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So far Craig R. Hersch has created 15 blog entries.

Don’t Major in “Pre-Law”

The Dartmouth college newspaper recently reported that in 2014, 120,000 students matriculated into law schools, which is the smallest class since 1987 and a 7% decline from 2013. This is likely a reflection of the oversupply of lawyers throughout the country. Yet there are many who still aspire to the degree.

Since I now have two college-aged daughters, I am often asked by their friends (who one day hope to become lawyers) whether they should, as an undergraduate in college, major in pre-law.

I always tell them “No!”

Before being accepted into and attending law school in the United States, one must first earn an undergraduate degree. The degree can be in anything, so long as it is earned at an accredited institution. Many colleges and universities now offer a “pre-law” curriculum designed to attract undergraduate students who plan to attend law school.

I advise against an undergraduate degree in pre-law because I believe that it doesn’t provide a solid foundation in a base knowledge that is necessary to become a better practicing lawyer. Further, I believe that a pre-law degree doesn’t give the student any more than what he or she will learn during their first year of law school. A pre-law major, for example, will likely take courses in introductory research, writing and reasoning classes, philosophy of law and courses covering the makeup of our government and constitutional systems.

First year law students get all of that and more as they are required to complete courses in contracts, torts, jurisprudence (history of the law), research and writing, constitutional, criminal, civil procedure, and property law. The second and third year of law school allows the student to take “electives” where they can learn certain specialty areas, which is very important today, since law, like most occupations is highly specialized.

You don’t find many “general practitioners” any more, as most attorneys concentrate their practices in one field or another such as estate planning, tax, real estate, business organizations, civil litigation, intellectual property, and family practice.

If one wants to become a tax or estate planning attorney, for example, it would be far better as an undergraduate to major in accounting or business so that the student will have a frame of reference for the complex income, gift, estate, business, and trust laws that they will encounter in practice. Many attorneys who practice intellectual property law (patents, trademarks and copyrights) have an engineering degree which helps them understand the complexities of their clients’ inventions. One of my law school classmates was a physician who went into medical malpractice law.

Other undergraduate majors that aren’t occupational specific serve better than pre-law in the lead in to law school. English and literature majors, for example, become proficient in reading, analyzing and expressing thoughts through superior written communication skills. Some of my classmates who were tapped to write for the prestigious Florida Law Review were English majors as undergrads.

The problem with what I am recommending is that it asks an eighteen or nineteen year old not only to commit to a path that leads to law school, but also to commit to a specific type of law. Most young people coming out of high school have no idea where their career interests may lie.

One good way to look at obtaining an undergraduate degree that provides certain definable skills is that if the individual changes their mind about going to law school, at least they will have a solid undergraduate degree in something worthwhile. Where is a pre-law degree going to take you if you either can’t get into law school or don’t want to go after your undergraduate years? Perhaps it would be a good background to work as a paralegal or in law enforcement, so if that’s your fall back, then that could work.

A varied undergraduate degree will also help the student land their first job. As an estate planning lawyer, when I am looking to add an associate lawyer in my office I’ll likely look for a candidate who has an accounting or business background. In my field of work, I feel that a candidate with such a background will likely hit the ground running faster than someone with a pre-law undergraduate degree.

Equally important to the undergraduate degree is the course work that the student selects in their second and third years of law school. Most law schools offer a wide variety of electives for the second and third years, allowing students to specialize their education into a given field.

There are many choices out there. If one is crazy enough to want to earn a law degree and then go out and practice law, I hope that I have provided some valuable insight.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

The Importance of a Pre-Need Guardian Document

“Howard” was the son of his father, “Jeffrey,” who had been diagnosed with early stage Alzheimer’s disease. Jeffrey had been widowed several years earlier, but was seeing a woman who Howard believed to be a gold digger.

Howard was sitting in a chair in my conference room. His father wasn’t present.

“I don’t want to appear that I’m just here in an effort to protect my inheritance,” Howard began, “but I’m really worried. I hear that she’s asked Dad to transfer the home to her along with a lot of his investment accounts. She’s promised to take care of Dad for the rest of his life if he does this. I tried to warn him but he isn’t thinking rationally. He voluntarily resigned as trustee of his own trust some time ago, and I’m acting as a trustee. So if I’m in that position, can Dad still make these transfers?”

“I believe that he can,” I answered. “Although he’s not the trustee of the trust any longer, he retains the right to amend and revoke it. He can theoretically pull the money out of the trust and gift it to her. As far as the house, there’s no reason that he can’t sign a deed transferring it to her as well.”

“But he’s incompetent!” Howard said. “That’s why we took him off the trust – we have a diagnosis from the doctor that effectively removed Dad from remaining as his own trustee.”

“For purposes of the trust instrument he is incompetent,” I said, “Except legally he has never been declared incompetent by a court of law. So his signature still means something.”

“Can’t we just challenge any transfer that he makes based upon the fact that he has Alzheimer’s?” Howard asked.

“You can – but then you’re trying to get something back that he’s already transferred. That could be very difficult, time consuming and expensive. And, if he happens to marry this woman, she may have legal rights to his home and to a portion of all of his other assets without him making any transfers at all. Spouses have all sorts of rights under most state laws, including Florida’s.”

“So how do we prevent this from happening?” Howard said, exasperated at the thought.

“You need to have him declared incompetent in a guardianship court – before he makes any transfers or marries this woman. This would be an adversarial process, and the Judge is going to be reluctant to adjudicate your father incompetent, as it takes away most of his legal rights to act on behalf of himself. He couldn’t sign a marriage license, for example, if he was adjudicated incompetent. He couldn’t sign a transfer form for any of his accounts. But you should know that the court will appoint an independent attorney to represent him in this action.”

“Sounds rough,” Howard said.

“Yes, it’s serious,” I replied. “But you should know that your father did sign, as a part of his estate planning package, a pre-need guardian document that names you as his guardian. This is good news. Suppose, for example that this woman tried to become your father’s guardian. He already signed a document while he was competent that appoints you as the person he has confidence in to serve in this role.”

“What if Dad didn’t have that paper?”

“Well, almost anyone who claims to be interested in your father and his affairs could try to become his guardian. Then a judge must decide who really has his best interests at heart. Your father’s signature on a pre-need guardian document should carry a lot of weight with the court.”

This case (names and facts have been changed to protect confidentiality) illustrates the importance of deciding, ahead of time, who should act as your guardian in the event that it becomes necessary to adjudicate you incompetent to protect you from yourself. Once that decision has been made, it is vital to sign a pre-need guardian document.

You might suspect that having a revocable trust or a durable power of attorney will avoid the guardianship process, and in most cases you would be right. It’s not usual for someone to want to transfer away their assets once they have ceded the authority of their day to day financial lives to someone else. Unfortunately, there are predators out there who view elderly people with wealth as “easy prey.” When this occurs, an adjudication of incompetency might be the only means to prevent a financial disaster from happening.

This is just another question that you may want to ask of your estate planning attorney.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

How are Gift and Estate Taxes Related?

I’m often asked how the gift tax rules and the estate tax rules relate to one another. Gift and estate taxes are known as “transfer” taxes, based upon the value of assets being transferred from one person to another.

The federal tax system entitles each of us to a $5.43 million lifetime exemption from gift and estate taxes. This exemption can be consumed during your lifetime, and any unused exemption may be applied at your death. So assume that I own a commercial office building worth $5 million and transfer that office building to a family partnership owned by my three daughters. I have consumed $5 million of my lifetime exemption against gift and estate taxes, leaving me with only $430,000 of exemption to be applied at the time of my death. If, at the time of my death, my will bequeathed another $2 million of assets to my three daughters, then an estate tax would be due from my estate since I have made total transfers of $7 million against my lifetime exemption of $5.43 million.

The estate tax is paid before the additional transfers are made, so my daughters would receive a net inheritance after the tax is calculated and paid. The federal estate tax return actually “adds back” prior taxable gifts to compute the amount of gross estate tax owed. The net estate tax equals the tax on the taxable estate (lifetime taxable gifts plus gross estate value at death) less the total amount of exemption available at the time of the death.

You may have noticed that I referred to “taxable gifts.” Certain gift transfers that are made during your lifetime do not reduce the gift/estate tax exemption available to you. The first is an “annual exclusion” gift. You may gift up to $14,000 annually to anyone that you want, and not have that gift counted towards your lifetime exemption. You may also gift unlimited amounts for someone’s health or education, provided that you make the gift directly to the medical care provider, or the educational institution respectively.

My daughter Gabrielle attends Brandeis University. I can gift Gabi $14,000 annually (as can my wife) so she can receive gift tax free transfers from both of us in the amount of $28,000 without anyone having to report the gift on a Federal Gift Tax Return Form 709. Even if the entire $28,000 was paid from my personal checking account, so long as Patti and I timely file a Federal Gift Tax Return where we elect to “split the gift,” no part of the gift will be deemed taxable, meaning that we will not reduce our federal estate and gift tax exemptions. These annual exclusion gifts must be “present interest” gifts, meaning that they have to be currently available to the recipient rather than being restricted in any way, such as contributed to a trust that the recipient has no access to.

In addition to the annual exclusion gifts to Gabi, my wife and I can also pay Gabi’s tuition at Brandeis, so long as we write the check directly to the University. I can also pay Gabi’s health insurance premiums, doctor bills and prescriptions, so long as I don’t give her the money to pay those expenses and I pay them directly myself. None of those gifts should reduce our lifetime exemption.

Spouses can transfer unlimited amounts between themselves, both during their lifetimes and at their deaths and not incur any transfer taxes, so long as both are United States citizens. Bill Gates can transfer his entire fortune to Melinda without incurring any transfer taxes.

You can probably determine that it’s important for your estate tax attorney to both know, and have copies of, any taxable lifetime transfers. This can be readily accomplished by providing your estate attorney copies of all prior Federal Gift Tax Return Form 709s filed with the IRS. Without this information, your attorney may assume that you have not made any lifetime transfers, and the estate plan recommended for you might not be proper.

Further, if you have made lifetime transfers that haven’t been reported, you should meet with your attorney and/or CPA to discuss filing a late return. When one files a Federal Gift Tax Return, the IRS generally has three years in which to challenge the return. When transfers are made of hard to value assets like real estate or business interests, the IRS isn’t shy about challenging the value and assessing back taxes, interest and penalties. Failure to file a return opens the door at the donor’s death for the IRS to go back in time and make assessments.

It’s always a good idea to discuss these issues with your tax professionals.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Different Baskets

When choosing how to approach your estate plan, it’s important to realize that the different types of assets that you own have different legal and tax treatments. The way that I most often explain it is to consider them grouped into separate baskets, and then deciding how you want your estate plan to distribute each type of basket.

The first basket consists of your Florida homestead. Florida law limits what you can do with your homestead in your estate plan. If you are married, for example, and do not have a nuptial agreement with your spouse, then you must bequeath your homestead in fee simple to your spouse. You cannot bequeath a life estate interest or put your homestead in some kind of a trust that benefits your spouse for life and then distributes it to others. If you do, then you have an invalid devise. I’ve written other columns on this topic before. If your plan involves bequeathing your homestead other than outright to your spouse, then this basket needs attention – and likely will need at least a limited nuptial agreement dealing with this issue.

The second basket consists of your IRA, 401(k), pension and profit sharing plans (“Qualified Retirement Accounts”). Here, whomever you leave these accounts to will have income tax liability associated with any withdrawals, just as you presently recognize taxable income (unless you have Roth accounts) when you take distributions. While a spouse is the only beneficiary who can “rollover” the account into his or her own account, non-spouse beneficiaries will have Required Minimum Distributions (RMDs) upon receiving an inherited IRA, regardless of their age. If a minor is named as a beneficiary, a court process will also be required without proper planning. Moreover, if you name a trust as the beneficiary of this kind of account, income taxes may be accelerated without proper planning.

The third basket consists of stocks, bonds, mutual funds, cash and bank accounts that are not Qualified Retirement Accounts. These assets receive a step-up in tax cost basis at the death of the account owner, meaning that unrealized capital gains are usually eliminated. These types of accounts have the fewest restrictions on how you can bequeath them in your estate plan.

The fourth basket consists of closely held business interests. These assets aren’t easily disposed of, as they are not traded on any stock exchange. Moreover, you may have other family members or third parties involved in the business or entity. There may be a shareholder, partnership or membership agreement that either restricts the disposition, or requires that the interest first be offered to the other shareholders at death. In the case of “S” Corporation stock, there are important elections that must be made within a certain time period after the death of the owner, and the type of beneficiary is restricted under federal tax law.

The fifth basket consists of annuities and life insurance policies, which have beneficiary designations. Annuities are similar to Qualified Retirement Accounts because the beneficiary will usually recognize taxable income when receiving distributions. Wills and trusts generally do not govern the disposition of these assets unless they are named in the beneficiary designation. Trusts named as beneficiaries of annuities may incur higher income taxes than direct beneficiaries due to their compressed federal income tax rate structure.

The sixth basket consists of real estate that is not your Florida homestead. There may be inheritance taxes associated with this asset if it is owned in a state that imposes such taxes. Commercial real estate may be held in the form of a corporation, partnership or LLC discussed above. The ongoing management of this asset should be considered in your estate plan.

Yet another basket might be a trust in which you are a beneficiary and possess a “power of appointment” that would allow you to alter its disposition from the default provision in the governing document, which might be a parent’s will or trust. Your attorney should determine whether you have a power of appointment, whether it is limited in any way, and whether the value of the trust will be considered taxable in your estate for federal estate tax purposes.

There may be other baskets in any individual plan. So as you can see, when planning your estate, all of the different baskets should be considered, along with their unique legal and tax consequences. Failure to consider the intricacies of each type of asset might result in missing planning opportunities or in unintended adverse results.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Trust Administration

Note: This is an edited excerpt from Craig’s recently published book – Legal Matters When a Loved One Dies – available on amazon.com

There’s much confusion for family members when a loved one dies with a revocable trust. Often they believe that the successor trustee can simply wrap things up and distribute the trust assets right away. That’s not the case. When all or some part of the decedent’s assets are held in a revocable trust at the time of his or her death, then the successor trustee has many of the same duties that the personal representative has when probating a will, as I described in last week’s column.

Simply said, whoever is serving as trustee must, under Florida law:
1. Marshal the assets of trust—change title of the accounts from the decedent as the original trustee of the trust to whomever is acting as trustee of the administrative trust;
2. Obtain date of death values of the trust assets;
3. Preserve the trust assets (prudent investor rule) during the trust administration;
4. Ensure that all of the decedent’s creditors are paid;
5. File all necessary tax returns and ensure that taxes are paid;
6. Prepare and file accountings to the beneficiaries; and
7. Make distribution to the beneficiaries or establish the testamentary trusts (Chapters Eleven & Twelve) created under the terms of the trust.

The difference between the personal representative duties in a probate administration and a trustee’s duties in a trust administration is that the probate administration is overseen by a court of law. It is a public process that must await a judge’s order to act.

Determining the most recent (and therefore governing) trust document and any amendments is different. Recall my “Uncle Ed” story last week where the probate court ruled which of Uncle Ed’s wills and codicils controlled the disposition of his estate assets. In a trust administration, the trustee must have confidence that she is operating with the most recent document. That is why it is important for the trustee (through her attorney) to forward what she believes to be the most recent documents to all interested parties. This gives all the right to present any other trust document that may amend or otherwise conflict with the documents that the trustee is aware of.

If the trustee and any other party can’t agree which of the decedent’s documents control, then the trustee is likely to institute a civil court action to determine the proper beneficiaries.

The person named as trustee next accepts the office by signing an acceptance document that is filed with the probate court. Because a probate may not be necessary, Florida law provides that this public document puts everyone on notice that there is a trust with assets—and provides the trustee’s contact information as well as that of her attorney.

Another significant difference regards clearing the decedent’s creditors. The probate process has a definite time period (three months) under which a creditor must file a claim against the estate. Once all of the creditors are cleared, then the personal representative is free to make final distribution without fear of having to satisfy a creditor claim out of his own pocket.

The statutory time limit in a trust administration, in contrast, is two (2) years under Florida law. Florida’s trust administration statutes do not contain a corresponding legal function to clear creditors in a relatively short 90-day period as exists under Florida’s Probate Code. The Probate Code also contains provisions to deal with creditor disputes through its objection to creditor claims statutes. Florida’s trust administration statutes do not provide the same type of laws.

So what is a trustee to do? If he makes final distribution before the two-year window expires, then he could have to come out of pocket to satisfy a creditor. One answer is to open an “empty probate” simply to clear creditors in a 90-day window. By “empty probate” I mean that the probate proceeding is opened only to use the Probate Rules to ensure that all creditors have had “due process” to make a claim against the estate. It’s not as onerous as a regular full probate because the court doesn’t have any jurisdiction over the trust assets. The probate inventory is zero, as all of the assets are held in the trust. Another option is to hold some assets in a reserve fund until the two-year window closes.

After filing the necessary tax returns and either making payment of or reserving sufficient funds for taxes, the trustee must work to prepare accountings to the beneficiaries, and eventually make distribution of the assets.

Revocable trusts commonly contain testamentary trusts that benefit the surviving spouse for the rest of his or her life (marital trust) or a continuing trust for children or other family members. Here, the trustee will transfer the assets from the administrative trust to the trustee of the continuing trusts.

Since there is no court to discharge a trustee like there is in a probate to discharge a personal representative from liability, it is important for the trustee to obtain consents and waivers from the trust beneficiaries indicating that they have had the opportunity to review the trust, to verify the trust inventory, and to approve or waive any objection to the accounting.

One final comment—sometimes there are assets in the trust as well as in the decedent’s name individually. When this happens, you have a simultaneous probate and trust administration. This isn’t the best situation, and usually happens because a revocable trust was only partially funded during the grantor’s lifetime. Here, there are laws that serve to coordinate the actions of the trustee and the personal representative. Often these are the same individuals, but there are different notice and accounting rules when they are not. The attorney’s expertise is vital in this situation to help guide the process.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

What is Probate?

Note: This is an excerpt from Craig’s recently published book – Legal Matters When a Loved One Dies – available on Amazon.com

Many people who visit with me in my office are under the misimpression that all Wills avoid probate. False. Some people believe that if their estate is less than whatever the federal estate tax exemption is (In 2015 the exemption is $5.43 million), then there won’t be a probate. That’s false too.

Almost any asset that is subject to disposition by your loved one’s Will is actually distributed by the probate process. Understanding what probate means, then, is crucial to understanding these issues.

Probate is a legal process under which the deceased’s assets are transferred to their beneficiaries. The Last Will is filed with the probate court in the state and county in which the decedent resided at the time of his or her passing. This is known as the “domiciliary estate.” The personal representative (executor) in the Will petitions the court for “Letters of Administration,” which gives the personal representative the authority to transact business on the estate’s individually held accounts.

It does not matter whether bank and brokerage accounts are held in the same state in which the probate is opened. A bank account in New York, for example, is governed by the probate court in Florida.

If, however, the decedent owned real property in his or her individual name in another state, then an “ancillary probate administration” must usually be opened in that state. If the real estate is held in a trust, corporation, partnership, LLC, or in joint name, then the ancillary administration is usually not necessary.

Why is probate necessary? It’s not just for attorneys to make fees, as many might expect. The probate process actually “protects” both the beneficiaries of your estate, as well as any potential creditors and of course, the taxing authorities.

Imagine that there was no probate process. Suppose in a codicil to his Will your Uncle Ed left you his entire estate. But what if Uncle Ed dies and your cousin brings a copy of his old Will into the bank naming cousin as the beneficiary, and cousin demands that Uncle’s accounts be distributed to him pursuant to the Will? How does the bank know that this is really Uncle Ed’s Last Will? What if your cousin beat you to the bank and you didn’t realize it? What recourse would you have once the bank distributed to your cousin? The probate process protects against just this scenario and many others.

If you submit a Will as the Last Will of Uncle Ed to the court, and someone else submits a codicil to the Will to the same court, now we have a centralized system that can ensure Uncle Ed’s wishes are carried out. The personal representative marshals all of the assets of the deceased and files an inventory with the court so all interested parties can determine in full light what the estate is worth. They can also question if the inventory is complete or may be missing assets.

Florida law provides that creditors have three months from the date of “notice of publication” of the probate administration to file a valid claim against the estate. There are laws that deal with creditors, how they are to make claims, and how the personal representative may object to any such claim. The personal representative actually has a duty to notify reasonably known creditors of the administration.

Once all of the creditor claims have either been dealt with and all tax clearances have been obtained, the personal representative submits an accounting of the estate to the court. All of the income and expenses are listed, as are items of capital gain and loss. The personal representative presents a schedule of proposed distributions pursuant to the terms of the Will.

The distributions may be to beneficiaries, to trustees of testamentary (after death or continuing) trusts established under the terms of the will or, in the case of a pour-over will (a will that distributes all assets into a revocable living trust), distribute the probate assets to the decedent’s trust.

All of the beneficiaries have the chance to object to any item listed in these petitions, and can appear before the court. A judge decides if any objection has merit.

Once all of the distributions have been made, the personal representative petitions to close the estate and be discharged from further obligations as a fiduciary for the estate. Receipts of distributions are filed with the court at this time.

So as you can see, probate is actually a strictly supervised court (public) process. It is very hard for any “monkey business” to get by a judge. In a future column I’ll compare this process to a trust administration – which is necessary when all assets are owned by a revocable living trust.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

What is Income?

Back when I was a sophomore at the University of Florida (32 years ago!) during one of the first meetings of my introductory accounting course, the professor (Dr. Garvin) asked what we all thought was a stupid question.

“What is income?” She asked.

“When you earn money, that’s income,” one student said.

“Interest and dividends,” another shouted out.

“When you sell something you get income,” yet another offered.

“Yes and no,” Professor Garvin replied.

“Huh?!” we all exclaimed.

“If we don’t report those items on our tax return won’t the IRS penalize us?” I asked.

“Yes,” Professor Garvin answered, “but none of you asked in what context I was asking the question. Craig, your question speaks to the issue of ‘What is taxable income.’ There are other types of income, such as trust and accounting income.”

We were all befuddled. I imagine that you, the reader, are also befuddled.

But this is an important issue for many in their estate plans. So I believe it makes sense to review these issues here in today’s column.

Suppose that my trust provides at my death for a continuing marital trust for my wife, Patti. The trust directs that the trusts is to pay Patti all of the income, and she can also receive distributions of principal for any health, education, maintenance or support needs that she may have. This begs the question as to what constitutes income and what constitutes principal.

Principal, by the way, is the “corpus” of the trust. In other words, principal is made up of the assets that the trust holds. So if my trust owns stocks, bonds and mutual funds, those are the corpus. The dividends and interest earned on the corpus are income.

Seems pretty straightforward so far.

Suppose that the trust now sells a stock holding for $100,000 that has a tax cost basis of $75,000, realizing a $25,000 capital gain. The capital gain is taxable income. But if the trust says to distribute all of its income to Patti, does that mean the trustee of the trust should distribute the capital gain?

The answer is “No.” The capital gain is deemed to be corpus of the trust. It should be reinvested to produce more “income” unless Patti needs a principal distribution for her health, education, maintenance and support. As you can see, for income tax purposes the capital gain is taxable income, but for trust accounting purposes, the capital gain is not income but is instead principal.

Who pays the tax on the capital gain then? Assuming that the trust retains the capital gain and does not distribute it to Patti, then the trust will pay the tax on the gain. Capital gains are, for the most part, taxed to trusts at roughly the same rate than they would be to the beneficiaries who receive the distribution.

But ordinary income (as opposed to capital gain) is quite different. Allow me to illustrate with another example. If I named the marital trust as a beneficiary of an IRA or an annuity – and the marital trust said only to distribute the income to Patti but the principal was to be retained in the trust rather than distributed to her, what do you think happens? Assume further that the IRA has $500,000 of assets and that the Required Minimum Distribution for this year is $35,000.

Withdrawals from IRAs are generally taxed as ordinary income. But is the distribution from the IRA for trust purposes income or principal? If you said “principal” you’d be right. The $35,000 was part of the corpus of the IRA. Even though the withdrawal is taxable as ordinary income, it shouldn’t be distributed to Patti in my example since the trust directs the trustee to not distribute trust principal, only distribute trust income. Therefore, only the interest and dividends earned going forward on the $35,000 should be distributed as income.

To make matters even worse, when the $35,000 is trapped inside of the trust, the trust pays the income tax on it. Trusts have a compressed income tax rate schedule – meaning that any income accumulated over approximately $12,000 incurs tax at the highest marginal income tax rate (39.6% + 3.8% Medicare surtax). Consequently, 43.4% will likely be lost to federal taxes. If Patti lives in a state that also has a state income tax, even more will be lost.

This problem is more common than you might imagine with IRAs, 401(k)s and annuities. That is why it is important to draft special provisions into trusts which are going to be named as beneficiaries to an IRA, 401(k), pension, profit sharing plan or to an annuity. All of these types of assets are called “income with respect to a decedent” accounts, meaning that the distributions will normally incur income tax.

Getting back to Professor Garvin – who happened to be one of my favorite accounting professors – the lessons that she taught me helped greatly when I took my income taxation of estates and trusts course in law school. These are not easy concepts to master, but are important to review to not only ensure that the right beneficiaries receive the proper distributions, but to also minimize income taxes in the process.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Florida Homestead Descent and Devise

Most of us are familiar with the Florida homestead exemption that saves a few hundred dollars on property taxes. If you were a resident of Florida this past January 1st, and have not yet applied for your Florida homestead exemption, now is the time to do that since the deadline is fast approaching in March.

In addition to the annual savings, claiming Florida homestead entitles you to a cap on the annual increase to your home’s assessed value. Even if the value of your residence exceeds a 3% increase, the appraiser’s office can only increase the value by 3%. Over the years, the “Save Our Homes Property Tax Assessment Cap” can save thousands of dollars.

Today, however, I wish to discuss a lesser-known consequence of Florida homestead. This has to do with the “descent and devise” rules found under Florida’s Constitution and our statutes.

Simply stated, if your spouse and/or minor children survive you, you cannot devise your home (through your will or trust) to anyone other than your spouse. If you devise the homestead to any other person or entity then that devise is invalid.

Assume, for example, that you and your spouse purchased your Florida home before you became a Florida resident. In order to “balance out” your estate for federal estate tax purposes (necessary under the old estate tax laws but different since portability implemented in 2012) your attorney up north may have advised to place the Florida homestead in one spouse’s trust and the northern residence into the other spouse’s trust.

The trusts probably contain “credit shelter” and/or “marital trust” provisions for the surviving spouse. Even if the trust of the deceased spouse continues on for the surviving spouse, and if that trust owns the Florida homestead, it is an invalid devise. The devise may have been perfectly fine the day before you became a Florida resident, but once you claimed Florida residency, this problem arose.

When an invalid devise exists, then Florida law does not care what your will or trust says about who is to inherit your homestead. Instead, your spouse may choose between a “life estate” interest in the home or an undivided ½ interest as tenants in common. The rest of the interest of the home is owned by the decedent spouse’s children.

What this means is that the surviving spouse cannot sell the home without the consent of the children, and the children must agree as to the sales price and will share in the sales proceeds. If any one of the children do not consent to a sale or transfer, then it cannot occur. Further, if one of the children has an economic, tax, creditor or divorce issue then the title the home may become clouded.

Obviously, an invalid devise should be avoided. An update of the estate plan to Florida documents and Florida law is the first step. Sometimes more advanced planning is necessary. Take, for example, the circumstance where husband and wife are in a second marriage, each with children from a prior marriage. Wife owns the home, but if she predeceases husband she wants him to remain in the home rent free for the rest of his life, but also wants the equity of the home to one day benefit her children and not his.

Wife may even want husband to have the opportunity to sell the home and reinvest the proceeds into a new home of his choosing, so long as the equity of the original home ends up with her children.

In order to satisfy wife’s intent, it will be necessary for husband and wife to enter into a valid nuptial agreement waiving the Florida Constitutional and statutory homestead descent and devise rights. Under Florida law, such a nuptial agreement will require each party to have separate legal counsel, as well as full disclosure of their assets, even though the parties presumably don’t wish to waive rights to each other’s assets.

Once the husband and wife satisfy the nuptial agreement/waiver requirement, then wife can direct her attorney to draft an appropriate residential property trust within her will or trust documents.

This is but one example of how the Florida descent and devise laws affect the disposition of one’s homestead. If you own Florida homestead and haven’t updated your legal documents, it may be time to visit with a qualified estate planning attorney to discuss these important issues.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

The Vultures

Those ugly turkey vultures are quite ubiquitous throughout Southwest Florida. You see packs of them on the side of the roads picking at road kill. I suppose that they serve a useful purpose, disposing of the carcasses of various dead creatures big and small.

But family vultures are quite different. They’re not present in all families, obviously. Vultures can be found in just a few I would say. But when they’re present, someone has to stand guard.

While both Dad and Mom are alive and well, they circle patiently overhead, not making a sound. But then Dad dies, and when Mom’s vulnerable, you see them become more aggressive.

“My car won’t start anymore and I can’t afford a new one.”

“The kids’ private schools are so expensive, and I just don’t know how we’re going to pay the tuition bills.”

“I haven’t been on vacation in years and I’m burning out at the office.”

“Now that I’m middle aged no one will hire me.”

And so on. The vultures prey on Mom’s maternal instincts to take care of her children, even though those children are now adults and are quite capable of taking care of themselves. They knew that they couldn’t ask for money while Dad was alive, because he would say “No” and might even disinherit them for even asking.

But now that Dad’s gone, they look at Mom’s retirement account as a lump sum that can and should be shared by all. The vultures don’t realize that the corpus of the retirement account is necessary to generate annual income for Mom. Since yields are so low these days it takes a lot of money to generate even modest income.

I’ve seen the vultures swarm several times throughout my career. Mom’s financial advisor warns her that she really can’t afford to make such large gifts to her children without compromising her standard of living. Yet she does so anyway.

And I don’t mean to be sexist. Sometimes the surviving Dad is the one being preyed upon. More often than not it’s Mom, only because women tend to have longer life expectancies than do men, and as I said before, the instinct to assist even capable adults seems stronger with the parent who actually carried and gave birth to that person, even though it was several decades ago.

And sometimes the vultures sweep in while both parents are alive. Not too long ago I represented a long time married couple who were bled completely dry by one of their adult children. Even though Son had a job and apparently did reasonably well (or overspent) as he took vacations to Europe with his family. But Son also demanded that his parents pay for the plane tickets to bring his family of four down to visit, and expected Mom and Dad to pick up the tabs when they went out to eat, and for the family’s activities. This was on top of the annual assistance he said he needed to make ends meet.

Despite the pleadings of their professionals, including the CPA and the couple’s financial advisor, Mom and Dad couldn’t stop themselves from making large gifts to Son. When Daughter found out about it, she became terribly upset and frustrated, but there was little that she could do by that time. The damage had been done.

So what’s the answer? How do you protect yourself from a circling vulture?

That’s a complicated answer, since every family’s situation is unique. But there are some common threads. When your advisors are telling you that you really can’t afford to make gifts that your adult children request, the first line of defense is to say “No.”

But this is hard to do for many.

If you find yourself unable to say “No” when you know that you should, that’s the time to name a co-trustee in your revocable living trust who does have the ability to help you say “No” and will monitor your financial situation. That co-trustee might be a trusted son or daughter who won’t try to take advantage and will act as a gatekeeper to their vulture-like sibling. It could also be a trust company that can serve the same role in a less emotional and more impartial way.

When I mention professional management, oftentimes my client will bemoan the fees that they would have to pay. I remind them that they are likely already paying management fees of one sort or another, but even if they aren’t, paying 1% for someone to stand guard is better than losing large amounts to vultures whose appetite never seems to diminish.

If you suspect that you have vultures circling, please do yourself a favor and ask your team of advisors what steps you should take before you jeopardize your own financial stability.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Who is a Descendant?

New reproductive capabilities pose interesting challenges to one’s estate plan. Typical language in a will or trust might read, for example, “upon the death of my wife, the remainder of my estate shall be distributed to my descendants, per stirpes.” The per stirpes designation means that the next generation steps into the shoes of a parent who predeceases the testator of the will or trust.

This therefore begs the question – who are your descendants? The answer may not be as clear-cut as you might imagine.

Modern medicine has turned reproductive capabilities – and therefore who might be considered a descendant of yours – upside down. In generations past, once a woman’s biological clock expired, she couldn’t have any more children – and the only way to expand a family beyond such event would be to adopt.

Today eggs can be harvested, frozen cryogenically and artificially inseminated at ages that used to be considered beyond one’s normal child-bearing years. Further, with surrogate mothers and donations of both eggs and sperm, the biological “parent” of the embryo isn’t as certain as it was yesterday.

Allow me to illustrate my point. Assume that Father and Mother have two sons, Greg and Peter. Father dies leaving everything to Mother. Mother’s will directs that the estate is to be left equally to Greg and Peter, and if either son predeceases her, then the share that would have been distributed to the predeceased son would instead be distributed per stirpes to that son’s descendants.

Assume further that Peter predeceases Mother, leaving behind his wife Sarah, and a daughter Rachel. Peter’s wife Sarah decides to have a reproductive specialist artificially inseminate her with Peter’s cryogenically frozen sperm. After several procedures it doesn’t work out as Sarah has reproductive deficiencies of her own. So Sarah finds a surrogate mother who is then artificially inseminated with Peter’s sperm and gives birth to a son, Jacob. Mother then dies without ever changing her will.

Who inherits Peter’s share? Remember that Mother’s will says everything to Greg and Peter, per stirpes. Since Peter died, the per stirpes designation would mandate that Peter’s child(ren) would step into Peter’s shoes to inherit. So we know that Greg still receives one-half (1/2) of Mother’s estate. But who are Peter’s children? We do know that Rachel is Peter’s daughter. That much is a fact. Does Rachel inherit Peter’s ½ or must she share it with Jacob?

The legal question therefore is whether Jacob is a descendant of Peter? Peter’s sperm produced Jacob after Peter’s death, but before the death of Mother – at the direction of Peter’s wife Sarah through a surrogate mother. I believe that under Florida law, Jacob would be entitled to split Peter’s share with Rachel.

Consider, however, that Peter may have even more children depending upon who had custody of his seed and how often it was used. What if Sarah produced another child in the same way Jacob was produced? Assume that the next child was born after Mother’s death. Couldn’t you argue that the class of beneficiaries who would inherit Peter’s share could be unlimited? How could the personal representative for the estate know when to distribute Peter’s share if another child could be born long after Mother’s death? For this reason Florida law would likely treat any children born before Mother’s death as a descendant of Peter for purposes of Mother’s will.

What if Peter had instead donated to a sperm bank and a married couple, not related to the family at all, used it to produce a child? Here Florida law would not treat that child as Peter’s descendant. Donations to a sperm bank for third party use are generally not, for legal purposes, considered a descendant of the donor.

With modern reproductive medicine improving all of the time, and with the number of different choices that are available today, it isn’t hard to imagine any number of scenarios that could call into question who a proper descendant may be under any given will.

All of these issues can be addressed through the drafting of language that clarifies the intent of Mother and Father. If Mother and Father only wanted biological and adopted children of Peter during his lifetime to step into his shoes for purposes of inheritance, then this could be written into the legal documents: “For purposes of our will, a descendant of a child of ours shall only include those individuals born or adopted before the death of our child, or those born within nine months following the death of our child.”

On the other hand, Mother may want Jacob, and any other similar issue – to step into Peter’s shoes for purposes of the inheritance. She may look at Jacob as a gift from Peter – regardless how Jacob was conceived.

These are difficult concepts that many estate plans fail to consider. If you have strong feelings one way or the other, it might be time to dust off your documents to review how “descendant” is defined under the document, if it is defined at all.

The Sheppard Law Firm has its main in Fort Myers and also in Naples by appointment.

© 2017 Craig R. Hersch. Originally published in the Sanibel Island Sun.

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