Stites on Estates

What to Do with an Estate with Foreign Assets (Even that “Little” Bank Account in Europe)

Posted in Estate Administration, Income Tax Planning, Trust Administration

johnny-automatic-professor-Earth-300pxThis article regards estates of decedents who owned foreign assets and the tax and reporting requirements.  Many people are quite shocked to learn about the reporting requirements for foreign bank accounts, in particular.  After all, tax is typically being paid in the foreign jurisdiction, or perhaps the foreign bank accounts generate little to no income that is taxable anyway.  There are, however, two categories to be concerned with, first, of course is taxation.  Second is reporting in and of itself.  How does this all relate to estates?  Well, if the estate has foreign assets and the proper reports are not made, then the personal representative of the estate could be liable.

One of the main reporting obligations is actually not an IRS form at all, it’s a treasury department Form FinCen 114, commonly called an FBAR (Foreign Bank Account Report). It’s part of the financial crime enforcement network, and if the foreign bank accounts in the aggregate exceed $10,000 at any point during the year (even very briefly) then this report must be electronically filed.  The penalties for failure to file can be quite draconian, including willful penalties of 50% or more of what is not reported.  Again, note that this filing has nothing to do with the amount of tax owed, if any.  If a person has signature authority of foreign financial accounts then there can also be a reporting requirement, even if there is no financial interest in the account.  As such, one should be careful about the accounts that a person has signature authority over.  Similarly, one should be careful about having a power of attorney over one’s parents who have a foreign account, as there could be a reporting requirement.

As for tax reporting, several years ago an act of Congress commonly called FATCA added Form 8938, Statement of Specified Foreign Financial Assets.  It is very important that this form is filed, since the statute of limitations never runs if it is not – meaning that there could be a potential tax problem forever.  The IRS recently released regulations requiring this form to be filed by certain domestic entities as well.

Foreign mutual funds held in an estate of a United States citizen or resident are particularly problematic. A United States citizen or resident should never own foreign mutual funds due to the extensive reporting under Form 8621, PFIC shareholder filings and the often very unfavorable tax treatment and the difficulties in obtaining information from often very reluctant foreign financial institutions (FATCA and PFICs are two of the main reasons it’s often hard for United States citizens and residents to open accounts overseas). Although there may be some elections available to alleviate some of the tax burden, foreign financial companies often refuse to supply the needed information.

Of course, some will wonder how the IRS would ever know about these accounts.  Well, FATCA requires foreign financial institutions to identify and report US holders of non-US financial accounts.  The US already has agreements with most countries for this reporting.

The major forms to be concerned with are set forth in the list below.  This is not an exhaustive list and not every form is needed in every circumstance.  The form number is listed with its title in parenthesis:

  • FinCen 114 (Foreign Bank Account Report),
  • Form 926 (Transfers to Foreign Corporations),
  • Form 1042 (Payments to Foreign Taxpayers),
  • Form 3520, 3520A (Foreign Trusts),
  • Form 5471 (US Owned Foreign Companies),
  • Form 5472 (Foreign Owned US Companies),
  • Form 8233 (Independent Personal Services by Nonresident),
  • Form 8621 (Passive Foreign Investment Corporations),
  • Form 8833 (Treaty Based Disclosure Form),
  • Form 8840 (Closer Connections Form),
  • Form 8858 (Foreign Disregarded Entities),
  • Form 8865 (Foreign Partnerships),
  • Form 8938 (Specified Foreign Financial Assets),
  • Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding).

Now, back to the subject of personal representative liability.  Pursuant to Title 31 U.S.C.§3713(b) any personal representative who pays “any part of a debt of the . . . estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government.” Therefore, the personal representative may be liable for taxes, interest and penalties if the distribution leaves the estate unable to pay the government and the personal representative had notice of the government’s claim.  In terms of notice “the executor must have knowledge of the debt owed by the estate to the United States or notice of facts that would lead a reasonably prudent person to inquire as to the existence of the debt owed before making the challenged distribution or payment.” United States v. Coppola, 85 F.3d 1015, 1020 (2d Cir.1996). Therefore, there is a duty of inquiry regarding the existence of these obligations, and as such important that the proper reporting is done and taxes paid.

The good news, however, is that much of the reporting, aside from the PFIC reporting of course, is actually not very difficult.  Moreover, there are generally tax credits that can be used due to foreign tax paid, meaning that the US tax liability is often quite small.  If there are past years that have not been reported, the government currently offers several different programs to settle the tax and reporting obligations for reduced penalties (provided that a person comes forward prior to receiving IRS notice).  Considering the severity of the penalties, proper reporting is obviously very advisable.

 

Estate Planning With Partnerships: Important New Considerations

Posted in Estate Tax Planning, Income Tax Planning, Trust Administration

Two recent acts of Congress (including the rather interestingly named Protection of Americans from Tax Hikes Act) created new audit rules for partnerships.  Normally one would not think that a change to “audit rules” would impact estate planning.  However, many estates have LLCs taxed as partnerships, or even limited partnerships or limited liability partnerships, which are used as family limited partnerships in order to obtain valuation discounts through lack of control and lack of marketability (provided that all of the proper procedures and documentation is followed).  Moreover, many estates have revocable trusts that own limited liability companies, which is a common way to avoid the often lengthy process of probate for business assets.  Again, these techniques are quite common.

So what are the new audit rules, and how do they impact estate planning?  Briefly, starting in 2018 the new audit rules allow for a partnership level determination of deficiencies if the partnership is audited as the default regime.  The problem with this determination is that if there are different partners currently than the year under audit, then the current partners could end up being liable for the past deficiency.  There also can be issues with allocation, since the IRS won’t undo erroneous allocation and will simply assess the net increase against the partnership.  Another problem is that this deficiency will be assessed at the highest tax rates.  The tax matters partner is no longer, and instead there is a partnership representative who does not even need to be a partner.  It will be important to select a partnership representative since the IRS gets to choose the representative if one is not selected.  Due to the possible negative consequences of the new laws, many partnerships will want to opt out (which will keep determinations at the partner level).  The issue is whether trustees that own partnership interests on behalf of trusts will be able to opt out.

The new audit rules allow opting out if there are less than 100 K-1s, and the “each of the partners of such partnership is an individual, a C corporation, any foreign entity that would be treated as a C corporation were it domestic, an S corporation[note that there are some additional rules for S Corps], or an estate of a deceased partner.”  Unfortunately the new code section does not mention trusts or trustees at all, so it is currently unclear as to whether partnership that have trusts as owners will be able to opt out.  I recently attended a tax conference, and the IRS representative on a panel there informally stated that there would likely be regulations regarding grantor trusts and the ability to opt out (the new audit rules do allow the IRS to prescribe similar rules for other partners not listed in the new code section).

What to do now?  For partnerships, family limited partnerships, limited partnerships, limited liability partnerships (and limited liability limited partnerships), as well as LLCs taxed as partnerships, that are currently being formed, it would be prudent to include some of the language from the new code in partnership and operating agreements in order to insure later that the entity is in compliance, in case the partners do not return to amend the agreements.  For existing partnerships, it makes more sense to wait to amend as more regulations are promulgated by the IRS.  Extra caution should be taken regarding trusts (particularly non-grantor trusts) as owners, since it is unclear how or if partnerships with trustee owners will be able to opt out.

Designing Trusts for a Surviving Spouse’s Remarriage

Posted in Blended Families, Estate Planning, Life Cycle Estate and Financial Planning, Trust Administration

gv10209In the 90s, when the Internet was new and Bill Clinton still had more tomorrows than yesterdays, the estate tax exemption was $600,000, an amount even Thomas Piketty might think was rather low.

In that sort of environment, credit shelter trust planning for married couples felt almost mandatory.

We live in a very different world today. The Internet, no longer new, has gone social and mobile. A Clinton third term may occur.

The estate tax exemption is $5.43 million and indexed for inflation – with the result that 99.8% of estates won’t be taxable.

Yet, as we’ve discussed recently, taxes weren’t the only reason to use trusts.

One of the most significant non-tax reasons to use a trust is planning for a surviving spouse’s remarriage.

What are the risks to family wealth when a surviving spouse remarries, and how can using a trust (and designing that trust thoughtfully) reduce them?

  • Asset Leakage to a New Spouse. We’ve covered these risks in depth. Simply put, Kentucky’s elective share statute allows a surviving spouse to elect against their deceased spouse’s will, and instead receive one-half of their deceased spouse’s probate estate (except real estate, in which a surviving spouse has only a one-third elective share).

Here’s why the elective share statute is a problem when a trust wasn’t part of the estate plan: the surviving spouse might get remarried, without getting a prenuptial agreement.

If your spouse has inherited outright from you, and doesn’t get a prenuptial agreement before remarrying, and their second spouse survives, the second spouse has strong economic incentives and the legal right to divert half of the inheritance your spouse received from you away from your descendants.

Does that sound like a good outcome to you? (I’d expect it doesn’t.) Continue Reading

Designing Incentive Trusts: Adam Smith and The Wealth of Beneficiaries

Posted in Estate Planning, Life Cycle Estate and Financial Planning, Trust Administration

adam smith 20 pound noteCertainly one of Adam Smith’s core insights in The Wealth of Nations was that incentives matter.

I believe examples are everywhere about how Smith was correct – ranging from California water shortages and student loan debt, to tax policy and white collar crime.

If incentives matter in these areas, shouldn’t they matter in designing trusts that maximize successful outcomes for descendants?

Clients often have an instinct that “incentive trusts” may improve outcomes for their descendants.

While I don’t discourage this instinct, I do try to channel it.

Precisely because incentives do matter, it’s important to design incentive trusts very thoughtfully.

 Incentive trust design begins with several questions:

  • What do you want beneficiaries to become?

Usually, answers center on the general theme of “becoming productive, engaged, flourishing adults.”

  • What do you want beneficiaries to do?

Certain achievements and behaviors tend to correlate highly successful, fulfilling life outcomes – and clients often want to encourage these.  Examples include the obvious – finishing college and/or graduate school, avoiding debt, working productively, dodging divorce, and staying healthy.

  • What do you want beneficiaries not to do?

There are obvious pitfalls clients want beneficiaries to avoid, often including substance abuse problems, criminal activity, serial failed relationships, and workforce non-entry or failure.

Once a family develops clarity on the key questions above, they and their advisors can consider a wide range of incentive trust design options, including:

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Design Factors for Your Family’s Trust

Posted in Asset Protection, Estate Planning, Life Cycle Estate and Financial Planning, Trust Administration

imageThese are interesting years in estate planning for families in the Upper Middle and Lower Upper Classes.

As a high estate tax exemption has reduced the tax-driven imperatives for using trusts to hold inheritances, non-tax applications of trusts come to the fore.

As non-tax issues in trust design assume greater relative importance, what factors should a family consider when deciding whether to use a trust?

If they will use a trust, how should that trust be designed?

To answer these questions, a family should do the best it can to look ahead to its future, and make reasonable (but unavoidably imperfect) estimates of what its future might look like.

That takes us back to the Quadrant at the heart of a Life Cycle approach to estate and financial planning, with its four domains of Facts, Forecasts, Life Stages, and Unexpected Events.

Life Cycle Estate and Financial Planning Quadrant

The decision whether or not to use a trust to hold an inheritance begins with a family’s Facts.

  • Who would be receiving the wealth?

The array of options includes the obvious, but thinking about the beneficiaries is the right place to start.

Common potential inheritors include a widow(er), a surviving spouse and children, adult children, nieces or nephews, parents, siblings, and/or charities.

  • What will the trust’s funding level be?

Funding is a tremendously important Fact underlying good trust design.

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Minor Children and IRA/401Ks Beneficiary Designations: Dangers and Concerns

Posted in Estate Planning, Retirement Planning

1950s-picnic-photoAs a parent, one of the most difficult issues that I have had to deal with is what would happen to our young child should anything happen to my wife and I.  No one likes to contemplate their own mortality or the idea of not being there to watch their children grow up.  Unfortunately, mortality is inescapable, and proper planning is essential. Often people believe that once they have their Will drafted everything will be settled. This is rarely the case.

The first concept to understand is probate versus non probate in terms of assets. Assets owned directly by you, and that do not have a beneficiary designation (or survivorship/tenants in the entirety, etc.), will generally be a part of your probate estate. This means your Will would be able to direct where these assets go. For accounts with beneficiary designations, such as IRAs, 401Ks, life insurance, certain bank accounts (as well as joint with survivorship or pay on death or transfer on death designations), certain financial accounts (with named beneficiaries), and even some real property (joint with survivorship, tenants in the entirety, etc.) might all pass outside of probate. Your Will would have no effect whatsoever on how these non-probate items are distributed. Instead, those non-probate items would be distributed in accordance with the various beneficiary designations (or through survivorship or tenants in the entirety, etc.), regardless of what is written in your Will. Since these items could make up the majority of your estate, it is important to plan properly.

One idea that many people have is to simply name their estate as the beneficiary and therefore have those assets come under control of the Will. However, naming the estate as the beneficiary can be disastrous for qualified plans (IRAs, 401Ks, etc.), as such designations generally have adverse tax consequences and may have adverse asset protection consequences.

What happens if assets go directly to a minor child? Generally, if it is more than a certain amount (as determined by the states, usually about $15,000-$20,000), the parent/guardian would not be able to simply hold the child’s assets, and a conservatorship would have to be obtained. Until the child reaches age 18, the conservator would have to be bonded (which can be expensive), and the court would be involved in determining how the money is spent. Upon reaching age 18, the child would get the full value of the assets. For most families conservatorships should be avoided through proper planning.

One solution is to have the minor named as beneficiary pursuant to one of the uniform transfers to minor’s acts of the various states. The downside to this designation is that not all qualified plans allow for this designation, and there is little flexibility, as the child will get everything remaining at age 21, which may not be what is desired.

Another solution is to create a trust, and have the trust be the beneficiary of the funds. The trust can be created either as a stand-alone document, or created via the Will as a testamentary trust. Great care should be taken in the creation of this trust.

If the deceased dies after their Required Beginning Date for Minimum Required Distributions (April 1 of the year following the year in which the deceased turned 70 ½) than any Required Minimum Distributions from the qualified plans (IRAs, 401Ks, etc.) would be based upon that decedent’s life expectancy, unless the trust properly sets forth a Designated Beneficiary or Beneficiaries (which would generally be your children). If a proper Designated Beneficiary is set up, then the distributions would be based on the longer of the oldest beneficiary’s life expectancy or the deceased’s life expectancy. It may be beneficial, especially if there is a lot of difference in age between the children, to set up multiple trusts each with a different Designated Beneficiary (i.e. child) so that the stretch-out of the payments isn’t limited to the lifespan of the oldest child. If the deceased dies before their Required Beginning Date and there is no Designated Beneficiary, then the entire balance of the account must be distributed within five years of the date of the deceased’s death, which is a terrible result. The longer the distributions can be stretched out the longer the tax is deferred (and perhaps at a lower rate as well since income taxes are on a graduated scale) and the longer tax free growth is allowed for the funds remaining in the qualified plan.

You would generally have your spouse named as primary beneficiary, and then the trust (or trusts) as contingent beneficiaries. The spouse would have the option of rolling over his or her inherited IRA into their own IRA (which would then provide asset protection once it is rolled over), and the properly drafted trust (which follows all of the rules regarding designating a beneficiary) would provide asset protection to the non-spousal beneficiaries. A recent Supreme Court case stated that inherited IRAs are not asset protected since they are not retirement accounts, and that is why the spousal rollover, and the trust for the contingent beneficiaries, is important from an asset protection standpoint (unless your state already protects inherited IRAs anyway).

The final issue to be careful of in regard to trusts for qualified plans regards accumulation of income. It may be desirable from an asset protection standpoint to accumulate the distributions in the trust. The downside to having distributions accumulate in a trust (rather than distributing annually) is that trusts are taxed at disfavorable rates. Trusts reach their maximum tax bracket at only $12,150 of income. Therefore, how and when to distribute the distributions coming into the trust from the qualified plan must be carefully considered.

As for other assets (other than from qualified plans), generally the trust can either own the asset directly or the trust can be a beneficiary. Depending upon the tax, estate planning, and asset protection objectives, these trusts can be set up in a variety of ways, and as such a qualified attorney should be consulted as to the appropriate structure depending upon the particular facts of the situation.

Hopefully this article provides a good, brief overview of an often overlooked part of estate planning, e.g. the importance of checking all of one’s beneficiary designations and checking all of one’s deeds, account titles, etc.  Do not simply assume that the Will can take care of everything, because often a Will might have no effect whatsoever of a great deal of a person’s property.

Design Options for Education Trusts

Posted in Estate Planning, Life Cycle Estate and Financial Planning, Trust Administration

Boarding School Cross Country MeetI often work with “Wealth Creators” who have built substantial wealth themselves, most notably as founders of companies or early-stage employees at startups.

I also work with “Inheritors” managing wealth built in prior generations for the benefit of descendants.

Although every instance has unique aspects, in general, I find that Wealth Creators have conflicted feelings about what being Inheritors will mean for their descendants.

They often tell me they don’t want their children to have “too much” wealth.

Obviously, this presents a difficult question: how much wealth is too much? Answers to that question vary.

Amidst that variance, a very common instinct is that even if they aren’t confident about whether their children (or, instead, charity) should receive the bulk of their wealth, they do want to leave assets in trust to pay for their descendants’ education.

This instinct makes a tremendous amount of sense, and I never discourage it.

Education is a critical component of human capital formation, and human capital has often been the unique element in why any particular Wealth Creator built such success.

If funds are going to be left in trust for descendants’ education, what should the key provisions of those trusts be?

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What About the “Stuff”? – Options for Distributing Tangible Personal Property from Estates or Trusts

Posted in Estate Administration, Estate Planning

distributing tangible personal propertyDuring an estate or trust administration, it’s easy to divide and distribute financial assets. Distributing tangible personal property (such as furniture, collections, artwork, jewelry, etc.) can be much harder.

Executors, trustees, and beneficiaries are usually very surprised by how little household goods and personal property are worth in an estate administration context.

Nonetheless, simply because property isn’t economically valuable doesn’t mean it might not have substantial emotional and sentimental value.

This makes it all the more important to be thoughtful about ways to thoughtfully avoid conflict, expense, or even litigation relating to personal property.

There are several ways to approach these issues.

The simplest approach (but in my experience, one that is not that common) may be to sell all of the property and divide the proceeds as directed in the estate plan.

Positives of this approach include transparency and fairness, because sale proceeds can be accounted for, and money can be divided easily.

Negatives include the typically low sale value of the property, and a lost opportunity to preserve its sentimental value within the family.

A far more common approach is to “work it out” among the family.

The executor or trustee might ask beneficiaries which items they want and see if a consensus appears. If a particular item is a focus for more than one family member, a bit of trading might occur, or (in extreme cases) those items might be sold.

This approach often sorts itself out with surprising speed and not that much fuss.

Its advantages include keeping items in the family that family members want.

Disadvantages may arise if one beneficiary is particularly pushy, and another is conflict-avoidant. In these instances, items may be distributed, but bad feelings among beneficiaries may simmer afterwards.

Families use a “draft pick” approach less frequently, but this offers the opportunity for increased fairness, and a structure that may reduce conflict.

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Avoiding Family Fights In Estate Administration

Posted in Blended Families, Estate Administration, Estate Planning, Life Cycle Estate and Financial Planning

1962 VolvoEstate administration can be a frustrating experience for families and their advisors, because it’s an occasion when families fight. Sometimes the fights are necessary, and unavoidable. Many other times, to a detached observer, the fights seem silly.

Whether justified (or not), whether necessary (or not), conflict makes estate administration cost more (even when litigation doesn’t occur). When tensions boil over into litigation, costs skyrocket.

Because I think preventable conflict is wasteful, I want to offer some perspective on some of the most predictable conflict triggers in estate administration, along with suggestions for how clients and their advisors can reduce the risk of some of these pitfalls.

Pitfall: End of a Dependent Child’s Financial Support

Many clients have children with very divergent career and life incomes as adults (for more on this, see here). It’s not uncommon for one child to be much less economically secure than his or her siblings. Sometimes the cause is downsizing that ended a career early. Other times, it’s serially unsuccessful entrepreneurship, divorce(s), and/or unresolved addictions.

This sort of child (let’s call them, bluntly, a “dependent” child) has often received financial support from parents that other siblings don’t receive in similar amounts.

In extreme situations, the dependent child continues to live at home with his or her parents and “help” them with various home maintenance and aging issues, often in return for access (direct or indirect) to the parents’ pension income, Social Security, and retirement account required minimum distributions.

Invariably, the dependent child will view financial support he or she received as “gifts,” while his or her siblings will view the same transfers as “loans.”

In a perfect world, aging parents of dependent children would keep clear records clearly proving whether the transfers were gifts or loans. In the real world, those records are usually incomplete or nonexistent.

When the alleged loans aren’t documented, and a sibling other than the dependent sibling is named executor, estate administration can turn into an ugly “witch hunt” that in some ways seems like an effort by the executor to punish a dependent child for having been unsuccessful or irresponsible.

On the other hand, when the dependent child is named executor, any undocumented loans (that weren’t really gifts) are very unlikely to ever be repaid.

Solutions: When a client has a dependent child that receives financial support, keep careful records clarifying whether the support is a gift, a loan, or an advancement against a future inheritance.

Consider not having a dependent child serve as executor, and consider the risks a more financially successful child serving as executor might seek “payback” against a dependent child.

Consider whether use of a bank or trust company executor or co-executor might better preserve sibling relationships.

Pitfall: The Family Home Becomes a Long-Term Holding

Estate administrations often last much longer than they should because children cannot agree about what to do with their parents’ house (particularly if they grew up there and are sentimentally attached to it).

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Regional Economic Risk and Your Personal “Plan B”

Posted in Business Planning, Life Cycle Estate and Financial Planning

37Flood-1stBreckLately I’ve been thinking a lot about what a “Corporate Event” at Humana might mean for Louisville. A rosy analysis I’ve heard suggests that Aetna might buy Humana, and then move its headquarters here.

We’d all love that outcome (sorry, Hartford).

Other Humana transactions may have collateral effects on our city that are to put it mildly, non-accretive.

But, if Tip O’Neill was correct when he famously observed that “all politics is local,” then it’s probably equally true that “all merger impacts are personal.”

  • What would regional economic risk like a Humana event mean for you?
  • What are your particular exposures?
  • Most importantly, what can you do to get ahead of those risks?

Because I believe the right pictures help clarify things, I created an Economic Risk Quadrant to evaluate your personal impacts from regional economic risk (whether sudden, or gradual).

Locating yourself, your business, or your employer on the Economic Risk Quadrant suggests how you might be affected, what you can do to prepare, and how you can most effectively adapt and respond.

Economic Exposure Grid

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