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Thursday, July 24, 2014

Phillip Seymour Hoffman Didn't Leave Anything to his Kids -- and That's Not Surprising

Phillip Seymour Hoffman left nothing to his children the headlines proclaim. http://www.today.com/parents/philip-seymour-hoffman-leaves-35m-partner-instead-kids-1D79959171 He didn’t want “trust fund kids.” http://nypost.com/2014/07/21/philip-seymour-hoffman-didnt-want-trust-funds-for-his-children/ Many people have scruples about inherited wealth, and people as diverse as Sting, Anderson Cooper, and Warren Buffett have recently expressed their views that it can sap initiative and otherwise adversely affect children. But in the case of Phillip Seymour Hoffman, it actually would have been much more surprising from an estate planning standpoint if he had left substantial property to his children.

Why? Because when a person is relatively young, and dies leaving a surviving spouse or partner, and all children are from that relationship, and especially if all children are minors, the usual plan is to leave everything to the spouse or partner. The reason is that the spouse or partner will likely need to use those assets for his or her support and the care and support of the minor children, and the spouse or partner is the best person to look out for the children and do what is in their best interests. All of those factors applied in Hoffman’s case. And, in fact, he left substantially everything to his partner, Mimi O’Donnell, the mother of his three young children.

Sometimes people leave property to the surviving spouse or partner in trust. There are various reasons for that, including lack of expertise in managing money, creditor protection issues, and concerns about making sure that property is not diverted to a subsequent spouse, partner or child of the survivor. But especially when the survivor is young and the children are minors, leaving property outright is not unusual.

So what Hoffman did is typical. But Hoffman did have a special estate planning challenge: his estate was large enough to be taxable, and he was not married to Ms. O’Donnell, and so could not take advantage of the marital deduction. If he had been married he could have left his entire estate to her completely free of estate tax. Because he was not, and assuming he left a $35 million estate, his estate faces a hefty estate tax bill of some $12 million.

Thus, the true estate planning challenge in Mr. Hoffman’s estate would have been figuring out ways to transfer property to Ms. O’Donnell in a more tax advantaged manner and/or incorporating some charitable planning in order to reduce the estate tax burden - but that had nothing to do with his views about “trust fund kids.”

Disclaimer – Postings Not Legal Advice

This blog is not legal advice and no attorney-client relationship is formed. The information and materials on this blog are provided for general informational purposes only and are not intended to be legal advice. The law changes frequently and varies from jurisdiction to jurisdiction. Being general in nature the information and materials provided may not apply to any specific circumstances. Nothing on this blog is intended to substitute for the advice of an attorney. If you require legal advice, please consult with an attorney licensed to practice in your jurisdiction.

Tuesday, June 10, 2014

Donald Sterling & ... Charitable Foundations?

The Donald Sterling case continues to provide fodder for discussion of legal topics. The latest news is that part of the sales proceeds for the Clippers will be used to create a charitable foundation. According to this article, it will be 10% - or $200 million – of the total $2 billion sales price. http://www.cnn.com/2014/06/07/us/clippers-sterling-sale/

A charitable foundation is basically a private charity – in fact, the technical legal term is a “private foundation.” Just like a public charity, a charitable foundation must serve a charitable purpose. That usually means doing something beneficial that relates to health, education or the general public good. In this case it is reported that the foundation will aim to help “abused and battered mothers, underprivileged children and particularly those in urban, minority communities.” http://www.huffingtonpost.com/2014/06/10/shelly-sterling-charity_n_5475592.html

One reason wealthy people create charitable foundations is to avoid gift and estate tax. When a person dies, his or her estate is subject to estate tax if the estate is larger than a certain amount – for 2014 that amount is $5,340,000. However, property left to a charitable foundation is not subject to estate tax (or to gift tax during lifetime). Thus, charitable giving is usually an important part of estate planning for wealthy people.

Wealthy people certainly do make large gifts to public charities. For example, Michael Bloomberg, the former Mayor of New York, has given a staggering $ 1.1 billion to his alma mater, The John Hopkins University. http://www.nytimes.com/2013/01/27/nyregion/at-1-1-billion-bloomberg-is-top-university-donor-in-us.html?pagewanted=all&_r=0 But sometimes wealthy people prefer to create a private foundation, because then they can be sure the money will be used for the charitable purposes they really care about. For example, a major focus of The Bill and Melinda Gates Foundation is improving health and reducing poverty in the developing world. http://www.gatesfoundation.org/Who-We-Are/General-Information/Foundation-Factsheet

Some other well-known foundations are the Pew Charitable Trusts, created by the founder of the Sun Oil Company and his family, the Robert Wood Johnson Foundation, created by the founder of Johnson & Johnson and focused on health care, and the John D. and Catherine T. MacArthur Foundation of “genius grant” fame, just to name a few.

So how does the proposed Sterling Foundation stack up size wise against other charitable foundations? Well at $200 million it would not even make the list of the top 100 private foundation, falling short by a cool $500 million of No. 100, The Ford Family Foundation, at $721,115,314. http://foundationcenter.org/findfunders/topfunders/top100assets.html

Disclaimer – Postings Not Legal Advice

Monday, June 2, 2014

What the Sterling Case Tells Us about Defining Incapacity in a Trust

Don Sterling’s legal woes have of course been all over the news, and one topic that has been much discussed is the fact that the Clippers are owned by a Family Trust. It may be that this is a revocable trust, commonly referred to as a “living” trust. Such trusts are often used instead of a Will in order to avoid probate. Because California is a community property state, in California typically such a trust is created jointly by husband and wife, and both husband and wife act as trustees.

Another benefit of a living trust is that it can be used to manage property when someone becomes incapacitated. Usually the way this works is that the trust provides that if husband or wife become incapacitated, they will cease to act as trustee and the other spouse (or sometimes a third party, such as a child, close advisor, or professional trustee) will step in to act as trustee and manage the trust property. This can be a major advantage to provide continuity in the case of a business or other type of property that requires ongoing active management.

The key to making this type of trust provision work effectively is precisely that you don’t have to go to court to have someone declared incompetent, because going to court to get a person declared incompetent is a long, public and potentially expensive process. Instead, the trust itself typically specifies how someone may be determined to be incapacitated. For example, it might be by the unanimous decision of two physicians, or by the unanimous decision of a trusted friend and a physician. Such a provision might be along the lines of the following:

A trustee shall be deemed to be incapacitated if he or she is determined by two physicians (including such person’s personal physician, if any), at least one of whom is a neurologist, to be experiencing substantial difficulties in managing his or her financial affairs and that such difficulties are not expected to be short-term.

We do not know exactly what the wording was in the Sterling trust, although the gossip site TMZ sports has reported that it was “an inability to conduct business affairs in a reasonable and normal manner” as determined by two doctors. http://www.tmz.com/2014/05/30/donald-sterling-alzheimers-los-angeles-clippers-shelly/#ixzz33EKs9ypm It has also been reported that Mr. Sterling may be suffering from Alzheimer’s disease. We do know that this determination of incapacity has now become the focus of some controversy. On the one side is Mr. Sterling’s wife, Shelly, who claims that Mr. Sterling is incapacitated, meaning that she alone as the remaining trustee can decide whether or not to sell the Clippers. She has reportedly indeed agreed to sell the team to Microsoft billionaire Steve Ballmer --presumably much to the relief of the NBA, and for the staggering price of $2 billion! On the other side Mr. Sterling’s lawyers disagree, claiming that Sterling has only a “modest mental impairment” and is “slowing down,” but does not meet the definition of incapacity in the trust. http://www.cnn.com/2014/05/30/us/nba-clippers-sterling/ Because the sale to Mr. Ballmer avoids a forced sale by the NBA and is clearly at a tremendous price, it’s not entirely clear what Mr. Sterling’s objection to the sale is at this point. Moreover, he had already sent a letter to the NBA agreeing to the sale of the team.

Obviously this story is still developing, but at this point it looks as if the definition of incapacity in the Sterling Family trust did help to resolve a complex and difficult business situation fairly quickly. Thus, the Sterling case generally reaffirms the importance of including a definition of incapacity in a trust instrument, recognizing that such a provision is not an iron clad guarantee that the matter will avoid all dispute or remain entirely out of court.

Disclaimer – Postings Not Legal AdviceThis blog is not legal advice and no attorney-client relationship is formed. The information and materials on this blog are provided for general informational purposes only and are not intended to be legal advice. The law changes frequently and varies from jurisdiction to jurisdiction. Being general in nature the information and materials provided may not apply to any specific circumstances. Nothing on this blog is intended to substitute for the advice of an attorney. If you require legal advice, please consult with an attorney licensed to practice in your jurisdiction.

Saturday, May 17, 2014

Who Gets the Dog?

As a society our views about animals have changed significantly over the last 25 years. A recent book by David Grimm, wittily titled “Citizen Canine,” discusses many of the interesting legal issues that arise in the area of animal rights as a consequence of those changes. One, which we blogged about last month, is that a majority of states now have special laws to permit a pet owner to create a trust to care for his or her pet after death. This week we are writing about pet custody when pet owners divorce.

Despite the affection we may have for them, pets are still considered property for purposes of divorce law. That means a prenuptial or postnuptial agreement can be entered into to establish who gets ownership in the event of a break-up. Family lawyers have observed a rise in pet custody disputes, so entering into an agreement ahead of time may be a good solution. http://www.prnewswire.com/news-releases/pet-custody-disputes-on-the-rise-find-nations-top-matrimonial-lawyers-245220181.html For example, during the recent temporary (albeit dramatic) break-up of Johnny Weir and his husband, Victor Voronov, one of the subjects of dispute was custody of their Japanese Chin lapdog, Tema. Although Weir bought the dog, Voronov claimed the dog was gifted to him by Weir and that Voronov was the primary caretaker. Before they reconciled it was reported that a New Jersey judge had ordered them to temporarily share custody pending a final decision about ownership.

As with other issues in divorce, mediation may be a good solution to resolve a pet custody dispute. If the dispute does end up in court, some judges may evaluate the way the parties have cared for the pet and their relationship to the pet in order to decide who gets the pet. Last year a New York judge held a hearing, reportedly the first of its kind in New York, to determine which spouse’s ownership would be in the “best interests” of a dog named “Joey.” Such a hearing is similar to those held to determine contested child custody in a divorce. In a 2007 Virginia case the court actually appointed a lawyer to help determine the best interests of a dog who was the subject of a 4-way custody battle after the death of its owner. http://voices.yahoo.com/dog-involved-custody-battle-assigned-lawyer-335484.html?cat=17. In a recent Vermont case a judge held an extensive evidentiary hearing before awarding a dog, “Belle,” to the husband. The judge decided that the husband had taken better care of Belle during the marriage – the husband took Belle to work with him every day and, in the judge’s words, treated Belle as a dog, while the wife treated Belle as a child. http://www.courthousenews.com/2014/05/02/67558.htm

In general, factors that may be relevant in awarding custody include: whether the pet was owned prior to marriage by one of the parties, who cares for the pet on a day to day basis, whose schedule is better to set up to care for the pet, where the pet will be safest, and where any children of the marriage will be living (it may be the pet should be with the parent who has primary custody of the children).

Because they are considered property, some courts have taken the view that ownership of a pet must be awarded to one spouse or the other, with no power to direct visitation or other type of shared custody. In the Vermont case about Belle, the wife appealed to the Vermont Supreme Court, challenging also the judge’s refusal to order any shared custody. The Vermont Supreme Court, however, agreed with the trial judge. On the issue of shared custody the Vermont Supreme Court said: "In contrast to a child, a pet is not subject to a custody award following a determination of its best interests. Because a pet is property, the family division must assign it to one party or the other. Like other aspects of the property division, the assignment is generally final and not subject to modification. Unlike child custody matters, there is no legislative authority for the court to play a continuing role in the supervision of the parties with respect to the care and sharing of a companion animal." Courts in in several other states have reached a similar conclusion. On the other hand, in a 2010 case a Maryland judge directed a divorcing couple to share custody of a dog named Lucky – with each caring for the dog for 6 months of the year -- based on the theory that the dog was joint marital property under Maryland law. Lucky’s case shows that some judges may be more sympathetic to pet loving litigants than others. However, if the parties want to arrange shared custody it is probably better if they work that out privately rather than relying on a court which may conclude it lacks the power to do so.

Another family law related issue that has recently come up is custody of a pet in cases of domestic violence. A proposed New Hampshire Bill would let judges grant custody of pets and include them in a restraining order in some cases. The bill is intended to protect pets from domestic violence, and also give victims of domestic violence assurance that their beloved pets will not have to remain behind and be subject to abuse. There was concern that some victims of domestic violence might hesitate to leave if they had to abandon their pets. http://portsmouth-nh.patch.com/groups/politics-and-elections/p/pets-could-be-included-in-domestic-violence-law

Disclaimer – Postings Not Legal Advice

Wednesday, May 7, 2014

Estate planning for the “Modern Family

Do you watch “Modern Family?” Jay Pritchett is the family patriarch, age 60, a wealthy man presiding over his large family. He has a young wife, a baby son, a gorgeous home – and two of the most classic estate planning challenges.

First, he is married for the second time and has children by both his current and his prior marriage. That is a classic estate planning issue. Fulgencio (“Joe’) is his young son with second wife Gloria. Claire and Mitchell are his adult children from his first marriage. A complicating factor is that Gloria is much younger than Jay -- in fact Gloria is about the same age as Claire and Mitchell. And as if that wasn't enough, Gloria also has a minor child, Manny, from her prior marriage. Manny lives with Jay and Gloria and Jay considers Manny in all ways to be his son (although as far as we know Jay has not legally adopted Manny). That is a complicated family situation

Second, Jay is apparently the sole owner of his successful closet business, but only one of his children, Claire, works in that business. Although she only recently started working there after taking time off to raise her children, Jay seems to be planning for Claire to succeed him in running the business.

Jay definitely needs to consult a good estate planning lawyer! Maybe we will see that episode someday. In the meantime, we can speculate about what his estate plan might look like.

Make sure documents treat Manny as a Descendant. First of all, Jay would provide in his planning documents (Will/trust) that Manny is to be treated as his descendant for all purposes.

Set things up so Claire can run the business, but the whole family can own it. Jay would then probably take steps to separate the control of the business from the economic benefits, so that Claire can continue to run the business after his death even as Gloria and other family members also benefit economically. One way to accomplish that is to restructure the business (via an LLC or LP) to create two classes of ownership interest, one with control rights and one without, and with the control piece representing only a small part of the economic value. Jay can then gift or bequeath the control piece to Claire.

And maybe get a little fancy. If Jay wants to give up control during his lifetime, this can be even further refined. For example the control piece itself might be held by an LLC owned 1/3 by Jay, 1/3 by Claire and 1/3 by Mitchell. The advantage of this type of structure is that during Jay’s lifetime Claire and Mitchell would have to act together in order to overrule Jay (we can just see the TV episode when Jay tries to convince Mitchell to side with him). Seriously, Jay has invested a lifetime in the business, has been successful, and has a commanding personality, so this type of structure would probably be more comfortable for him and would also reflect the family dynamic. Mitchell is a lawyer and Claire and Mitchell get along quite well, so it is suitable for Mitchell to have some voice in the business; in fact, we suspect Claire would welcome his involvement especially after Jay’s death. Jay would then leave his 1/3 to Claire, so that she would control the business after his death.

However, there is also a major tax planning issue here because if the business is restructured so that Jay does not own a controlling interest at his death, then the business should also be worth less in his estate. If we assume Jay’s estate is well into the taxable range (north of $20 million) that may be a beneficial result. In fact, Jay might consider making lifetime gifts of non-controlling interests to a discretionary trust for the family, in order to take advantage of valuation discounts and other benefits of lifetime giving. Weighed against that is the fact that a lower estate tax value also means a smaller step up in basis for income tax purposes, and there is a carryover basis for gifts made during lifetime. We need to also consider that a large portion of Jay’s estate will likely be marital and Gloria is much younger than Jay and so can be expected to live for a long time after his death. Suffice to say this is a complicated analysis!

Leave Property to the kids in trust - and create the Pritchett Dynasty? . Jay would probably take advantage of the $5,340,000 federal exemption to give or leave property in trust for Mitchell and Claire, their children, and possibly their husbands (as Mitchell and Cam are soon to be married). Since Gloria is roughly the same age as Mitchell and Claire, they will likely not receive any benefit from Jay’s estate if they have to wait until after Gloria’s death. Because family relations are good, Claire and Mitchell and their husbands are self-supporting, and there are no special needs, a discretionary trust for the entire family would be a good option for this piece. Joe and Manny should also be included as beneficiaries of this trust, and Gloria can be included as well for maximum flexibility. Such a trust could serve as a “Dynasty Trust” to establish a long-term pool of protected wealth for the family which might well appeal to Jay.

Take Advantage of the Marital Deduction to leave property to Gloria. Jay would presumably use the marital deduction to leave the balance of his wealth to Gloria. She is young and has two children to care for, so she will likely have significant support needs after his death. Jay might consider leaving the bulk of that wealth in a QTIP trust, but also a part outright. Although there are many advantages to trusts, emotional factors are important, and Gloria may well feel that Jay didn’t trust her (no pun intended) if she does not receive a fairly sizeable outright bequest, perhaps 1-2 million dollars. That would not be inappropriate given what appears to be Jay’s significant level of wealth, and would also permit Gloria to benefit her own mother and other family members.

Watch the Retirement Assets. If Jay has any retirement accounts, those should pass to Gloria at his death. Because retirement accounts are IRD and Gloria is so much younger than Jay, Gloria will likely benefit from rolling those accounts into her own retirement account and deferring the payout.

Community Property? We should note that California is a community property state and there is no indication that Jay and Gloria have a prenuptial agreement, so Gloria would be deemed to own ½ of the community property in any case. With regard to Jay’s business in particular, some part of the business reflecting the earnings during the marriage is presumably community property. However, Gloria would likely be willing to transmute property or otherwise engage in any planning steps that would benefit the family overall. On the plus side, the entirety of the community property would receive a step up in basis at Jay’s death.

Avoid Probate & Plan for Incapacity with a Living Trust. Finally, Jay would almost certainly use a living trust to avoid probate, ensure continuity of management for the business and incorporate planning for incapacity.

Pay for Alex to go to college & Lily to go to pre-school. And by the way, Jay should be paying school tuition for all the grandkids, from Lily’s pre-school all the way to Hayley’s community college. Paying school tuition is one of the best ways to transfer wealth and benefit a modern family.

Disclaimer – Postings Not Legal Advice

business prior to marriage and continue to

Tuesday, April 29, 2014

Using Trusts in Estate Planning for the Second Marriage

The recent news reports about Oleg Cassini’s estate got us thinking about estate planning for second marriages, particularly a second marriage where the spouse is the same age (or in some cases even younger) than the children from a prior marriage.

One possibility when there are children from a prior marriage is to use a trust for the second spouse for life, with remainder to the children. The goal is to provide for the support of the spouse during his or her lifetime, but ensure that the children will receive their inheritance after his or her death. By using a trust, the spouse cannot control what happens to the property and divert it away from the children (for example, to a subsequent spouse and/or children). An impartial trustee can ensure that the trust is well managed and any distributions comport with the trust terms. That may be a workable strategy when the children are adults who don’t need immediate access to the wealth after the death of their parent, and the spouse is close in age to the deceased parent. But what if that is not the case? What if the decedent does have minor children from a prior marriage or relationship, so that the decedent will need to meet the support needs of both the children and the surviving spouse? Or what if, as in the Cassini case, or even TV’s “Modern Family”, the surviving spouse is around the same age as the adult children, so that waiting to inherit until after the death of the surviving spouse is not a viable option?

The best approach in such a case may be for the decedent to create two separate pools of wealth, one for the children and one for the surviving spouse. This can be accomplished by simply dividing the estate under the Will into a share for the spouse and a share for the children. The spouse’s share can still be in trust, with the remainder after death going on to the decedent’s issue, so that the wealth stays in the family. The main problem with this approach is that if more than the $5,340,000 exemption is left to the children, the estate will be subject to federal estate tax, which is not at all desirable. In such a case the pool of wealth for the children will likely have to be created either by well-structured lifetime transfers and/or by life insurance held in an irrevocable life insurance trust (ILIT) for the benefit of the children.

Another option would be a shared discretionary trust with both the spouse and the children as beneficiaries. The advantage of this approach is flexibility in that the property can be made available to the entire family with distributions made to those who most need it from time to time. The disadvantage is that unless family relationships are excellent, a shared trust is highly likely to become a bone of contention and cause conflict within the family – again, not at all a desirable result. Also, such a discretionary trust could only be used in any case up to the remaining exemption amount before federal estate tax would be imposed.

The emotional factors at play in a second marriage situation can make estate planning challenging. Ideally such planning will reduce the risk of dispute between spouse and children by providing appropriate wealth and financial security for all parties.

Disclaimer – Postings Not Legal Advice

Monday, April 21, 2014

Estate Planning With Basis in Mind

Income tax aspects are an important part of estate planning. One of the most crucial of those aspects is the distinction between the “carryover basis” rule for gifts and the co-called “step up” in basis rule for inherited property.

Under the carryover basis rule for gifts, the donee usually takes over the donor’s basis. So for example, let’s say father Frank buys stock for $1,000. Frank is a savvy investor, and a few years later the stock is worth $10,000. Frank then gives the stock to daughter Diane. Diane’s basis in the stock is $1,000, “carrying over” Franks basis. Consequently, if Diane sells the stock for $10,000 she will have taxable gain of $9,000 (the difference between the $1,000 basis and the $10,000 sales price).

By contrast, inherited property gets a new basis equal to its value on the date of death. This is called the “step up” in basis – although of course it could be a step down in basis in some cases, depending on the value of the property at death! The step up applies even if no estate tax is due at death. All that is necessary is that the inherited property be included in the federal gross estate. So going back to our example, let’s say instead of making a gift when the stock was worth $10,000, father Frank died and Diane inherited the stock from him at that time. In that case, Diane’s basis in the stock is $10,000, equal to its value at the date of Frank’s death. Consequently, if Diane were to sell the stock for $10,000, she would not have any taxable gain.

Traditionally, people were usually more concerned about estate tax than income tax consequences. In the first place, estate tax rates were much higher than long term capital gains tax rates. In addition, estate tax was imposed at a much lower level of wealth —for example, in 2004 there was only a $1.5 million federal estate tax exemption. By contrast, the federal estate tax exemption is now $5,340,000 (and is scheduled to be increased for inflation in future years). Meanwhile, the top federal estate tax rate is now lower at 40%, while the top long-term capital gains tax rate is now 23.8% (including the ACA surtax), and 28.7% on average if state capital gains taxes are also taken into consideration. As a result, fewer people are paying estate tax and planning to avoid capital gains tax has greater significance.

Interestingly, if assets have gone down in value from the date of purchase, the gift basis for gain could actually be higher than the inherited basis. Even if the fair market value is lower than basis at the time of gift, if the property is later sold at a gain the donee can still use the donor’s carryover basis. For example, let’s say mother Meg buys stock for $1,000 and it goes down in value to $800. If Meg then gives the stock to son Sam, Sam’s basis for gain is still $1,000, the “carryover” of Meg’s basis. On the other hand, if Meg dies and Sam inherits the stock, Sam’s basis is only $800, the value of the stock at the time of Meg’s death.

In such a situation a prospective donor like Meg might choose to sell the property and take the loss assuming he or she can use it. However, some property is not easy to sell, and/or the donor may wish to pass certain property on to family members regardless of its current value. In that case, it may be better to gift the property to take advantage of the higher carryover basis. To preserve the opportunity to make such a gift it may be important to have a durable power of attorney in place that grants broad gifting authority, as the donor may lack capacity to make gifts in the period before death.

In the case of assets that have increased in value from the date of purchase, if the estate will not be subject to estate tax it is likely better from an income tax standpoint for the recipient to inherit the property and get the step up than to receive it by gift – recognizing that there is no absolute certainty that the estate will remain low enough to be non-taxable (and that the tax law could also change again). In this stratum of wealth the desire to actually include assets in the estate has led, for example, to renewed interest in retained life estates, by which property can be technically given away during life but yet included in the estate at death to get the step up in basis.

If the estate is of a size that estate tax is likely to be a concern then many factors -- including the overall size of the estate, post gift appreciation, future exemptions and rates of tax and the basis of the property -- will be relevant in evaluating whether a lifetime gift is likely to be more beneficial than holding the asset until death. In general, this is a complex analysis but may at a minimum argue in favor of making any gifts in trust to maintain some flexibility in tax planning.

Disclaimer – Postings Not Legal Advice