The Law Offices of Thomas E. Napolitano
900 Lake Street, Suite B Ramsey NJ 07446

Estate Related Terms and Issues of General Concern

PROBATE
EXECUTOR
ADMINISTRATOR
PERSONAL REPRESENTATIVE
LAST WILL - Formalities
NO LAST WILL?
POWER OF ATTORNEY
ADVANCE DIRECTIVE FOR HEALTH CARE
LIVING WILL
POLST (Practitioner's Orders for Life Sustaining Treatment)
LEGAL FEES FOR AN ESTATE
FEDERAL GIFT AND ESTATE TAX - GENERAL DISCUSSION
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 – A DOLLAR THAT'S NOT WORTH A DOLLAR
CHARITABLE GIFTS AND TRUSTS
GIFTS TO INDIVIDUALS
TRUSTS
GENERATION SKIPPING
RESIDENCES IN MULTIPLE STATES
NJ INHERITANCE TAX
MOVING TO ANOTHER STATE
ANNUAL GIFTS
DIGITAL ASSETS
NOTE
CIRCULAR 230 DISCLOSURE


PROBATE

 “Probate” is the legal process by which a local court accepts a particular document as the Last Will of a decedent and ratifies the decedent’s appointment of Executors, Trustees and Guardians.

Should Probate be avoided?

In many states the probate process is complex, archaic and expensive – involving an actual court proceeding and in some states the payment of large probate fees. Trusts created during one’s lifetime are frequently used in these states to avoid probate.  In New Jersey, this is not the case; the Probate process is simply accomplished by the filing of a few documents in the Surrogate’s office.  While each county’s procedures vary, the process is universally efficient, convenient and inexpensive.



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.
 
The above discussion relates to business matters.  A different, specialized Power of Attorney is used for medical matters.  See “Advanced Directive for Health Care”.


ADVANCE DIRECTIVE FOR HEALTH CARE

An “Advance Directive for Health Care” or a “Health Care Power of Attorney” allows you to designate another person to make health care decisions on your behalf if you are unable to act on your own.  



LIVING WILL

A “Living Will” may be combined with an Advance Directive but generally a Living Will is oriented only to death bed decisions concerning artificial life support and the like.  In sum, a Living Will allows you to declare what “extraordinary means” you would like to be used/not used to prolong life under certain circumstances.



POLST (Practitioner's Orders for Life Sustaining Treatment)

This is a medical document – not one prepared by an attorney.  It is a medical order form that details your wishes regarding life sustaining treatment and is currently in use in 42 states.  The form is completed jointly by you and your physician or advanced practice nurse and becomes a part of your medical file.  It is intended to follow the patient from his/her residential care facilities to/from a hospital, etc.  It complements an Advance Directive.



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 - GENERAL DISCUSSION

In January 2013 Congress revised the Federal Estate Tax law. 

Under the 2013 law, each person will continue to have a lifetime exemption of $5,000,000 indexed for inflation since 2010 (see next paragraph).  The rate applicable above the exemption is 40%.  Appreciated assets receive a step up in basis at death for income tax purposes. 

The $5 million exemption is “indexed to inflation.”  It will be adjusted upwards annually in $10,000 increments to reflect increases in the cost of living.    For 2017, the adjusted figure is $5,490,000 (up $40,000 from 2016).

In the past, wealthy married couples used tax planned Wills to assure that neither spouse’s exemption would be wasted (which would have unnecessarily inflated the survivor’s estate).  This generally involved creation of a By Pass Trust in the Will of the first spouse that would benefit the surviving spouse for life but “by pass” his/her future estate for tax purposes.

The 2013 law continues a provision that was new to the law in 2011 reflecting a concept called “portability”.  Portability is intended to allow a married couple to allocate their Estate Tax exemptions between their estates as needed at the time to minimize estate taxes without the use of Trusts.  In practice, the surviving spouse’s estate can elect to use any unused exemption from the first spouse’s estate.  (This presupposes that the first estate filed a timely tax return and determined the surplus exemption.  It also assumes that the law remains the same through the second death.)  In effect, this will allow a couple to pass up to $10 million of wealth to children or others tax free and without complexity. 

Effective January 1, 2011, the gift tax has been re-unified with the Estate Tax.  This means that the exemption is $5 million (up from $1 million) and the rate above the exemption is 40%.

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 $5 Million per donor are potentially taxed.   Annual Exclusions:  a) An unlimited number of present interest gifts can be made during life of up to $14,000 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 $28,000 per year to anyone with no gift tax consequences even if the asset is owned by only one spouse.  To qualify for the Annual Exclusion the recipient must have immediate use and enjoyment of the gift (present interest).  Gifts of future benefits do not qualify.  Unlimited gifts can be made between a husband and wife or to charity with no gift tax consequences.



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 state level Estate Tax has been 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.  For deaths prior to 2017 the NJ Estate Tax allows an exemption of only $675,000.  NJ’s tax is applied at rates of 5% to 16%.  The NJ Estate Tax law does not contain the portability concept which was added to the Federal Estate Tax in 2011.  
 
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 NJ Estate Tax is being phased out.  Effective January 1, 2017, the exemption has been raised to $2 million.  Effective January 1, 2018, the tax is repealed. 

 



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.
 


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 – A DOLLAR THAT'S NOT WORTH A DOLLAR

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 60 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 70%.  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 25 to 30 cents if the same asset passed to them.



CHARITABLE GIFTS AND TRUSTS
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 appreciated 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 contributes 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 $14,000 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 $14,000 gifts to a trust the trust must have specific provisions in order to make the gift eligible for the $14,000 exclusion.
 
In addition to gifts made using the annual exclusion amounts paid directly to schools for tuition and related items and to medical providers for medical services 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 “intervivos” 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 or as a testamentary substitute to avoid probate.  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 fund for the benefit of minor children or elderly relation.  It can also focus on protection against creditors.  Of course, it can also mean professional management of very large sums.

Many Trusts are oriented to saving income tax and/or estate tax.  Their variations are too numerous to discuss here.  Among these are Irrevocable Life Insurance Trusts; QTIP Trusts to gain the marital deduction; Disclaimer Trusts (to hold disclaimed assets); Asset Protection Trusts; QDOT Trusts to gain the marital deduction for a non-citizen spouse; and Special Needs Trusts designed to provide benefits that won’t disqualify the beneficiary from government benefits.



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 $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)  or "Domiciliary" (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 present (even for a minute), etc.  This is an evolving area of the law as more states become aggressive in their tax collection efforts.  Domicile is usually the place you intend to return to as your home.  It may be different from your current place of residence.  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 such as spouses, children and grandchildren (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.


MOVING TO ANOTHER STATE

Many New Jersey residents decide to move to another state to save taxes.  The logic is sound but one must be careful to avoid being taxed by two or more states.  See “Residence in Multiple States”, above.



ANNUAL GIFTS

(See Gifts to Individuals)



DIGITAL ASSETS

It is becoming more important to consider planning for a “digital property” or “digital assets”.  At present the vast majority of states do not have a law that specifically deals with access to and transfers of rights in digital accounts when the owner/subscriber dies or is incapacitated.  Each service provider has “terms of service” and “privacy policies” that severely limit access by anyone but the original subscriber/member.  The service provider is often in a different state than the subscriber so additional issues of which state’s law should govern and whether the provider in State Y will accept the authority of a probate court in State X add to the confusion.  Federal electronic data privacy laws threaten the service provider with large penalties if access is given without proper legal authority; hence most ‘terms of service’ agreements are very restrictive.

Independent of the legal issues surrounding digital assets one should consider the immediate practical aspects of whether and how you may enable another to gain access to your on-line accounts and the like if you are disabled or die.  Will your spouse/children know what accounts you have, know your passwords, etc.?



NOTE

This outline is intended to convey some general information and should not be relied on as legal advice.  Each person’s situation is different.  Of necessity, the outline is brief and general.  There are exceptions and complexities in many areas of the law including those referred to in this outline.  You should seek competent legal/tax advice.



CIRCULAR 230 DISCLOSURE

CIRCULAR 230 DISCLOSURE:   To comply with Treasury Department regulations, we inform you that any tax advice contained in this outline is not intended or written to be used, and cannot be used, for the purpose of  avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law.




Contacts

900 Lake Street, Suite B Ramsey NJ 07446
Phone: (201) 327-0333
Fax: (201) 327-6372
tom@tnapolitanolaw.com