PROBATE
EXECUTOR
ADMINISTRATOR
PERSONAL REPRESENTATIVE
LAST WILL - formalities
NO LAST WILL?
POWER OF ATTORNEY
LEGAL FEES FOR AN ESTATE
FEDERAL GIFT AND ESTATE TAX - Uncertain but predictable
FEDERAL GIFT AND ESTATE TAX - GENERAL DISCUSSION
ESTATE TAX EXEMPTION and its other names
GROSS ESTATE - what is subject to the Estate Tax?
SPECIAL ITEMS
STATE INHERITANCE TAX/ESTATE TAXES
THE "MARITAL DEDUCTION"
NON U.S. CITIZEN SPOUSE
INCOME TAX
INCOME TAX AND "IRD" ASSETS
CHARITABLE GIFTS AND TUSTS
GIFTS TO INDIVIDUALS
TRUSTS
GENERATION SKIPPING
RESIDENCES IN MULTIPLE STATES
NJ INHERITANCE TAX
NJ ESTATE TAX
PROBATE
For a document to be accepted as the decedent’s Last Will, several statutory formalities must be followed. In general, the document must be typed and signed by the Testator in the presence of two witnesses who must sign – stating that the Testator and witnesses were all in the presence of each other when the Will was signed.
The document should not have any erasures, scratch outs or other marks. The text must not be ambiguous in any way and must dispose of all of the decedent’s assets.
Failure to follow any of the formalities may cause the document to be rejected by the Surrogate for Probate in routine fashion. This will result in the need to seek probate through a formal court proceeding – a procedure that will be time consuming and expensive. Similarly, ambiguities can result in a contested court proceeding causing significant expense and possibly resulting in a disposition of wealth not intended by the decedent.
EXECUTOR
The Executor is the person named in a Last Will to wind up the decedent’s affairs, pay creditors, file needed tax returns, and distribute the net estate pursuant to the Last Will.
See “Personal Representative.”
ADMINISTRATOR
When there’s no Last Will, there is no Executor. The “Administrator” is the person appointed by the Surrogate’s court to wind up the decedent’s affairs, pay creditors, file needed tax returns and distribute the net estate per the law of Intestacy. The Surrogate follows the state’s statute which sets forth a priority list among the decedent’s relatives as to who may be appointed. This person must usually post a surety bond – an insurance company’s undertaking to reimburse the estate for any losses attributable to the dishonesty of the appointee.
See “Personal Representative.”
PERSONAL REPRESENTATIVE
The term “Personal Representative” means the Executor or Administrator of the Estate.
The Personal Representative’s first duty is to pay the creditors of the Estate – including the State and Federal taxing authorities. The Personal Representative may have personal liability to creditors if assets of the Estate are not properly used to pay the creditors.
The Personal Representative is entitled to a fee for his/her services. The amount of the fee is set by statute and reflects the size of the estate.
LAST WILL - formalities
For a document to be accepted as the decedent’s Last Will, several statutory formalities must be followed. In general, the document must be typed and signed by the Testator in the presence of two witnesses who must sign – stating that the Testator and witnesses were all in the presence of each other when the Will was signed.
The document should not have any erasures, scratch outs or other marks. The text must not be ambiguous in any way and must dispose of all of the decedent’s assets.
Failure to follow any of the formalities may cause the document to be rejected by the Surrogate for Probate in routine fashion. This will result in the need to seek probate through a formal court proceeding – a procedure that will be time consuming and expensive. Similarly, ambiguities can result in a contested court proceeding causing significant expense and possibly resulting in a disposition of wealth not intended by the decedent.
NO LAST WILL?
What happens if you don’t have a Last Will? Your estate – large or small – will pass under the law of Intestacy of the state in which you are domiciled at death. Every state has a statute that spells out who will inherit your wealth if you have no Will (called the law of Intestate Succession.)
In general such statutes are the legislature’s attempt at providing a distribution believed to reflect what an average person with certain assumed surviving relatives would desire. Each state’s law may differ from another’s and may be revised from time to time.
In general, the statute also directs who among the survivors should be the Administrator or Personal Representative – the person given authority to wind up the decedent’s affairs, pay creditors, file needed tax returns and distribute the net assets pursuant to the law of Intestasy.
This person must usually post a surety bond – an insurance company’s undertaking to reimburse the estate for any losses attributable to the dishonesty of the appointee.
POWER OF ATTORNEY
A Power of Attorney is a document which authorizes another to act for you during your lifetime. A general Power authorizes the other person to act on all or most matters. The authority is usually ongoing; in other words, it continues in force until it is revoked or the grantor dies. By contrast, a person can grant a Limited Power of Attorney; i.e., an authorization that covers only a specified matter such as the sale of a home, a particular bank account, etc.
A Durable Power of Attorney is one that by its express language continues in force even if the Grantor becomes mentally incompetent. This is important since without express language making the Power continue, the grantor’s mental disability may constitute a revocation of the Power of Attorney under state law. This would void the Power when it might be needed most.
All of the above discussion relates to business matters. A different, specialized Power of Attorney is used for medical matters. This document is frequently referred to as an “Advance
Directive for Health Care” or a “Health Care Power of Attorney” The term “Living Will” may also be used but generally a Living Will is oriented only to death bed decisions concerning artificial life support and the like.
LEGAL FEES FOR AN ESTATE
Attorney fees should reflect the services provided. They may be based on the attorney’s expenditure of time (hourly billing) or another approach such as flat fees for particular services.
Fees will and should vary based on the relative simplicity or complexity of the assets of the estate, taxation issues, tasks performed by the Executor, etc.
In the distant past, attorneys based their fees for representation of an estate on the size of the estate applying a percentage factor to the estate to determine the fee. This practice is now rare since the size of the estate bears little relation to the legal services required.
FEDERAL GIFT AND ESTATE TAX - Uncertain but predictable
Note: All references to a $3.5 Million exemption below are based on the law in effect in 2009; consider such references to be merely illustrative of a possible new law.
Congress failed to amend the Estate Tax law prior to December 31, 2009, resulting in a temporary “no estate tax” situation for those dying in 2010. The House voted to keep the tax as it existed in 2009 for the future but the Senate took no action. It is generally anticipated that the tax law will be amended/reinstated during 2010 with possible retroactive application. In part, this is expected since in the absence of an amendment, the existing law contains a provision returning the Estate Tax to its 2001 configuration as of January 1, 2011. The $1 Million exemption of the old law would result in many middleclass Americans being impacted by the law. Throughout its history the Estate Tax has been adjusted to apply only to the wealthiest decedents. Hence, Congress is widely expected to amend the law to provide an exemption of at least $3.5 Million.
FEDERAL GIFT AND ESTATE TAX - GENERAL DISCUSSION
For decades a Federal Estate Tax has been imposed on the death of each person to die with a net worth in excess of that person's lifetime exemption. The amount of the exemption has gradually been increased. In 2009, it was $3.5 Million. As noted below, most large gifts made during life trigger the same tax at the same rates, etc. Note that the exemption for lifetime gifts is $1.0 Million (cumulative.)
The Federal Gift Tax and Estate Tax laws and tax rates are component pieces of one tax so as to apply equally to any large transfers of wealth whether made during life or at death. Gifts made during life incur a tax immediately or are "added back" to your Estate for computation of Estate Tax with the result that all transfers of wealth above an aggregate amount of $1 Million per donor are potentially taxed. Exemptions: a) An unlimited number of gifts can be made during life of up to $13,000 per year from anyone to anyone with no gift tax consequences. b) A husband and wife can make an unlimited number of joint gifts of up to $26,000 per year to anyone with no gift tax consequences even if the asset is owned by only one spouse. c) Unlimited gifts can be made between a husband and wife or to charity with no gift tax consequences.
Except for the above exempted gifts, all lifetime gifts use up a portion of your $3.5 Million lifetime exemption and when the $1 Million gift tax exemption has been used up, additional gifts incur tax. Similarly, once the applicable exemption is used up (during life or at death), transfers of wealth at death incur the Estate Tax.
The Federal Gift/Estate Tax rate applicable above the $3.5 Million lifetime exemption has recently been 45% (lower rates apply on gifts between cumulative $1 Million and $3.5 Million.) In simple terms, once one's $3.5 Million exemption is used up, his/her net worth would be taxed at 45%. The tax is cumulative; that is, for the first $3.5 Million it is structured so that each person's wealth can only benefit once from the "low" rates. By adding back lifetime gifts and giving a credit for gift tax paid, everyone's net worth should be taxed the same whether the wealth was transferred during life or at death or by any combination of lifetime gifts and gifts at death.
Again, note that all references to a $3.5 Million exemption are based on the law in effect in 2009. That law is no longer in effect. It was anticipated that the Estate Tax law would be amended during 2009 to reset the exemption level and tax rates for 2010 and thereafter. Congress did not act thus resulting in a previously legislated “no estate tax” period. During this period, while there is no Estate Tax, a future income tax will apply to many families under a “carryover basis” rule. Under current law, at the end of 2010, a harsher set of Estate Tax rates/exemption from 2001 is scheduled to become effective. To end the “no estate tax” period, complex “carryover basis” rule, increase federal revenue and avoid the illogical return to 2001 law, Congressional action is expected in the first half of 2010.
ESTATE TAX EXEMPTION and its other names
The $3.5 Million exemption for Estate Tax purposes is not really an exemption at all; it's a tax credit that just happens to effectively equal a $3.5 Million exemption. The credit is sometimes called a person's "Unified Credit" since it's used under the "Unified Gift and Estate Tax".
The above exemption is sometimes referred to as one's "Exemption Equivalent" which reflects the explanation above.
The exemption is sometimes referred to as one's "Lifetime Exemption" which simply means that everyone receives one and only one exemption. It can be used during life to offset Gift Tax that would otherwise be due or at death to offset Estate Tax or partially during life and partially at death.
GROSS ESTATE - what is subject to the Estate Tax?
A person's "Gross Estate" for Estate Tax purposes includes everything he/she owns at the time of death valued at fair market value. Deductions are allowed for debts, bequests to a spouse (called the "Marital Deduction"), charitable bequests, and funeral and administration expenses which yields one's "Taxable Estate". It is the Taxable Estate to which the tax rates discussed in this outline are applied to compute the actual tax due. A limited tax credit is allowed for foreign death taxes paid and a deduction is allowed for state inheritance/estate taxes paid.
SPECIAL ITEMS
The text of this outline tries to simplify the subject by avoiding the technical terms and relatively small deductions and credits. If you have large foreign investments or assets that would be difficult to value a special focus on those items may be appropriate. If you have large liabilities or plan to make a large charitable gift at death the Estate Tax due would be less than otherwise projected. Minority interests in a business or other illiquid assets may need special attention to be properly valued – (i.e., discounted in value to reflect their true market value.)
STATE INHERITANCE TAX/ESTATE TAXES
In addition to the Federal Tax, a person's estate is usually subject to a State Inheritance Tax and/or an Estate Tax imposed by the State. The state of your domicile at the time of your death is the applicable state for this type of tax. In New Jersey the Inheritance Tax exempts all gifts to close family members (spouses, children and grandchildren). It taxes gifts to some other relatives (such as brother and sisters, nieces and nephews) at 11% on bequests on up to $1.1 Million with higher rates above that. Bequests to distant relatives and non-family members are taxed at 15-16%.
In New Jersey and many other states, a revised state level Estate Tax is now being imposed to preserve revenue that used to flow to the State via a tax credit under the Federal Estate Tax but which was eliminated by 2001 Estate Tax amendments. The law of each state is unique. In many cases, the new New Jersey Estate Tax will cause wealthy families to pay some tax to the State on the death of each spouse. While it may be possible to defer the New Jersey Estate Tax until the second spouse's death, to do so will probably cause a significantly higher Federal Estate Tax on the second spouse's death. The applicable tax rate in New Jersey for the State Estate Tax ranges from about 5% to 16%. The tax is no longer offset by a Federal credit; the State tax is deductible on the Federal Estate Tax return as an expense of the Estate but will still result in a significant cost to the estate.
The New Jersey Estate Tax allows a credit for any New Jersey Inheritance Tax paid and vice versa. In effect the Estate pays the higher of the two taxes but is not taxed twice by New Jersey.
THE "MARITAL DEDUCTION"
The Federal Estate Tax law allows a married couple to defer payment of all Estate Tax until both spouses have died. This is done by allowing what's called an "unlimited marital deduction" for the first spouse's estate for any wealth passing to the surviving spouse. This is permitted since the government knows it will collect a tax on the same assets when the second spouse dies. Note that the surviving spouse must be a US Citizen in order to be eligible for the marital deduction.
While the simple “everything to the spouse” Last Will will defer all tax to the second death, it may result in the second spouse’s estate unnecessarily incurring a large estate tax. The disadvantage (for tax purposes) of giving everything to the surviving spouse is the wasting of the first spouse's $3.5 Million exemption and the resulting increase in the size of the second spouse's estate so that wealth that might have passed to the next generation tax free in the first spouse's estate because of the $3.5 Million exemption is subject to tax in the second spouse's estate. In other words, the exemption of the first spouse was "wasted" because the marital deduction was used to pass even the first $3.5 Million of wealth to the spouse rather than to a By Pass Trust or to the children.
Use of a "Marital Deduction Formula Clause Will" is intended to solve the first problem mentioned above; that is, $3.5 Million of the first spouse's estate is channeled into a trust to use up his/her $3.5 Million exemption. The trust usually provides that the income goes to the spouse for life but the principal passes upon the spouse’s death to the children or others as directed in the first spouse’s Will. This is called a "By Pass Trust" since it is not included in the survivor's estate and hence the wealth passes to the next generation or other beneficiaries of your choice "tax free". In simple terms, the couple got the use of the tax exemption in each estate – thus passing more wealth to the next generation free of tax.
Use of such a trust provides a vehicle for management of the funds during the surviving spouse’s lifetime. It also protects the assets against the survivor’s possible second spouse, creditors, etc. and assures the assets will eventually pass as the first spouse envisioned.
NON U.S. CITIZEN SPOUSE
Under the Federal Estate Tax the unlimited marital deduction is available to an estate only if the surviving spouse is a U.S. citizen. The law provides that a marital deduction can be available for a non citizen spouse if a special Trust is put in place to control the assets. The Trust and its tax consequences are complex but use of such a trust can result in deferral of the Estate Tax to the death of the surviving spouse. For a wealthy couple such a deferral can be extremely important.
INCOME TAX
It’s important to note that Estate and Inheritance Taxes are wholly different from income taxes. Estate and Inheritance Taxes are imposed on the wealth that passes from a decedent at death; i.e., it’s a one time tax on the net assets owned rather than on income. This includes everything at its fair market value (including life insurance owned or controlled by the decedent).
Generally, an inheritance is not “income” for income tax purposes of the beneficiaries.
INCOME TAX AND "IRD" ASSETS
There is one substantial category of wealth that may be subject to both estate and income tax. This is “income” of the decedent that’s never been taxed as income to the decedent. The most common examples are one’s earned but unpaid salary, deferred compensation plans, pension plans, profit sharing plans, 401 K’s and/or IRAs.
For many decedents retirement plan assets make up a large portion of the decedent’s wealth. As a result these assets need special attention for tax planning purposes. These assets are called “Income In Respect of a Decedent” (IRD).
Generally, one measures wealth by its purchasing power. One Dollar of most kinds of wealth could purchase One Dollar’s worth of goods for the decedent immediately prior to his/her death. If that wealth is subject to the Estate Tax, its purchasing power drops to only about 50 cents per dollar. IRD assets do even worse under this measure. They will also incur income tax before they are spendable by the decedent’s family – thus potentially reducing their purchasing power very substantially.
If the owner of IRD assets is survived by a spouse, the tax impact may be partially deferred to the spouse’s death but at that time the net value may be taxed under both the estate and income tax laws of both the Federal and State governments – an aggregate tax burden that can be over 75%. Some wealthy people use IRD assets to fund charitable gifts since such gifts pass free of tax; i.e., the charity receives 100 cents per dollar while the family would have only received 20 to 25 cents if the same asset passed to them.
CHARITABLE GIFTS AND TUSTS
Gifts to charity during life generally entitle the donor to an income tax deduction under the Federal income tax law, subject to certain limitations. Bequests to charity at death generally entitle the Estate to a deduction for both Federal and State Inheritance and Estate Tax purposes.
Gifts during life can be made using appreciated publicly traded securities. Such gifts are valued at fair market value for income tax deduction purposes; the unrealized profit escapes income tax since the donor never sells the security; when the charity sells the security, its tax exempt status causes no tax to be due. Gifts of other types of assets can also be made but the deduction is frequently limited to the donor’s basis.
Gifts can also be made to specially drafted “Split Interest” Trusts. In a Charitable Remainder Unitrust, the donor makes a gift of the remainder interest in the gift to a charity while retaining the right to the income generated by the gift – expressed as a fixed annual percentage of the gift value. For example the annual Unitrust distribution might equal 4% of the Trust’s value as of December 31 of the prior year; the percentage can be selected by the donor but is usually between 3% and 5%. The Unitrust amount must be recomputed each year. The Unitrust interest can be retained for life or for a fixed number of years. The Trust is viewed as a tax exempt entity for income tax purposes; hence the Trustee can sell the original gift property tax free and re-invest the proceeds in higher yielding assets or assets with more growth potential. The donor can sometimes enjoy increased annual income compared to that received before the gift since the donor selects the percentage rate for the Unitrust distribution and the assets can be sold/reinvested without an income tax cost.
In a Charitable Lead Trust, the donor can contribute the income interest from the gift property for a specified period of time to charity while retaining the remainder interest for himself or his family. This is essentially the opposite of the Charitable Remainder Trust.
In either of the above gifts to a Trust, the deductible gift for income tax purposes is the value of the interest given to charity rather than the full value of the asset put into the Trust.
GIFTS TO INDIVIDUALS
Gifts of up to $13,000 per donee per year can be made by each spouse to as many donees as you wish free of any gift or estate tax consequences (the gift tax “Annual Exclusion.”) This is a useful way to pass amounts of wealth "tax free" to your children and grandchildren (or anyone else) over an extended period of years. To be eligible for the exclusion, the gift must be of “present interest.”
Note that if you wish to make $13,000 gifts to a trust the trust must have specific provisions in order to make the gift eligible for the $13,000 exclusion.
Amounts paid directly to schools for tuition and related items also do not use up the Estate & Gift Tax lifetime exemption. This can be useful if one or more children are in private school or college since it allows a wealthy grandparent or other relative to pay many of the school expenses without gift tax consequences. Note that the payment must go directly to the school. Note also that the education related rules change more frequently than do the general Gift and Estate Tax provisions. Special incentives and “savings” plans such as Section 529 plans are frequently created by Congress and changed or phased out after a few years.
TRUSTS
A Trust is essentially a written set of instructions to a Trustee. The Trustee becomes the owner of the assets in the Trust and has responsibility for the investment/re-investment of said assets for the benefit of the beneficiaries of the Trust. The Trust document spells out when and how all or part of the Trust’s income and/or the Trust’s assets should be distributed to the beneficiaries.
Some Trusts are created during one’s lifetime – others are created in one’s Last Will. Trusts created during life can be revocable or irrevocable. “Irrevocable” also means non amendable. Generally, revocable Trusts do not have consequences for estate or income tax purposes. They are frequently used for asset management purposes. Irrevocable Trusts are used for tax planning purposes as well as for asset management. “Asset management” can mean simply use of an adult to manage a small fund for the benefit of minor children. Of course, it can also mean professional management of very large sums.
GENERATION SKIPPING
This is an estate tax concept applicable only to the very wealthy; more specially, those who feel their children’s estates will incur estate tax on the children’s death and seek to minimize this future tax cost.
If significant gifts or bequests to grandchildren are desired, sophisticated planning is needed. The federal tax law has complex provisions intended to prevent “generation skipping” for estate tax purposes. While up to $3.5 Million can be passed to grandchildren (i.e., skipping the potential estate tax on one’s children’s deaths) very careful planning is required.
RESIDENCES IN MULTIPLE STATES
If you spend significant periods of time in a state other than New Jersey, you should make an effort to assure that only one state seeks to claim you as a “resident” for tax purposes (Income, Estate and Inheritance taxes). Generally you would want to maintain all of your “ties” to one state so that a second state can’t successfully seek to tax you as a resident. Traditional indicia of residency are voting registration, church or other memberships, past tax returns and postal address usage, number of days in residence, etc. This is an evolving area of the law as more states become aggressive in their tax collection efforts. Suffice it to say, you can be taxed twice – i.e., as a “resident” or domiciliary of two (or more) states. If you live part of the year in different states try to plan your affairs to minimize this risk. Conversely, if you seek to establish a “nominal” residence in a low tax state to save state taxes you should recognize that there is an increasing risk that other states in which you reside part of the time may aggressively challenge such residences with the result that taxes (and penalties) can be owed to multiple states.
Note also that the terms’ residency and domicile are not interchangeable – they are used for different tax issues, have different criteria and different consequences.
NJ INHERITANCE TAX
The Inheritance tax is a tax on the receipt of wealth from a decedent. Close family members (called Class A beneficiaries) are exempt. The tax is calculated separately for each recipient at rates starting at 11% and 15% depending on the relationship between the decedent and the recipient.
NJ ESTATE TAX
The New Jersey Estate Tax is a tax on the decedent’s net worth – similar to the Federal Estate Tax. In fact, the Federal Estate Tax Return is used in a hypothetical calculation to determine one’s New Jersey Estate Tax. The two major distinctions between the Federal and NJ tax are:
1) NJ allows an exemption of only $675,000 and 2) NJ’s rates are much lower than the Federal rates. NJ’s tax is applied at rates of 5% to 16%.
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