Eleven Estate Planning Mistakes to be Avoided

We have all heard the probate horror stories. Someone’s last will and testament took five years to be probated, generating hundreds of thousands of dollars in attorneys’ fees. All of the assets from someone else’s estate were stolen by the personal representative (executor), leaving the family with nothing. The probate judge was unfair. Such stories instill fear about probate administration, which can lead to estate planning decisions with unintended consequences.

The following are the top eleven mistakes one should avoid:

1. Adding a Child’s Name as Co-Owner to Residential Deeds, Vehicle Titles, Brokerage Accounts, etc.

Adding a child’s name to a deed, title, or account as a co-owner conveys ownership, with all the legal rights and responsibilities that go with it. Parents usually regret this decision once they learn that they cannot sell, mortgage, or even refinance their home without their child’s consent and involvement. For bank or brokerage accounts, distribution checks cannot be cashed or rolled over without the signature of all listed owners. Perhaps the most important concern is liability exposure. Assets to which child’s names are added are at risk for levy by their creditors.

Capital gains taxes are a rarely considered, but very important concern. In most situations, when one sells a capital asset such as a home, the capital gains tax would be based on the difference between the sales price and the original purchase price. This is known as the “tax basis.” Typically, when a child inherits a home from his parents, he enjoys a “step up” basis, meaning his tax basis would be the value of the home at the time of his parents’ death. Then, if the child immediately sells the home, there would be no capital gain.

If the child is added to the deed prior to the parents’ death, however, he will only enjoy the step up in basis for the percentage of the home he did not own prior to his parents’ death. Depending on the value of the equity in the home, adding a child’s name to the deed may create a “taxable event,” requiring the filing of a federal gift tax return.

2. Leaving Everything to One Child, with the Understanding that He or She “Will do the Right Thing”

Many parents will add the name of just one of their children to their assets, with the understanding that this child “will do the right thing” for his siblings. Typically, the selected child is either the oldest, the perceived smartest, or simply the one who happens to be still living at home. These arrangements are almost always an invitation for probate litigation, especially when the selected child feels entitled to more than his fair share.

3. Having Estate Planning Documents Prepared by an Inexperienced Attorney

Some inexperienced attorneys present seminars for the sole purpose of scaring people away from probate and toward more costly estate plans involving the use of trusts. These attorneys may not mention, however, that some smaller probates may be completed quickly in Probate Court, with just a simple will. While estates with complex tax considerations typically require the use of trusts, some estates would be better served by administration through the Probate Court. For example, if there are concerns regarding the trustworthiness of the named trustee, then court supervision may be necessary to ensure the proper distribution of assets. An experienced planning attorney will take a detailed history for each client, analyze it, and then provide the pros and cons for each estate planning option.

4. Poor Trustee Selection

If an estate plan requires a trust, the most important decision with respect to the plan will be selection of the trustee.  Michigan law provides enormous power to trustees. In most situations, the selected trustee will manage and distribute your assets without court supervision. Too often, the person for whom the trust is drafted will select a favored son-in-law or best friend who happens to be “good with numbers.” This should not be the primary consideration.

Trustees are usually permitted to hire attorneys, accountants, financial planners, and other professionals to assist in the administration of the trust. Instead, the individual selected to serve as trustee should be the one believed to be the most trustworthy. The trustee should share the person’s goals and values and should have a clear understanding of how the person would want his assets to be managed and distributed.  Absent court intervention, the trustee will have complete control over the trust’s checkbook.

5. Improper Tax Planning

An estate plan that reduces probate fees will not necessarily reduce the federal estate tax. Probate fees are governed by state law, and the federal estate tax is calculated according to the Internal Revenue Code and corresponding Treasury Regulations. For example, naming a beneficiary on an insurance policy will avoid probate, but the face value of the insurance policy could still be subject to the federal estate tax.

The estate tax exclusion amount was finally made permanent by Congress in 2012. For 2014, single taxpayers may now exclude up to $5,340,000 from the federal estate tax.

Married couples, if proper planning is in place, may exclude up to $10,680,000 by either using credit shelter trusts or by electing portability as provided by the 2012 Tax Act. To elect portability, an Estate Tax Return (IRS Form 706) must be fi led by the deadline.

With over $10,000,000 available for their applicable exclusion amount, married couples may be tempted to ignore estate planning altogether. However, couples who have credit shelter trusts in place as part of their estate plan should meet with an experienced estate planning attorney to determine whether the use of credit shelter trusts is still necessary to achieve their goals. Otherwise, surviving spouses could find that access to their once joint accounts is unnecessarily restricted by an outdated estate plan. An outdated estate plan may also subject certain trusts to the new 3.8% Net Investment Income Tax imposed by the Affordable Care Act, also known as “Obamacare.”

6. Failure to Plan by Same-Sex Couples with Recognized Marriages

In United States v. Windsor (June 26, 2013), the U.S. Supreme Court overturned the Defense of Marriage Act (DOMA) on constitutional grounds. Specifically, the Court found that DOMA violated the Equal Protection Clause of the Fifth Amendment. The IRS then issued Revenue Ruling 2013-17, and IRS News Release 2013-72, which state that the terms “marriage” and “spouse” in the Internal Revenue Code will be interpreted as including same-sex marriages. The Revenue Ruling also provides that a same-sex married couple’s state of residency is irrelevant for purposes of Federal recognition of the marriage, so long as the individuals are lawfully married in a domestic or foreign jurisdiction whose laws authorize same-sex marriage. This means that the IRS will recognize same-sex marriages only, and not registered domestic partnerships, civil unions, or other similar formal relationships that are not specifically denominated as a marriage under the particular jurisdiction’s law.

Just as importantly, the IRS will apply this Revenue Ruling retroactively, for “open tax years.” For most taxpayers, open tax years will generally mean within the three-year statute of limitations. So same-sex married couples may file amended tax returns and claim refunds going all the way back to 2010 or earlier for special circumstances, such as if the taxpayer had signed an agreement with the IRS to extend the statute of limitations.

7. Failure to Complete the Estate Plan

This is perhaps the saddest and most frustrating mistake. Probate attorneys see many beautifully drafted trusts with nothing in them. To fund a trust, one must legally place the desired assets into the trust by either designating the trust as the owner, naming the trust as a beneficiary, executing an assignment, or by executing a pour-over will with the appropriate provisions. Assets should also be listed in the trust’s schedule of assets. Each method of funding has a different purpose and tax consequence.

A failure to fund a trust means that the assets will pass to beneficiaries through probate or in accordance with the last beneficiary designation on the account or insurance policy. The result could be that the wrong beneficiaries receive the wrong assets, with possible adverse federal estate tax consequences. Expensive litigation could then follow.

Equally important to the failure to fund a trust is the funding of a trust with inappropriate assets. For example, it is not always advisable for a married couple to place their primary residence into a trust, because this would alter their ownership as a “tenancy by the entireties.” The result could be decreased protection from creditors. While there are circumstances in which it would be appropriate to place a primary residence into a trust, this should never be done without the advice of an experienced estate planning attorney. The same rationale applies to Individual Retirement Accounts (IRAs).  Changing the ownership of an IRA from an individual to a trust creates a “taxable event” and could have adverse tax consequences.

8. Failure to Preserve Homestead Exemption

If a primary residence is placed into a trust, the correct statutory election should be made with the local municipality in order to preserve the Homestead Exemption. This is necessary in order to limit the rate at which the local municipality can increase property taxes.

9. The Unknown Estate Plan

All the money, time, and effort that one puts into an estate plan will be useless if no one can find it. Fiduciaries and/ or beneficiaries should know that an estate plan exists and where the documents are located.

Depending on the bank, beneficiaries may need a court order to gain access to a safe deposit box. Some banks will allow limited, supervised access to a safe deposit box in order to allow family members to view a will. One should be familiar with the bank’s policies and procedures regarding access. Other options for storing planning documents include a fireproof safe at home or the attorney’s office. Wills may be filed with the County Probate Court.

If confidentiality is not an issue, some insurance claims adjusters have recommended that important documents be stored in the refrigerator. If the seal remains intact, the refrigerator may provide better protection from fire and water damage than a desk drawer.

10. Burial Instructions Contained in Wills

In most cases, wills are not reviewed until after the funeral. So, if one wishes to be buried in a Corvette, arrangements should be made outside of the estate plan.

11. Unequal Distributions among Children

An estate plan that provides for unequal distributions among children is not a mistake, per se. However, unequal distributions may cause discord among the children and then lead to probate litigation. Such estate plans should be created only after careful consideration.

Some parents may leave more money to an irresponsible child, under the belief that this child “needs the money more.” The unintended message, however, could be that the irresponsible child is being rewarded, while the responsible children are being punished. Other parents amend their estate plans often, disinheriting children and then bringing them back as a form of punishment or reward for particular behavior. When creating an estate plan, parents should be mindful that this could be their last word to their children.  There may not be time to amend the estate plan after the family fight of the week is resolved.

Attorneys at CMDA are available to prepare estate plans, answer questions, and review estate plans currently in place to ensure that the plans are updated as tax laws and family situations change.

Linda Davis Friedland is an attorney in our Livonia office where she concentrates her practice on commercial litigation, employment and labor law, corporate and business law, estate planning, utilities law and municipal law. She may be reached at (734) 261-2400 or lfriedland@cmda-law.com.