A recent Tax Court case, Estate of Minnie Lynn Sower, http://www.ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=11392, illustrates that, even though there is no estate due and a 706 return is filed to claim a deceased spouse’s unused exemption amount (“DSUE”) to preserve portability, care must still be exercised in preparing that return.
In Sower, the Tax Court re-examined the estate of the first spouse to verify that the DSUE claimed by the second spouse on her estate tax return was correct. As it turned out, the first spouse failed to report some lifetime gifts. The result, with penalties assessed, was that virtually all of the DSUE was lost. This was the case even though the executor of the first spouse had obtained a closing letter.
The Tax Court rejected the argument that the IRS was conducting a second examination of the first spouse’s return. Instead the Court said the IRS was examining the first spouse’s return only to properly evaluate the second spouse’s DSUE for her return. The Court further rejected the estate’s argument that looking at the first return violated the statute of limitation because the portability provision has no statute of limitation. As Stephen King once wrote “eternity is a long time.”
Texas has one of the most expansive homestead laws in the country. Homestead designation protects the homeowner from creditors claims, other than certain taxes and loans secured with the homestead. This blog post will cover the types of Texas homesteads, and who benefits from homestead designation.
Types of Homesteads
There are two types of homesteads, urban and rural. You have one or the other, not both. An urban homestead is limited to ten acres and is located in a municipality served by police and fire protection with at least three municipal services provided, such as water, electricity and gas. A rural homestead is any homestead that doesn’t meet the criteria for an urban homestead. A family can have a rural homestead of up to 200 acres, a single person 100 acres.
Tex. Prop. Code Ann. 41.002
Who May Claim Homestead Protection
A family may claim homestead protection. A family is a head of household, and those bound by blood or marriage that are depend on the head of household for support. This covers a spouse and minor children, but may include adult children in certain cases, such as an adult child living with a parent while attending college.
A single adult can claim homestead protection for an urban or rural homestead, but, in the case of a rural homestead, the homestead is limited to 100 acres instead of 200 acres.
The deceased spouse’s homestead rights pass to the surviving spouse so long as the surviving spouse continues to occupy the homestead.
Surviving Minor Children
The surviving minor children of deceased parents, have the right to claim their deceased parents’ homestead for the duration of their minority. This right pertains even if the minor children were not living in the home at the death of the parents.
The special occupancy rights of the surviving spouse or surviving minor children persist unless abandoned. The burden of proving abandonment is on the party seeking to terminate the homestead rights.
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The probate question I get asked the most often is whether a client should use a living trust to avoid probate. In many states the answer is an unqualified “yes.” In Texas, the answer is “it depends, but probably not.”
A living trust is a revocable trust to which the client will transfer his or her assets during life. Since the trust owns the assets and not the client, there are no assets to probate at the client’s death. Typically, a living trust is more expensive to complete than the drafting of a will, since the client will have to pay for the lawyer to draft conveyance documents to transfer the assets to the trust. Of course, the cost of probate is avoided when the client dies.
Probate in many states can be a slow and expensive process. Some states set fees for the court and attorneys, and most states require court approval of most executor actions during the probate process. Texas is somewhat unique in that it has probate system that is largely independent of court approval. Typically, the only trip to probate court the executor will make is the hearing to prove up the will and become appointed as the independent executor. The executor will have to file various notices and prepare an inventory of the estate’s assets, but will not have to seek approval from the judge to proceed with his or her duties.
Historically, one advantage of the living trust, even in Texas, is privacy concerns. Probate proceedings are public record, and the executor has to prepare an inventory listing the assets of the estate which is filed in the probate proceeding. A few years ago, however, Texas probate law was changed to allow the executor to file an affidavit in lieu of the inventory if the executor has paid off all unsecured debts of the estate. The executor still has to prepare the inventory, but does not have to file it.
It should be noted that while a Texas resident need not worry too much about avoiding probate in Texas, he or she should make sure probate is avoided in other states if property is owned there. For example, a Texas resident may have a vacation home in Colorado, and an ancillary probate in Colorado would be required to transfer ownership of the Colorado property to loved ones. Ancillary probate can be avoided by transferring the Colorado to a trust or limited liability company.
Asset protection planning is complicated. While estate and trust law changes very slowly, debt/creditor law can be quite dynamic in comparison. Good planning needs to take the long term perspective, and avoid a cookie cutter appearance.
Based on my experience, there are a few general rules I follow.
- Pigs get fat, and hogs get slaughtered. If there are any potential liabilities on the horizon, do not put assets in excess of those potential liabilities into an asset protection structure.
- Stay Home. A judge in the state of your residence is not going to like (i) an offshore arrangement, (ii) a nonresident domestic asset protection trust or (iii) an LLC or limited partnership organized under the laws of another state. There is a lot you can do under the laws of the state of residence. Focus there first.
- Control. There is an inverse relationship between the amount of control you retain and the effectiveness of your planning. Trust planning is most protective with an independent trustee with unfettered discretion over distributions. Cultivate a close relationship with a financial institution with a trust company. A corporate fiduciary with whom you have a close relationship can be a significant asset when undertaking asset protection planning.
- Business or Estate Planning Purposes. The best asset protection planning is planning that has the primary objective of meeting a business or estate planning purpose, with the ancillary benefit of asset protection.
If you follow these general rules, then you castle will have a solid foundation rather than a foundation of sand waiting to be blown away in a storm.
In my last blog post I noted that it might be a good time to reconsider discount planning with family limited partnerships (FLP). That thought has only increased over the last few weeks as the chances for tax reform dwindle. Indeed, while political predictions are a fools game, we now have to seriously consider a move left in 2020 and, at best, a stalemate until then. The move left could endanger discount planning again, so the next few years might be a window to make use of this kind of planning.
While this planning can involve transfers downstream via dynastic trusts, it can also involve leveraging the lifetime exemption using FLP discounts via gifts to spousal lifetime access trusts (SLATs). A SLAT is an irrevocable trust benefiting the spouse, and then descendants. Each spouse can create their own SLAT, provided they avoid the reciprocal trust doctrine, and the marital estate can still have use of the gifted assets during their joint lives. In December of 2012, with the risk of the lifetime exemption being reduced, many, many SLATs were implemented.
SLATs raise a number of issues to work through, in addition to the aforementioned reciprocal trust doctrine, but, in the right circumstances, they over an elegant solution that offers a bit of a have your cake and eat it too flair.
Earlier in the year the Treasury announced that it would undertake a review of regulations issued since January 1, 2016. Recently, in Notice 2017-38, the Treasury identified eight regulations for burden reduction, including the controversial proposed regulations under Internal Revenue Code 2704. Those proposed regulations would have severely restricted the use of valuation discounts in family owned entities, such as family limited partnerships and limited liability companies, when they became final.
Given that estate tax repeal is becoming less and less likely, it would seem to be time to began consideration of discount planning again. Even if repeal occurs, there are non-tax reasons for moving wealth downstream, and it is possible that the political winds could shift significantly in the other direction soon and discount planning could be under attack again.
As we watch Congress for clarity on tax reform, I am reminded of the Tom Petty song “The Waiting.” Many clients are frozen, unwilling to do any planning. However, the fact is tax law changes all of the time, and any “reform” today may be gone tomorrow. Life and death go on. The real reasons for planning transcend tax law.
You want to take care of your loved ones, and, if you have done well and have charitable goals, you want to leave something for the causes you care about. The basic structure of a will is not going to change much even if the transfer tax is repealed. You will still want to protect your loved ones from the uncertainties of this world, and possibly from themselves. So trusts will still be used for protection from lawsuits and divorce, and to create a protected family resource for lending and entrepreneurship.
In addition, I have found that, while clients may be motivated a bit by tax reasons for gifting during life, they often enjoy watching their loved ones enjoy the life experiences those gifts bring. The same is true for charitable giving.
Good planning should not be dependent on tax motivation. Good planning should not wait for tax motivation. So get on with it!
There are three basic types of intellectual property (IP): copyrights, trademarks and patents. Copyrights do not protect ideas, but do protect the way those ideas are expressed. Trademarks protect logos, slogans or other ways a business is identified. Patents protect inventions.
IP presents unique challenges for estate and business planning. It is a difficult asset to value. So before any arrangements are put in place, the client should engage an appraisal firm with IP expertise to assign a fair market value (FMV) for the IP. Once FMV is known the client can consider estate planning or financial transactions with the IP. For example, it is not unusual for a client to hold his IP in a separate entity from his business and enter into a license agreement with the business entity. The license agreement could be challenged as disguised salary if the licensing fee is not at FMV.
Copyrights and trademarks can last a long or indefinite amount of time, although, with respect to trademarks, they must be renewed every ten years. Patents, on the other hand, have a limited life, typically 20 years. These differences need to be taken into account when formulating planning ideas. A client with IP consisting largely of patents, for example, could license them to the business to provide retirement income, while the asset depreciates over time reducing his taxable estate.
In addition to the valuation difficulty, IP is an asset class that requires attention. Filings need to be renewed, and rights need to be defended if challenged. The client should identify people with knowledge of this area of the law during his life so that the value of the IP can be maintained after his passing. For example, probate alone will not transfer a patent. The executor must also file transfer documents with the USPTO.
Estate of Powell, http://ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=11260, is a recent Tax Court case that illustrates how not to do it. It involved perhaps the most aggressive deathbed planning I have ever read about. The decedent’s son, acting under a power of attorney that didn’t give him full authority to do the planning he undertook, transferred marketable securities to a new family limited partnership (FLP) in exchange for a 99% limited partnership interest. The son, then transferred the limited partnership interest to a charitable lead trust. Two of decedent’s sons transferred cash to the FLP for the general partner interest. The decedent died seven days later.
Given the facts is no surprise that the taxpayer lost this case, but Powell is significant because it extended Code Section 2036(a)(2) to a situation where the decedent only owned the limited partnership interests. The Court basically said the decedent’s lack of ownership in the general partner interest was illusory because the son acted for her under the power of attorney.
The majority opinion also, on its own accord, raised the possibility of double inclusion under Code Sections 2036, 2033, and Code Section 2043. That analysis is beyond the scope of this post.
Suffice it to say that just as Citizen Kane expressed regret about the road his life had taken on his deathbed by whispering “Rosebud,” aggressive deathbed estate planning can leave surviving family whispering their own words of regret…but those words probably are best left unsaid. And as planners we may be left whispering our own words of regret because often bad facts make for bad law, and this may be one of those times.
About Grady Dickens
I created this blog to comment on items of current interest regarding trusts, estate planning, charitable planning and tax law, and share my knowledge and over thirty years of experience as an attorney practicing in Dallas, Texas.