and a small cost saver.
2) Summaries of various common irrevocable trusts to be discussed later.