Safe Harbors and Jilted Children

Chris and Cindy adored their parents James and Mildred. James and Mildred did what a lot of married couples do in their later years, they created a trust to benefit them during their lifetimes, minimize the affect of estate taxes on their deaths, and distribute their assets to their children. This is the story of how all that planning can be threatened by undue influencers, and how the family can fight back.

Mildred died in 1994, about two years after they created the trust. The trust was split into three trusts: one revocable trust for James, and two irrevocable trusts designed to minimize estate tax exposure. Chris was named as the successor trustee to his father James.

Enter Flora Ibarra. A few months after his wife's death, James became romantically involved with Flora, and she then moved in with him and became his full-time caregiver. Eventually, Flora got James to amend his revocable trust nine times, giving Flora and her family greater shares of his estate, and removing Chris as successor trustee. James also exercised a power of appointment he had over the assets in one of the irrevocable trusts, and sold property in the trust to his revocable trust (which now had Flora and her family as beneficiaries). Flora also isolated James from his children Chris and Cindy. Finally, in one of the amendments to his trust, he added a long and draconian no-contest clause that would disinherit anyone who tried to challenge the provisions of the trust.

James died in 2006. Chris and Cindy did not find out about this until they got a probate notice and a notice of change of trustee. Chris then learned of the nine amendments to the revocable trust. Chris was now trustee of the two irrevocable trusts, which still named him as successor trustee, so he began to look into the assets of those trusts. The trust over which James had the power of appointment had no assets, and the other irrevocable trust had about $177,000 in it. Chris knew that prior to his mother's death, the trusts had over $7 million in assets.

Chris believed Flora Ibarra unduly influenced James to change his revocable trust and take the money out of the irrevocable trusts using his power of appointment to benefit her and her family. He sought to contest the changes, but he knew that the no-contest clauses would disinherit him. He filed a "safe harbor" petition, which asked the court whether his proposed challenges would be a contest subject to the no-contest clause.

Chris was smart, though. His challenge was as trustee of the irrevocable trusts, not as a beneficiary of his father's revocable trust. As trustee, he had a duty to marshall the assets of the irrevocable trusts, which had been siphoned off for Flora's benefit using the power of appointment. Flora, naturally, argued that this was a contest, and he should be disinherited.

The court disagreed with Flora. A trustee has a duty as a fiduciary to administer the trust, and cannot be subject to a no contest clause for exercising that duty. The probate code (at section 21305(b), if you're interested), specifically states that a pleading challenging the exercise of a fiduciary power is not a contest.

Although all the drafting under the sun cannot protect an estate from the Flora Ibarras of the world, the probate code and the courts do their best to keep the undue influencers in check.

Bradley v. Gilbert.

Gifting with Depressed Asset Values

The Wall Street Journal strikes again. In October 18's Money Matters column, Anne Tergesen writes about taking advantage of depressed asset prices and low interest rates to make gifts during your lifetime. This would take the assets out of your estate, and if done properly allow you to transfer the assets tax free.

Among other things, Ms. Tergesen writes that a transferring a depressed asset, such as shares of stock, to a family member could be a benefit when the asset price rebounds. The methods include Grantor Retained Annuity Trusts (GRATs) and Charitable Lead Annuity Trusts (CLATS). Read the column to get a brief overview of what these instruments are, and then call an attorney for more information.

Obama and McCain on Estate Taxes

Yesterday was the last debate between Barack Obama and John McCain before the election. Although they did not tread much new ground in their comments, one area that was covered (at least a little bit) was taxes.

And speaking of taxes, what are the candidates positions on the estate tax? As I posted previously, Obama favors freezing the estate tax at the 2009 level ($3.5 million exemption, 45% rate), whereas McCain's plan is for a $5 million exemption and a 15% rate, which matches the capital gains tax rate.

A major issue, on which both candidates seem to agree is portability. Basically, it means that married couples could use their spouse's exemption in their estate. This was reported on in yesterday's Wall Street Journal. Here's how it would work: Currently, each spouse's estate gets an exemption (for 2008 it is $2 million, increasing to $3.5 million in 2009) before the estate tax is assessed. When one spouse dies, and they leave their estate to the surviving spouse, it passes free of taxes (note: this is for opposite-sex spouses only at the federal level, courtesy the Federal Defense of Marriage Act.) to the surviving spouse. The surviving spouse, however, only gets to use their exemption. For example, if Husband dies and leaves his $2 million estate to Wife, and Wife has an estate of her own of $2 million, she will now have an estate of $4 million, but currently only a $2 million exemption. If Wife were to die this year, she would have estate tax exposure on the $2 million she inherited from her Husband. With portability, she could use her husband's $2 million exemption and avoid estate tax exposure. This would make estate planning somewhat less complex for opposite-sex married couples.

The primary purpose of estate planning should not be tax avoidance, but in reality, it plays an major role. Even with portability, there are many non-tax reasons for trusts of various complexity. That's a post for another time.

Estate Planning During Economic Catastrophe

I'm not an alarmist, but like you, loyal readers, I'm a little freaked by all the economic news. On the TV last night I watched esteemed economics professors using phrases like "classic bank run." And this was on News Hour on PBS!

So, what does this have to do with estate planning? Well, during times like this, you might be inclined to put your estate plan on the back burner. Don't. Here's why: your need for an estate plan doesn't go away because of economic uncertainty. If you don't have a plan, you should still get one. If you do have a plan that is out of date, you should still get it updated.

The fact is that estate plans can be expensive, and during times like these, you probably want to hang on to as much cash as you can for security. Here are some tips for keeping as much of that cash as possible, while still getting a plan in place:

Get a Will Instead of a Trust

Estate planning attorneys like to recommend trusts because they are more flexible than wills, they avoid probate (which can be expensive, time consuming, and is a public court record), and they can be set up to assist you if you become incapacitated. Because they can do so much more than a will, they are much more complicated documents. Because they are much more complicated documents, they are more expensive to prepare. If you want an estate plan, but cannot afford a living trust, a will might do for now. Let's look at the following scenario:

A married couple in their late 30s with two children under the age of 5. They own their own home worth about $550,000 (titled as community property), each have about $100,000 in separate 410(k) plans from current and previous employers, and each have $500,000 life insurance policies with 30-year terms naming the other as beneficiaries. They also have about $35,000 in checking and savings accounts. All of their assets are in California and are community property.

In a perfect world, an estate planner would recommend a living trust that is split into two trusts on the death of the first spouse (one for the surviving spouse, and another funded with the deceased spouse's estate that bypasses the surviving spouse to ensure something for the children), and trust for the children that will pay the money outright to them when they turn 25 or graduate from college. Such a plan would avoid probate, would ensure that there is some money to be inherited by the children when the surviving spouse dies, and would ensure that they children don't get the money before they are ready to handle it. In the world of living trusts, this is a more simple plan, but it is still a pretty complex document. It can also be very expensive to prepare.

Can you achieve the same result with a will? Not really, but you can come close. With the wills, you can create a trust with your estate, but you cannot split the estate into two trusts on the death of the first spouse. Because the assets are all community property each spouse's estate is half of each asset. That becomes tough to split when it is not held in cash (like the house). Although each spouse could leave their estate to their children in trust (rather than to each other), it would likely result in the liquidating of the estate assets in order to properly fund the trust. Since the surviving spouse would probably want to stay in the house, each spouse should give their estate to the other spouse. The house would automatically transfer to the surviving spouse because it is titled as community property. The surviving spouse would receive the insurance proceeds and 401(k) as beneficiary.

Their might not necessarily be a probate on the death of the first spouse. Assets held jointly (like the house) do not go through probate. Assets with beneficiary designations (like the life insurance and the 401(k)s) also don't go through probate. If a person's probate estate is less than $100,000, then probate can be avoided. Here, the actual assets subject to probate are less than $100,000, so probate can be avoided on the death of the first spouse. (The surviving spouse will probably not be able to avoid probate because the house will no longer be held jointly, and the proceeds from the life insurance will be held by the surviving spouse alone.)

To keep the will-based plan as simple as possible, they could leave their estates to each other, and if their spouse does not survive them to their children in a California Uniform Transfers to Minors Act (CUTMA) account. This holds the money in an account, and distributes the money to them outright when they reach an age between 18 and 25. The will can also name guardians for their children while they are still minors. They can execute durable powers of attorney for financial decisions in the event they become incapacitated, and advance health care directives for their medical decisions.

This is much more simple, and less expensive, to prepare than a living trust. It has some drawbacks, but it is far better than no plan at all.

If you are considering an estate plan, but are uncomfortable with the expense of getting a living trust, a will may be a good alternative. Once the ecomony picks up, and you feel better about spending the money on your estate plan, it can always be amended to include a trust.

Don't let economic uncertainty keep you from putting together that you know you should have.

Witness Requirement for California Wills relaxed

Wills are relics of an ancient era, and the laws surrounding them are often incompatible with our modern world, and sometimes internally inconsistent. For example, if you print out your will from a computer or pre-printed form, it must be signed by you and two other people, who either saw you sign the will or can acknowledge your signature, and who know that the document they are signing is your will. You can also handwrite your own will. If you do, then you don't need anyone to witness your signature. Also, if you execute a living trust, your signature doesn't necessarily need to be witnessed by anyone in order be valid. Why is the law so much more strict for pre-printed wills?

The State of California recently took steps to make my rhetorical question moot. On July 1, 2008 Governor Schwarzenegger (I am never going to get used to that) signed into law a revision of Probate Code section 6110 relxing the formal witnessing requirements of a pre-printed will. In the latest issue of the California Trust and Estates Quarterly, published by the State Bar of California's Trust and Estates section, Silvio Reggiardo III writes about the changes. Basically, a pre-printed will no longer has to be signed by two witnesses in order to be valid, if the person trying to enforce the will (usually the executor) can show by clear and convincing evidence that the person who wrote the will intended that the document be their will despite the lack of witness signatures.

Here's how it would work: Joe prints out a will using a pre-printed will drafting program. He signs it, but no one signs the will as a witnesses, even though two if his friends saw him sign the will. Joe dies, and the executor of the will submits the will to the court for probate. The executor presents the evidence from the two friends who saw Joe sign the will, and there is no evidence of any other document that was intended to act as Joe's will. It is up to the judge to determine whether this meets the "clear and convincing evidence" standard, which is greater than the "preponderance of the evidence" standard used in civil courts, but less than the "beyond a shadow of a doubt" standard in criminal courts. If the judge decides that the evidentiary standard is not met, then the will is not valid, and Joe's estate is distributed per California law applying to people who die without a will.

While this change in the law helps modernize will execution standards, it is still more onerous than the standard for executing a trust. This is yet another reason why a living trust is superior to a will. Trusts are much more flexible, and are less likely to be invalidated on arcane technical grounds.

Be Careful with Mediation Confidentiality

Mediation of disputes in the world of Trusts and Estates is not as common as it is in civil litigation generally. Nevertheless, it can be very useful in settling things among beneficiaries, or between beneficiaries and trustees, or among heirs and executors.

In California, documents prepared during a mediation are confidential, except when they are not. The default is to protect these documents from disclosure in litigation in order to foster more open discussion, but this confidentiality can be waived.

Whether the children of Thresiamma Thottam waived this confidentiality was the Estate of Thottam matter. The children disputed the division of property after the death of their mother. They agreed to mediate the matter, and signed an agreement that protected the confidentiality of proceedings "except as may be necessary to enforce any agreements resulting from the Meeting."

During the mediation, a chart was prepared showing an allocation of the assets of the mother's trust. The children all initialed the chart. Afterwards, disputes arose over the language of the settlement agreement memorializing the distribution and incorporating a copy of the chart. One child sued the other two for breach of the settlement agreement. The other children filed motions to keep the chart out of evidence, claiming that it was confidential under California. The trial court agreed, but the court of appeal did not, and reversed the trial court's decision.

The court of appeal held that California law provides an exception to mediation confidentiality where all parties agree in writing to waive it. The court found that the agreement the parties signed waiving confidentiality where necessary to enforce any agreements resulting from the meeting constituted a valid waiver under California law. They also held that the chart initialed by all parties was just such an agreement, although they did not rule on whether the chart was enforceable.

I think there are two important lessons from this case. First, remember that by law, all writings in a mediation are confidential. Be careful not to sign anything that could constitute a waiver of this confidentiality if you want to make sure that what happens in the mediation stays in the mediation. Second, if you come to a settlement, make sure that the document memorializing the settlement is clear and unambiguous. Even though the court did not rule on whether the chart in this case was enforceable, it frightens me to think that a chart, with no terms and nothing other than initials of the children, can be used as evidence of a settlement.

Legal documents sometimes seem pointlessly long and detailed. But there is often a very good reason for it.

Keep Your Special Needs Trust Up to Date When You Move!

Remember your Special Needs Trust when you or your child with special needs moves. Kevin Urbatsch, a special needs trust attorney in San Francisco, relates this article that gives useful information for people on the move who have special needs trusts.

While most benefits for those with special needs are federal, many are provided by the state (such as Medi-Cal). If you move to another state, you will need to re-visit the process of getting state-specific benefits. If you have a special needs trust that deals with the state benefits, the trust will need to be changed to reflect the new state benefits.

Thanks to Mr. Urbatsch for this useful info.

Recent Case Law Update

This is something I haven't done much of, but I think is important. So here goes.

California Antideficiency Statute Does Not Apply to "True" Guarantors

California passed antideficiency statutes during the Depression. They are codified in California Code of Civil Procedure sections 580a, 580b, 580d and 726. The law basically says that if you go into default on your home mortgage, for example, and the bank sells the property in a foreclosure sale for less than what you own on the mortgage, the bank cannot get a judgment against you personally for the difference (or "deficiency").

William and Janyce Hustwitt were guarantors of a loan to their irrevocable Investment Trust, secured by a trust deed for certain real property in Newport Beach, California. The Trust defaulted and the lender, which was actually another trust, foreclosed on the property. The lender sold the property for about $388,000 less than what was owed on the loan, and then sued the Hustwitts for the deficiency under their guaranty agreements. The trial court awarded the deficiency amount, plus interest, to the lender.

The Hustwitts appealed on the grounds that the antideficiency law applies to guarantors, and that in any event they were not "true"guarantors because they were too closely related to the debtor (which was their Investment Trust) as beneficiaries and trustees of the trust.

The appeals court didn't buy it. California law is clear that the antideficiency statute does not apply to guarantors. The antideficiency statute is intended to protect debtors. A guarantor is a separate and independent obligation from that of a debtor. The antideficiency laws do not protect the guarantors.

The appeals court also didn't buy the Hustwitt's argument that they were not "true" guarantors. Sometimes a debtor (or "principal obligor") will take on additional liability as a guarantor of the debt. Courts in California have held that this does not create any additional obligation on the part of the debtor, and that they are therefore not "true" guarantors. Thus, the antideficiency statutes would still apply, and the fact that the debtor is also a guarantor is irrelevant.

Here, the Investment Trust that held the property was an irrevocable trust with a corporate trustee. Although the Hustwitts were the settlors of the trust, they were only secondary, and not primary beneficiaries. The court held that this arrangement removed them from personal liability for the trust's obligations, and also limited their beneficial enjoyment of the property. The court concluded that they were "true" guarantors, and that the antideficiency statute did not apply.

The upshot of this case is that, although irrevocable trusts are a great tool for limiting your liability in and exposure to certain downsides, they are not a "get out of jail free" card. You cannot have it both ways - being protected from the liability of an obligor while taking advantage of certain protections afforded an obligor.

The case is Talbott v. Hustwitt and it was decided in the Fourth Appellate District of California (Orange County). You can read the entire decision here.

Valuation of Special Assets

I have been away in New York City for the past week (which explains my posting gap). While my wife and I were there, we had the good fortune to stay with some close friends. Our friends Joel Moskowitz and Sally Bernstein live in the Gramercy Park section of Manhattan. Joel owns his own business designing and selling hand tools for woodworking (check out www.toolsforworkingwood.com), and is an avid collector of rare books about woodworking and antique tools. We got to talking about the value of his collections, and I suggested that, in a typical estate administration, such a collection would be valued by an appraiser or an auction house when determining the value of the estate.

Joel was adamant that a typical appraiser or auctioneer wouldn't know the first thing about the true value of the rarest books or tools in his collection, and wouldn't value them correctly. And he's right. For most of the ordinary things people own (cars, clothing, furniture), a typical appraiser would be appropriate to value the estate. But what do you do with the book about woodworking from the early 19th century, of which there are only three or four copies in the whole world? Chances are the typical appraiser wouldn't even recognize the rarity of the book, much less be able to appraise it properly.

Joel's concerns point out a not-too-rare challenge in estate planning. If you have any kind of special asset, such as a collection of rare items, or anything that is unusual or difficult to value, it is critical to specifically identify it, and to name appraisers and others who could properly value it. As estate planning attorneys, it is our job to make sure that any special assets have been properly identified and that their valuation and disposition is properly accounted for. Things to think about when you are listing the items you own are:

• What special collections (such as coins, books, antiques) do I have?
• Are there any rare or unusual items that I have inherited or have been given as a gift?
• Are there any other special assets in my estate (such as mineral rights or copyrights)?
• Who do I know is an expert in valuing these assets?
• If I don't know any experts in valuation, who do I know who can at least know and understand the rarity of the asset?
  

For most special assets, particularly financial ones such as mineral rights or copyrights, your estate planning attorney can find an expert to value them. But for obscure and unusual items, you may know exactly who should be valuing them. My friend Joel knew the names of three people whom he trusts to properly value the rare books in his collection. If you know those people, make sure you identify them to your attorney, so that the valuation can be done accurately. As practitioners, it is our job to identify special assets, and to ask the client about assets we are unfamiliar with.

I don't mean to knock most appraisers, who are hard working and knowledgeable, and would in most cases at least know they are looking at a rare or unusual item, and would know to call in an expert. But why take that chance? They might now know the same experts you do. If you know someone whom you trust to value your collection, you should make sure to tell your estate planning attorney.

Good estate planning relies on good information. Getting it and providing it are the responsibilities of both the attorney and the client.

Investing Prudently Amid Turmoil

Regardless of how a trust is structured, a trustee has a fiduciary duty to invest the trust assets. With all the chaos in the markets these days (look here for the gloom), a trustee may be inclined to look at their mattress as the safest investment vehicle. As any student of the markets knows, however, there are always opportunities amid the crises.

Take stocks, for example. While the Dow has dropped about 10% from its all-time high of 14,279.96 on October 11, 2007, it is only down 2.4% from where it was a year ago. And the U.S. isn't the only place to invest money. European stocks have been pounded over the past year, but the markets in South America, South Africa, Hong Kong, Indonesia and India have all performed very well (this doesn't however take into consideration any erosion of returns cause by the declining dollar, which is another float in the parade of horribles).

Commodities, which include oil, corn and gold, are almost universally way up. It's impossible to know when anything is at the top of its price, but I think it is safe to say that the current upward price pressure cannot last much longer. Once the prices get too high, demand will fall off, and the prices will begin to drop. There is already some indication that demand for gasoline, which is comfortably over $4.00 a gallon here in California and is the only reason anyone cares about the price of oil, is beginning to fall. Commodities such as corn, soy and other food crops will probably be the object of government intervention at some point if their prices don't level off, and there is some amount of speculation built into their price because of their potential as an alternative to oil as a fuel source.

What is a trustee to do? Don't panic, you are a trustee after all. Look to the professionals. Ask your financial advisor for help. If you don't have one, get one. Make sure the trust allows you to hire an advisor and to pay them out of the proceeds of the trust. It's part of your job as a trustee.

I could go on about how and where to look for opportunities. They are out there. If you are a fiduciary, it is important to surround yourself with a trusted financial advisor who can help navigate these waters, which seem filled with sharks, icebergs, alligators, and what have you.

The mattress is never as good as it looks, anyway.

Living Trusts

S0-called living trusts are in vogue as will substitutes these days. In legal speak, they are known as inter vivos trusts, but they are also known as grantor trusts and revocable trusts. Since the purpose of this blog is to discuss estate planning issues in plain language, we'll just call them living trusts.

So just what is a living trust?

A trust is a set of instructions among three parties related to the use of property for a period of time. The person who places the property into (or "funds") the trust is known as the grantor, or trustor. The person who administers the trust, i.e., who carries out the instructions of the trust, is the trustee. The person who gets the benefit of the trust is the beneficiary.

In a living trust, these three roles are usually played by the same person. By doing this, you could place your assets into the living trust, carry out the instructions of the trust (including selling the assets in the trust or adding new assets, or revoking the trust entirely) and enjoy the use of the assets. In other words, after funding the trust with your assets, life pretty much goes on as it did before.

So why would anyone want a living trust?

What happens to the living trust during your lifetime is only the first half of story. The second half is related to what happens when you die. The living trust document contains instructions for what to do with the property in the trust when you die. This includes naming someone to carry out the instructions (known as the successor trustee) of the living trust, and a new beneficiary (or beneficiaries) who get to use the trust property (known as successor beneficiaries).

If that sounds a little like what a will does, it is. The big difference between a living trust and a will is that a living trust does not go through probate. Probate is a court-supervised proceeding where your estate is gathered and distributed among your heirs. Since it is a court proceeding, it is public, and all documents, including your will, become public record. A living trust, on the other hand, does not go through probate. It is administered by the successor trustee, and the assets in the trust are distributed per your instructions. Since a trust doesn't go through the probate process, it does not incur the fees involved in a probate. Probate fees and attorney's fees are set by statute, and depend on the amount of your estate. In California, probate fees are four percent of the first $100,000; then three percent of the next $100,000; two percent of the next $800,000; one percent of the next $9,000,000; one-half of one percent of the next $15,000,000; and a reasonable amount determined by the court for amounts above $25,000,000. Attorney's fees are based on the same schedule and are in addition to the probate fees.

If you have a large estate, your probate fees could be pretty high. For example, if you had a $400,000 estate, the probate and attorney's fees would be $22,000. In contrast, a relatively simple living trust would still incur costs to administer after your death, but they should be much less than $22,000.

Another issue is time. Probate is subject to the timing of the court, which can take six months to a year or longer depending on the court's backlog and the complexity of administering the estate. The relatively simple $400,000 trust should be administered in six months or less.

So Why Would Anyone Not Want a Living Trust?

If you have a small estate, say less than $100,000, then a living trust may not be advantageous. California law allows for summary procedures for estates valued at less than $100,000, and in some cases, probate can be avoided altogether. So if your estate is less than $100,000, the only potential disadvantage to going to through probate is its public nature. If you are OK with that, then there really is no need for a living trust.

Living Trusts are something everyone should consider, particularly if you have a large estate that would result in an expensive, lengthy probate proceeding. If, on the other hand, your estate is $100,000 or less, and you're not concerned about it becoming public record, a living trust is probably unnecessary.

In my next post, I will talk about wills, and why you need one in your estate plan even if you do have a living trust.