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.  

You Can Create a Pet Trust - Just Like the One For Choupette

According to multiple news sources, when the creative director and fashion designer Karl Lagerfeld died on February 19, 2019, he left his famous cat, Choupette, a significant amount of money in trust.

Pet trusts are now quite common, and specifically authorized by statute in most jurisdictions.  Many people consider pets as a part of the family, and want them to be cared for as such.  A pet trust can provide money to pay for a caregiver, food, pet supplies, and a veterinarian.  It can also provide a place for your pet to live (or board), and in the case of Choupette, a personal chef.

Most estate planning attorneys who create pet trusts will provide a check and balance on the trustee, the caregiver, and the remainder beneficiary.  In other words, we do not recommend that the person in charge of caring for the pet be the one managing the money and the ultimate remainder beneficiary when the pet dies, as this would create a perverse incentive for the caregiver to do a bad job in caring for your beloved pet.

For people who do not want to create trust, they can always leave money to a caregiver (or charitable organization) with the hope that the caregiver will maintain the pet properly.  The benefit of a trust is that it makes the arrangement more legally enforceable and provides greater oversight.

New Jersey, Pennsylvania, and Florida have statutes based upon the Uniform Trust Code.  The NJ Pet Trust Statute can be found at:  3B:31-24 Trust for care of animal.  The Pennsylvania Pet Trust Statute can be found at: 20 Pa.C.S.A. § 7738.  Trust for Care of an animal.  The Florida Pet Trust Statute can be found at: Florida Statute 736.0408  Trust for care of an animal.  The State of New York also has a statute specifically authorizing the creation of a pet trust, which can be found at NY Est Pow & Trusts L § 7-8.1 Trusts for pets. 

It should be noted that the NJ statute, enacted in 2015, amended a previous version of the law that limited Pet trusts to 21 years.  It also clarified that a Pet trust could be created under a revocable trust document, not just as part of a trust created under a Will.

It should also be noted that living money to a pet (in trust or to a caregiver) will likely give rise to an inheritance tax in both Pennsylvania and New Jersey. 

Understanding the Differences Between Special Needs Trusts and Supplemental Needs Trusts

"Special Needs Trusts" and "Supplemental Needs Trusts" are terms to describe trusts designed to provide benefits to a person in a way that will preserve the public benefits that he or she is entitled to receive. These types of trusts are most commonly created when a person has some sort of special needs or disability.  The person who benefits from the trust is called the beneficiary.

In New Jersey, Pennsylvania and Florida, the terms "Special Needs Trusts" and "Supplemental Needs Trusts" are often used interchangeably, although they should not be as it often results in serious problems.  I personally try to use the term "Special Needs Trust" as a way to refer to a First Party Special Needs Trust (i.e. the money used to fund the trust belongs to the special needs person). I try to use the term "Supplemental Needs Trust" to refer to a Third Party Special Needs Trust (i.e. the money used to fund the trust belongs to someone other than the Special Needs Person).

Both a First Party Special Needs Trust and a Third Party Supplemental Needs Trust are intended to protect different public benefits. Most disabled individuals and special needs individuals receive Supplemental Security Income (SSI), Medicaid, vocational rehabilitation, subsidized housing and food stamps.  The most important rule for all First Party Special Needs Trusts and Third Party Supplemental Needs Trusts is that the trust may not pay cash to the beneficiary and it may not pay to or for the benefit of the beneficiary for any medical needs covered by Medicaid, food, shelter, or any asset which could be converted into food or shelter.

A First Party Special Needs Trust and a Third Party Supplemental Needs Trust allow the beneficiary to continue to receive government benefits, but also have money for clothing, education, travel, cable and cell service, electronics, furniture, personal care, medical care not covered by Medicaid, and many other items that make life worth living. 

Key features of a Third Party Supplemental Needs Trust:

1.  It is a Discretionary Trust
A Discretionary Trust is a Trust that allows the trustee to give money for the benefit of the Special Needs Person as the trustee sees fit.  If the trustee has complete discretion whether to make distributions for the beneficiary, the trust principal and income will usually not be counted as available to the beneficiary for purposes of obtaining government benefits.

2.  Established using funds of someone other than the Special Needs Person
A Supplemental Needs Trust is most common when a parent, grandparent or other relative wants to leave money for the benefit of a Special Needs Person.  Care must be taken to avoid giving that person money outright, otherwise he or she risks losing public benefits.  The Supplemental Needs Trust is a way for third parties to provide a Special Needs Person access to money in a way that will not cause them to lose their benefits.

3.  No government payback upon the death of beneficiary is required
After the Special Needs beneficiary passes away, Medicaid does not require reimbursement for the funds it expended during the lifetime of the beneficiary if the trust is funded DIRECTLY with the money of someone other than the beneficiary.  Please note that if a parent leaves money to a child and then the child sets up a trust, that will be considered a First Party Special Needs Trust, and not a Third Party Supplemental Needs Trust.  The key difference is that the third party must set up the trust AND fund it to qualify as a Third Party Supplemental Needs Trust.

4.  A Supplemental Needs Trust can have more than one Beneficiary
While there are substantial restrictions on how the Special Needs Person can receive money, because the trust fund is not comprised of funds of the Special Needs Person, there are few guidelines on how the rest of the Supplemental Needs Trust can be administered. Accordingly, the sole benefit rule that applies to First Party Special Needs Trusts does not apply to Third Party Supplemental Needs Trusts.  As government benefits are available only to those with financial need, the most important rule is that the beneficiary should never be entitled to the money in the trust.

5.  Taxation of Third Party Supplemental Needs Trusts
A Third Party Supplemental Needs Trust can be established as a Grantor Trust while the Grantor is alive, a Qualified Disability Trust or a complex trust.  If the trust is set up as a Grantor Trust, income generated by the trust will be allocated to the Grantor (or Creator) of the Trust during his or her lifetime.   If the trust is taxed as a complex trust, the trust will pick up most of the tax consequences in these types of trusts. Designing the trust as a Qualified Disability Trust may offer a small tax break, but it offers less privacy.  Often privacy is better than saving a few dollars in taxes as it can reduce confusion by government officials looking into the benefits and income of the Special Needs Person.  When fewer people question the validity of the trust, that saves legal fees and aggravation.

Key features of a First Party Special Needs Trust:

1.  It is a Discretionary Trust
A Discretionary Trust is a Trust that allows the trustee to give money for the benefit of the special needs person as the trustee sees fit.  However, payments to any one person or entity in excess of $5,000 during a single calendar year requires government approval.

2.  Established using funds of the Special Needs Person
A First Person Special Needs Trust is most commonly created when a person inherits money outside of trust or is awarded money in a personal injury settlement.  Prior to actually receiving the money, the Special Needs Person can create this type of trust to avoid losing their public benefits.

3.  There is a government payback at the death of the Special Needs Person
After the Special Needs beneficiary passes away, the government requires that the First Party Special Needs Trust reimburse Medicaid for expenses it has incurred.  For this reason many trust specialists semi-jokingly recommend that the trustee of a First Party Special Needs Trust try to spend the last dollar of the Trust on the day the Special Needs Person dies.

4.  A First Party Special Needs Trust must be for the sole benefit of the Special Needs Person
The sole benefit rule of a Special Needs Trust is very tricky and many states, including New Jersey, have changed their definition of this term many times over the years.  For example, can payments be made for the care of a pet for a Special Needs Person?  Many New Jersey officials say no, but most will also say yes, if it is a therapy animal. The biggest issue comes up over incidental benefits.  For example, a First Party Special Needs Trust can pay for a Special Needs Person to go to an amusement park, but it shouldn't pay for the ticket of a family member caretaker even that caretaker has no interest in going to the park and is only going to assist the Special Needs Person.

5.  Establishing a First Party Special Needs Trust.
Creation of a First Party Special Needs Trusts is much more complicated than the creation of a Third Party Supplemental Needs Trust. Usually (but not always), a First Party Special Needs Trust must comply with a federal law enacted in 1993. That law requires that most First Party Special Needs Trusts be established by a judge, a court-appointed guardian or the parents or grandparents of the beneficiary with notification being given to the government so that they can appropriately monitor it.(In some cases Social Security regulations may also require a judge to sign off on the creation of trusts).  In addition, the trust must generally be created before the beneficiary turns 65 years of age.

6.  Alternate names of a First Party Special Needs Trust
First Party Special Needs Trusts are frequently referred to as d(4)(A) Trusts because that is the section of the government statute that allows for these trusts.  They are also frequently called self settled special needs trusts.

7.  Taxation of First Party Special Needs Trusts
Because this is a grantor trust for IRS tax purposes, all income earned by the trust is taxable to the Special Needs beneficiary. There is no option to tax the trust itself.  The trust is also includible in the gross estate of the Special Needs Person for estate tax purposes.  However, the trust still need its own separate EIN and must file a federal Form 1041.  (Note: This can be a very simplified form merely advising the IRS that the Grantor/beneficiary will be picking up all the taxable income on their personal income tax return.)

8.  Other Issues with First Party Special Needs Trusts
Income generated inside a properly created 1st Party Special Needs Trust should not affect the beneficiary’s eligibility for government programs.  However, while taxable income is not “countable” income for purposes of Medicaid or other government benefits, government agencies often get a “tracer” report from the IRS about the beneficiary's income, and may issue a notice that benefits will be terminated unless they receive proof that the beneficiary did not have countable income. The trustee must be prepared to explain that although the income was reportable to the IRS as the beneficiary’s income for tax purposes, the beneficiary only received "in-kind” distributions that should not be counted as income for purposes of SSI, Medicaid, or other programs.  In other words, the Trustee will likely have to explain to many different people that the Special Needs Person is being taxed on income that the beneficiary never receives.

Summary

The administration of First Party Special Needs Trusts and Third Party Supplemental Needs Trusts can be somewhat difficult. A special needs trust attorney, familiar with public benefits programs and special needs trust provisions, should always be involved in the preparation of a Special Needs Trust or a Supplemental Needs Trust. While many legal matters can be undertaken without a lawyer, or with a lawyer with a general background, special needs planning is complicated enough to require the services of a specialized practitioner.

Reasons to Value a Trust

Recently I gave a lecture on the valuation of trusts.  While I am not an accountant nor am I a valuation expert, I live and breathe trusts... and frequently the question comes up, what is value of a particular beneficiary's interest in a trust.

Keep in mind, just because a trust is worth $1M, it does not mean that the beneficiary's interest is worth $1M if they have limited rights to invade the trust or control it.  Here's are a few reasons to value a trust:

1. When a person dies, that person may have a beneficial interest in a trust.  Depending upon the type of interest a person has, it may or may not be includible in his/her taxable estate.  If the interest is includible in the deceased beneficiary's taxable estate, then the executor of the deceased beneficiary must report it on federal and state estate tax returns. 
2. Similar to the above, but slightly different, when a person dies, he or she may leave a beneficial interest in a trust to another person.  Particularly in New Jersey and Pennsylvania, you see this come up a lot when a person leaves money to a class A beneficiary in trust (such as a spouse), and then the remainder interest to an non class A beneficiary (such as a nephew or niece).  This triggers something known as the Compromise tax.
3. Financial Aid - Some colleges and schools will look at the trust terms, others won't.  Each school is different regarding the questions they ask on their forms.
4. Divorce.  Depending upon the state, a person's interest may be subject to equitable distribution, alimony and especially child support.  

• New Jersey tends to be fairly friendly to a trust beneficiary.  See Tannen vs. Tannen, where the Appellate Court ruled that a beneficiary's income interest should not be imputed for purposes of alimony.  The general rule was already that such an interest was not subject to equitable distribution.  (NOTE:  This case law is likely to be challenged in light of the fact that NJ recently enacted the Uniform Trust Act. 
• Pennsylvania is far less friendly to trust beneficiaries.  The general rule in Pennsylvania is that marital property does not include trust property acquired by gift, bequest, devise or descent prior to or during the marriage, but it does include the increase in value of such property. See 23 Pa. Cons. Stat. 3501(a.1)   
• As far as I am aware, both Florida and New York follow the NJ rule and generally considers trust property as separate property, not subject to equitable distribution.  
• Massachusetts recently came down with a terrible case:  See Pfannenstiehl.   (Note: I'm not licensed in MA)

Regardless of the reason why you need to value a trust, the first step in determining the value is to figure out what type of interest that person has.  Usually a beneficiary's interest includes one or more of the following:

• An income stream
• The right to receive income or principal for health, education, maintenance and support
• An annuity stream (such as $2000/month)
• Principal distributions once the beneficiary reaches a certain age
• The right to take out $5000 or 5% per year
• A discretionary interest

Once you have figured out a person's interest in a trust, the next step usually involves hiring a certified appraiser to figure out the value of a person's interest. A trust attorney can assist the appraiser by advising them on the nuances of the trust and not-so-obvious options that a person may have in invading a trust.  

If you are the beneficiary of a large trust, I would recommend that you have the trust reviewed to see if you should disclaim and renounce certain powers to minimize taxes upon your death.  

Dynasty Trusts Explained

I am frequently asked about the best way to transfer wealth to younger generations.  Sometimes people feel that absent having a minor child, a problem child or a special needs child, there is no reason to set up a trust.  Often times they are correct and there is no reason create a trust because the client has very responsible children.

Sometimes though, even if the children are quite responsible, if the client has a lot of money, it may be worthwhile to set up a dynasty trust.  Most trusts are designed so that the trust assets will be distributed to the beneficiaries at staggered ages (e.g., one-half at age 25 and the balance at age 30). On the other hand, a dynasty trust is a trust designed to hold assets for many generations usually without any requirement that the principal ever be distributed. 

Keeping assets in trust has many benefits.  If money is in trust it can be protected from creditors, including an ex-wife or an ex-husband.  Additionally, keeping assets in trust will protect it from estate taxes.  (If you give money to a child upon death, it is taxed, when they die, it is taxed again, and so forth...)  

The grantors of the trust can also control the flow of money out of the trust.  For example, they can allow for an income stream, they can allow for small percentage distributions when their heirs reach certain ages or graduate from college, they can allow invasion for certain expenses or they can simply let the trustee decide when and how to give their heirs money based upon whatever criteria they think is important.  The most common standard is for the health, education, maintenance and support of their heirs.

Another beneficial feature of a dynasty trust is that it can be located anywhere.  Typically, wealthy parents have provided for their children and already have good careers and plenty of their own assets.  If parents simply give more money to their children outright, it will be taxed in the jurisdiction where the children live.  If that state has a high income tax, it could be a drain on the funds.  If trust were created in a place that doesn't have a state income tax, that can save significant assets for future generations.

Almost anyone can be trustee of the dynasty trust other than the Grantor.  The Trustee is the party that manages the money and makes distribution from the trust.  Common choices of trustee include the heirs of the Grantor, a friend or an attorney or a corporate trustee.  If the Trustee is also a beneficiary of the trust, there will have to be restrictions on what the Trustee gives himself (otherwise you lose the tax and asset protection benefits).  Often times a trust is created with substantial flexibility so that an heir can act as trustee with limited invasion, but that heir also can be given the power to hire and fire additional trustees who have much broader discretion to distribute funds.  

A dynasty trust can go on for as long as the Grantor has heirs.  In case something happens to the entire family, most people usually name a charitable remainder beneficiary.  Other features that most good dynasty trusts include are the ability to relocate the trust to another jurisdiction (usually to obtain a more favorable tax rate), the ability to have a separate investment advisor, and the creation of a trust protector to modify terms of the trust in the events facts or circumstances change. 

A dynasty trust can be created during the lifetime of the Grantor (an intervivos trust) or upon his death (as a testamentary trust).  Usually it is better to create the trust during the lifetime of the Grantor because it will offer more flexibility in terms of jurisdiction (where the trust is located).  Jurisdiction is important because some states do not allow a perpetual trust, there is a state income tax in some states, and some states offer better creditor protection than others.  Another benefit to creating a dynasty trust during the lifetime of the Grantor is because the trust can be set up as an Intentionally Defective Grantor Trust (IDGT).

An IDGT is an irrevocable trust created during the Grantor's life that is not includible in the gross estate of the Grantor at the time of his death, but while the Grantor is alive, the income is taxable to the Grantor.  The benefit to this is that the Grantor can pay the taxes on the trust with his own money, allowing the trust to grow at a faster rate.  Essentially, it is like making a tax free gift to the trust in the amount of the tax.

Even if a trust is created during a Grantor's lifetime, it does not have to be funded until the Grantor passes away.  Sometimes a Grantor will want to or need to maintain control over certain assets.  Often, it is best to partially fund the dynasty trust with assets that the Grantor thinks will appreciate substantially in the future and transfer low basis assets that have already highly appreciated to the dynasty trust on death.

Because of the potential that these trusts can go on forever, it should not be set up unless the individuals involved have a fair amount of assets.  Normally I would not recommend it unless the Grantor is planning to fund it with several million dollars.  However, each client's situation is unique. Please contact our attorneys if you think a dynasty trust might be right for you.

Non-residents Non-citizens of the US Should Be Careful of How they Invest in American Assets

Many individuals who live outside of America like to purchase real estate in America or invest in the U.S. Stock Market.  It can be much safer than in investing in other parts of the world and often times the individual has children who have moved to America to live or study.

Florida and New York are particularly attractive locations for foreigners to buy vacation homes or rental properties, so I will focus on those jurisdictions a bit.

From a tax perspective, Florida is relatively easy to deal with as there is no estate tax. The transfer taxes are small and the process is pretty quick if you need to transfer the property during your lifetime. New York recently changed its estate tax laws, so that individuals can soon transfer over $5,000,000 before there is a state estate tax.  Transfer taxes are a bit higher and the process is a bit slower, but it is not terrible.

On death, it is a different story, both Florida and New York can be a royal nightmare and you should avoid probate.  Probate is the process of transferring assets on death and is typically quite expensive. It is also very easy to avoid by setting up a simple trust that is invisible for taxing purposes. A trust can also be set up to avoid the US federal estate tax, and I strongly recommend this.

With respect to the US taxes, a foreign investor must worry about both income taxes AND estate taxes.  While owning stock or real estate outright may be easiest and perhaps even best to minimize income taxes, it can be the worst thing to do for estate taxes.

The United States is not very friendly when it comes to foreign individuals who wish to transfer property in America. While a US citizen or resident alien may transfer $5,340,000 before there is a gift or estate tax, the threshold for non-resident is $14,000 for gifts (per person per year) and only $60,000 (total) on death.  A person may gift $145,000 (annually indexed for inflation) to a non-citizen spouse before there is a US gift tax.

For transfers in excess of the limits above, there is an 18%-40% tax depending upon the amount of the transfer.  You can defer the tax on a transfers to a spouse by setting up a Qualified Domestic Trust (QDOT).

Additionally, the rules are very complicated because some assets are taxed on death or gift and some assets are not.  The general rule is that if something can be considered a U.S. Situs asset, it is subject to the US Federal Estate Tax when the owner dies.  Examples of U.S. Situs assets include: real estate located in the U.S., cash or jewelry in the U.S., ownership in a US based REIT, and ownership of a US based Annuity.  Examples of Non-U.S. Situs assets include: real estate in foreign countries and stock in foreign corporations.  Less obviously, this also includes life insurance and debt obligations (such as bonds).

This is further confused by the fact that some assets considered non-U.S. situs for gift tax purposes differ from the assets that are non-U.S. situs for estate tax purposes.  Specifically, intangible property such as stock in a U.S. corporation or an interest in a US partnership or limited liability company are considered U.S. Situs assets for the estate tax, but not the gift tax. Additionally, cash on deposit in a checking or savings account at a U.S. Banking institution is a U.S. situs asset for gift tax purposes, but not for estate tax purposes.

To restate this another way, a gift in excess of $14,000 of cash on deposit in a U.S. bank is subject to a gift tax.   However, regardless how much cash is there when you pass away, it is not subject to the U.S. Estate tax.  Conversely, a gift of U.S. stock (regardless of how much), is not subject to the U.S. Gift Tax, but if you die owning the stock, anything in excess of $60,000 is subject to the estate tax.

(NOTE: a person must be really careful of that cash in a money market account is treated as an intangible asset so it is considered a U.S. Situs asset for estate tax purposes, but not gift tax purposes.) Please see this link to the IRS website which details assets that are subject to the US estate tax and those which are exempt.

If you are a non-resident, non US citizen who owns stock and real estate in the United States, your options include:
1) Paying the estate tax on your death;
2) Setting up a foreign corporation to own a local business entity (this will cause more income taxes now though, but save money on estate/gift taxes);
3) Sell the stock and property before you die and put the money into non-US situs assets until afterwards (this can be tough to time though).
4) Transfer the house to an LLC and then transfer the stock and the LLC to your children or to a trust for your children. As long as you survive for 3 years after the transfer, this should not be an issue for estate tax purposes.
5) Sell the assets and invest the money inside of a life insurance policy. That will be free of income tax and estate tax. The question is whether you can find someone to write the policy on a non-resident.

I generally recommend that if a person can afford it, you establish a US based trust in a state that doesn't have an income tax (like Florida) to own assets. Ideally you should transfer money into the trust from a non-US bank account. If you do not need the income from the trust, you can make the trust strictly for the benefit of your heirs. This will avoid an estate tax on the assets owned by the trust REGARDLESS OF WHAT ASSETS ARE NOW IN THE TRUST. This is how you can invest in the market or in real estate without worrying about an estate tax. As mentioned above trust will also help with administration and managing the funds by avoiding probate.

Remember a gift or transfer of assets may require the need to file an informational return with the IRS.  Also, the United States has tax treaties with several countries which may affect your need to do planning, so please confer with a competent international estate planning attorney before buying any assets in America.

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
0.3% 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.

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.

Setting up Trusts for High Maintenance Children

I was talking with a colleague the other day regarding a trust that he manages for a rather difficult benefiary. The trust is rather small in terms of overall dollars, but he advised me that it consumes a great deal of his time because the beneficiary calls hundreds of times a year - begging for money.

As trustee of this trust, he cannot give out much money because the goal of the person who funded the trust was to have the money last for a long time and only be used in the event of an emergency. The trouble is - EVERYTHING is an emergency to high maintenance beneficiary. These individuals live on the edge of financial ruin: they have trouble choosing friends, they are unable to understand the long term ramifications of their decisions, and they are terrible at budgeting.

It is a great imposition on the trustee to manage these trusts, and if the principal is less than $500,000, it is often not worth their time or energy to manage such trusts. What often happens is that the friend or relative that you named as trustee to help out your child no longer wants to be involved and resigns from the position.

If you are the parent of a high maintence child, and you want to set up a trust for your child, one thing you can do is make the job of the trustee a little easier is to really specify how you want the money to be spent. The more specific you make the trust, the easier it is for the trustee to say yes or no. The child realizes that the trustee has specific limitations, which makes it easier for the beneficiary and the trustee to get along.

The downside to this strategy is that it limits the flexibility of the trustee. However, for smaller trusts, it may be better to avoid the cost of constant trustee turnover than to try and allow for too much flexibility.

New Jersey Estate Tax

New Jersey has many different types of taxes, including two different taxes on death: the NJ Estate Tax and the NJ inheritance tax. The New Jersey estate tax is a tax on transfers at death and certain transfers in contemplation of death.

Transfers to charities, a surviving spouse or a surviving Civil Union partner are exempt from the NJ estate tax. Transfers to anyone else are taxable to the extent that the transfer exceeds $675,000. New Jersey never does anything in a simple manner, and it does not technically offer a $675,000 exemption from the estate tax. NJ actually exempts the first $60,000 of transfer and then taxes the next $615,000 at 0%. The effect of this is that the first $675,000 can almost always pass to whomever you want tax free.

Each New Jersey resident is entitled to the NJ estate tax exemption. Accordingly, married couples and Civil Union couples can double the amount that they pass on to their children with proper planning. (This usually involves setting up a bypass trust for the surviving partner or spouse rather than leaving them money outright.)

The New Jersey estate tax is a progressive tax, meaning that the more you pass on, the higher the tax rate. The NJ estate tax rate generally varies from 0% to 16% depending upon the amount of the transfer. The major exception is that for the first $52,175 over $675,000, there is a 37% tax. For a detailed breakdown of the tax rates, see page 10 of the NJ Estate Tax Return.

New Jersey offers two different method of calculating the state estate tax on the NJ Estate Tax Return: the 706 method and the so called "Simplified Method". The Simplified Method allows the executor or administrator of the estate to avoid filing a 2001 version of the federal estate return, but it often results in a higher tax. For this reason, it is often advisable to hire a competent estate planning attorney to minimize this tax liability.

A decedent's estate can be subject to both the NJ estate and inheritance taxes. New Jersey does offer some relief if an estate is subject to both taxes. For example, if a person with $1,000,000 dies and leaves the entire amount to her nephew, this transfer would be subject to both taxes. A transfer of one million dollars in normally subject to a $33,200 New Jersey estate tax. A transfer of this amount though is also subject to a $150,000 New Jersey inheritance tax. In such an instance, New Jersey would only collect only the higher tax, the 15% inheritance tax in this case.

The NJ estate tax is due within 9 months from the date of the decedent's death. This is different than the NJ inheritance tax, which is due within 8 months from the date of the decedent's death.

The NJ estate tax should not be confused with the federal estate tax. Unless Congress acts to extend the repeal of the federal estate tax (which I think to be highly unlikely), the United States will have a separate and additional tax on death.

Estate and Trust Litigation

Unfortunately I have been given another reminder of how important it is to select appropriate executors for your Will, trustees for your trusts and agents in your financial powers of attorney.

No matter how good an attorney does in drafting your estate planning documents, if there is a person in charge of the money who is not honorable, a large portion can be easily stolen. The person who you put in control of such money is known as a fiduciary.

When you name someone as a fiduciary, you must realize that while they are legally forbidden from taken this money for their own personal benefit, mechanically it is very easy to do. For this reason I always recommend that when deciding on who should be in charge of your finances you always choose someone who is trustworthy rather than someone who is good with money. A trustworthy person can always hire others to help who are good with money. You would be hard pressed to discover the money from someone who is smart and sneaky.

For people who want to do everything they can to avoid probate - just realize that by avoiding probate you are also avoiding oversight. So if you have named a bad trustee, it will just be that much harder to prove that they in fact stole the money.

If your heirs find themselves in a situation where they think that money has been stolen from an estate or trust, the first remedy is an accounting. Unfortunately there is very little satisfaction in this because it can take years and can be very costly. It is not uncommon for this type of litigation to start at about $40,000.

The best way to avoid estate and trust litigation after you are gone is to really think about the people you name as fiduciaries. If you can't trust anyone, there are plenty of independent fiduciaries that you can hire.

Estate tax liability for Non-Citizen Non-Residents of America

In this real estate market, some foreign investors may be tempted to buy property in the United States on the cheap. Overall, this may be a good idea, but I wish to caution you about one potential tax trap: When a person who owns property in America dies, and that person is not a citizen and is not a permanent resident alien, there will be a United States Estate Tax due based in part on the value of that property. What's worse is that the tax rate starts at 18% and quickly goes up to 45%!

American citizens and permanent resident aliens can pass on $3.5 million worth of assets before the estate tax hits. Non-citizen non-residents only have a tax exemption of $13,000, which shelters $60,000 worth of assets. (See Section 2102 of the Internal Revenue Code.)

So, let's assume you have a Japanese citizen (living in Tokyo) who owns a rental property in New York, and that property is valued at $500,000. Upon the death of the owner, a federal estate would be due in the amount of $57,800. Due to the credit, this is less than an 18% effective tax rate. Still, it may come as a rather large shock for those unfamiliar with US tax laws.

Even though Japan has a treaty with the United States, estate and gift tax treaties uniformly exempt real estate - so the country where the property is located gets to tax that property.

As long as you are alive though, you can still do planning to minimize or avoid this outcome by engaging in gift and trust planning.

Thoughts on Portability of Estate Tax Exemption

Currently the House and the Senate are mulling a proposal to allow married couples to transfer their estate tax exemption amount to a surviving spouse on death. Under the current law, it is a use it or lose it approach.

To give an example of what this would mean, let's take a couple with $4,000,000 worth of assets. The Husband has $3 Million in his name and the wife has $1 Million in her name. Under the current law, it is possible that this family's heirs could be taxed up to $900,000 in federal estate taxes. How you ask?

• Scenario 1. Regardless of whether Husband or Wife dies first, if they have a Will leaving everything to the surviving spouse before it goes to the children (an "I Love You Will"), then when the second spouse dies there will be a $900,000 tax. This is because the surviving spouse dies with assets worth $4,000,000 and an exemption of only $2,000,000. This assumes not increase in the value of the assets and the fact that the ederal estate tax rate stays at its current rate of 45%.
  

• Scenario 2. If Wife dies first and leaves the $1 Million to their children (or in a special trust for Husband), then on the subsequent death of Husband, there will be an estate tax of $450,000. This is because Husband would die with assets worth $3,000,000 and an exemption of only $2,000,000. Same assumptions as above.
  

• Scenario 3. This couple hires an intelligent estate planning attorney and the attorney helps them retitle their assets so that they each own $2,000,000. The attorney then sets up a special trust for the benefit of the surviving spouse so that he or she has access to all $4,000,000 ($2 Million of their own money and $2 Million in trust). However, this special structure makes full use of each spouse's estate tax exemptions - so that regardless of who dies first, there is no estate tax due and owing at the death of the second spouse.

So how would portability of an estate tax exemption affect this? Well, in each of the above scenarios, there would be ZERO tax. The proposals being bandied about would allow a spouse to transfer his or her exemption amount to a surviving spouse. So in scenarios one and two above, rather than the surviving spouse having an exemption amount of only $2,000,000, he or she would be entitled to an exemption amount of $4,000,000. Generally, this fits in line with the current thinking of most tax provisions in that the government wishes to treat a husband and wife as a single unit.

By and large, there is not much downside to this idea for people. In most proposals, the only thing one must do to take advantage of this is to file an attachment to a person's estate tax return or their final income tax return. The people who would benefit most from this proposal would be those with large assets that they cannot transfer to a spouse (e.g. people who own large retirement accounts).

My one word of caution would be that this could lull people into a false sense of security regarding their estate planning. I know that if people are not worried about taxes, they may be less inclined to get the proper documentation in place. This would be particularly worrisome in the event of 2nd marriage situations where the children of a first marriage could potentially be cut out entirely.

A final note on the status of this legislation is that it has passed the House and is currently stalled in the Senate.

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.

Benefits of a Life Insurance Trust

I. What is a Life Insurance Trust?

A. Legal Relationship - A trust is a relationship that exists when one person or an entity (the Trustee) holds legal title to money or property for the benefit of one or more individuals or organizations (the Beneficiaries). The terms of the relationship are decided by the person providing money for the trust (the Grantor), and are usually evidenced in writing.

1. Grantor/Settlor - The Grantor or Settlor is the person or entity that creates the trust by providing the money or insurance to fund it.

2. Trustee - The Trustee is the person or entity that manages the trust assets for the benefit of the beneficiaries of the trust. The trustee is bound by a fiduciary duty to act in the best interests of trust, as directed by the Grantor or Settlor.

3. Beneficiary - A Beneficiary of a trust is a person or entity that is entitled to receive money from the trust. The manner in which a person receives such money varies from trust to trust, and generally a Grantor may put in a range of provisions to restrict a Beneficiary’s access to the money.

B. Design - A life insurance trust is specifically designed to hold life insurance.

1. Irrevocable – Once created, a life insurance trust is almost impossible to change.

2. Loss of Control - Generally, the insured must give up all rights to control the trust and the life insurance policy in favor of a trusted advisor. The Grantor should decide the terms of the trust upfront so that the Trustee may carry out the Grantor’s wishes.

3. Tax - A life insurance trust is typically designed to save money on estate and inheritance taxes. It should also allow the Grantor to use his or her annual gift tax exclusion so that the premium payments are not treated as a taxable gift.

II. What are the benefits of an insurance trust?

A. Reduces estate and inheritance taxes - If life insurance is owned by a trust, and the trust is structured properly, the proceeds from the life insurance will NOT be includible in the taxable estate of the Grantor. Note: A trust must purchase the life insurance, otherwise there is a three year look-back period.

B. Allows for control of assets after you die – Despite the fact that the trust is irrevocable and you lose control once it is established, with proper planning, the trust can allow a Grantor to decide when and how his or her heirs should get the proceeds of the life insurance.

C. Asset protection – By giving money to your heirs in trust, it ensures that your heirs are less likely to squander their inheritance. It also protects it from creditors.

III. Who should consider an insurance trust?

A. Recent Divorcees – Many divorce decrees call for an insurance trust to be established. It benefits the custodial parents by giving them assurance of the existence of the policy. It benefits the non-custodial parent by giving them a voice in when the child gets the money and ensuring that they money benefits the children, and not the person they just divorced.

B. Individuals with Significant Assets – Individuals with substantial wealth may benefit from a life insurance trust as a way to reduce taxes or to create liquidity for an estate that may have other tax or cash flow issues.

C. Individuals with Large Insurance Policies – By itself, a large policy can create estate tax issues, so even if a person is not otherwise wealthy, it makes sense to transfer the wealth you do have with minimum tax consequences.

D. Same Sex Couples – Despite the recent changes in some states, including New Jersey, that benefit same sex couples, many states and the federal government still treat same sex couples as nothing more than friends for tax purposes. Accordingly, a life insurance trust will ensure that your loved one benefits upon your death without a large tax bite.

E. Individuals married to Non-Citizen Spouses – A non citizen spouse is not entitled to the unlimited marital deduction for estate and gift tax purposes. Accordingly, if you are married to a non-citizen spouse, the best way to avoid a large estate tax upon your death is to create a life insurance trust.

Reasons for a Will

1. General Benefits
   a) Ensures a clear WRITTEN clear plan for the distribution of assets after your death
   i. Provides proof of plan
   ii. You get to choose who serves as executor, trustee and guardian
   iii. A clear plan can help avoid infighting amongst surviving family members
   

   b) Important means of ensuring that money will go to whom you wish it to go rather than according to state law
   c) Eliminates need for Insurance bond for Trustees and Guardians (Savings of approximately $500 for every $100,000 that the estate is valued at)

   
   
2. Establish trusts for your children/grandchildren
   a) Minors – allows for both discretion over distribution and control over timing of distributions
   i. Tiered distribution – traditional means of giving money to children (age 21, 25, 30)
   ii. Dynasty trusts – stays in family blood forever if funded with enough money.
   

   b) Problem children – can give trustee discretion as to when to distribute money out

   
   
3. Flexibility
   a) A Modern Will should allow for a great deal of flexibility because of the ever-changing tax laws.
   i. Regardless of whether a Testator’s estate goes up or down, the will should contain formulas to take into account the current state of the tax laws and future anticipated changes.
   ii. Ability to take into account State Tax laws in conjunction with Federal Tax Laws
   

   b) Trustee provisions - Many problems occur when beneficiaries are stuck with trustees whom they cannot remove. A modern Will should have the ability for trusted beneficiaries to replace trustees and appoint independent trustees to allow for invasion of principal to beneficiaries in a way that will not produce adverse tax consequences.
   c) Post mortem planning - A will should allow for the surviving spouse or an independent executor to do planning after the death of the testator including tax planning.
   i. Disclaimers
   ii. Limited Powers of Appointment – You can allow the surviving spouse to appoint the balance of a trust among your children as he or she sees fit. (This is especially useful when children have varied income levels.)
   iii. Granting of a General Power of Appointment for tax purposes.
   

   d) Side letters – Under New Jersey law, a testator may revise the provisions regarding disposition of tangible personal properties without redoing the entire will. (E.g. You can easily change your mind about who you want to leave your golf clubs to without redoing your Will.)
   e) Combining trusts – A well drafted will (and trust) should allow you to combine two or more trusts with similar terms to save time and money.

   
   
4. Minimization of Tax consequences
   a) Establishing trusts allows couples to make full use of both spouses’ tax exemptions.
   b) Anyone who plans to distribute to non-lineal descendents, up or down, must plan to minimize inheritance taxes
   c) Establishment of multiple trusts for minimization of Generation Skipping Transfer Tax (GST tax)