The new tax act temporarily increases the lifetime estate exemption to $11.2 million. This change took effect on January 1, but sunsets on December 31, 2025. On January 1, 2026, the exemption reverts back to the current $5.6 million, subject to inflation adjustment. It is quite possible that the larger exemption doesn’t make it to December 31, 2025, if there is a Democratic administration and Congress come January 2021.
The upshot is that for wealthy clients there is a window to make lifetime gifts to take advantage of the temporary increase in the lifetime exemption. There are many ideas to consider, but in this blog post I want to mention the spousal lifetime access trust (SLAT). With a SLAT the grantor makes a gift to a trust that benefits his spouse or his spouse and descendants. The spouse may serve as trustee, if the trustee is limited to an ascertainable distribution standard.
If both spouses do SLATs, a couple has the opportunity to “lock” in the increased exemption amount and transfer a whooping $22.4 million free of estate tax to younger generations. With discount planning the amount could be even bigger.
If both spouses seek to do SLATs they must avoid the reciprocral trust doctrine, but that can be done with careful planning.
If you own real property outside of your state of residence when you die, you will have to conduct an ancillary probate in that state to transfer title to the property to your beneficiaries. In some states, like Texas, ancillary probate is a simple process of recording copies of the out of state probate in the state in which the real property is located. In others, the process is more complicated and will require hiring an attorney in the state and prosecuting a court proceeding.
One way to avoid ancillary probate is to form a limited liability company (LLC) or limited partnership (LP) to own the out of state property. If the client does this then he will no longer own real estate out of state. Instead, he or she will own an interest in an entity that owns real estate in that state. Accordingly, there is no longer the need to prosecute an ancillary probate. The entity can be formed in the client’s state of residence, the state the property is located or some other jurisdiction. It doesn’t matter. Use of the LLC or LP also adds a layer of asset protection for the client.
Note that using an LLC or LP doesn’t mean the client will not owe property taxes or income taxes (if a rental property) in the state in which the property is located.
As we wait to see if Congress can pass a tax bill, we now know that estate taxes for the very wealthy will not be repealed immediately or at all. The House bill that was passed yesterday bumps the lifetime exemption to $10 million indexed for inflation and retains the estate tax through 2023. The Senate bill, which is still being debated, doubles the existing lifetime exemption and retains the estate tax indefinitely. It is important to understand that since 60 votes was impossible in the Senate, a bill will have to be passed through reconciliation. This means it will be subject to sunset in ten years, so Congress would have to act to make it permanent. If not, the law will revert to the way it was before the bill was enacted into law.
But any bill may have a much shorter life. Polls show the bills are extremely unpopular. Polls also show historic unpopularity for the President and the Republican Congress. Accordingly, there is a significant possibility that any tax bill would be partially or completely undone by the next Administration and Congress.
Accordingly, if a tax bill is enacted into law, wealthy individuals would be wise to consider taking advantage of the increased exemption amounts by making gifts next year. As previously noted on this blog, discount planning is alive and well again. So leveraging the large exemption to migrate wealth downstream presents a compelling opportunity. This is particularly so when transfers are made to perpetual dynastic trusts. Next year may be a very busy year.
A power of attorney is a document in which you give someone else the power to act on your behalf for financial transactions. Texas, like many states, has adopted a statutory durable power of attorney form. The form has a laundry list of transactions from which you can pick and choose from, and you can add additional powers as you wish. The most significant issue to decide is whether to make the power effective immediately or become effective upon disability. The problem with making the power effective upon disability is that the powerholder will have to prove disability to the third party to whom the power is presented. Accordingly, I usually recommend that the power of attorney be effective immediately. Now there have been situations in my career, where husband and wife didn’t trust each other, and were insistent on making the power effective upon disability. They probably should have come to see a marriage counselor, instead of an estate planning lawyer.
In certain cases, such as where the the client has complicated assets, it is recommended that the client go beyond the statutory form and prepare a power of attorney that addresses specific transactions that might arise in the management of these complicated assets.
Powers of attorney are a simple but important piece of any adult’s personal planning. Usually used in the case of an illness or travel, they can be a lifesaver in more dire situations. I remember years ago a client came to me with the follow situation. Her husband had disappeared (his car was found abandoned on the way to work), but no body was found. Since he couldn’t be presumed dead under Texas law for four years, the wife couldn’t sell the family home. With the husband being the sole provider, she was forced to give up the home in foreclosure.
Proposed Valuation Discount Regulations Under Section 2704
This week the Treasury pulled proposed regulations under Code Section 2704 that would have virtually eliminated valuation discounts for family limited partnerships. https://www.journalofaccountancy.com/news/2017/oct/treasury-will-pull-sec-2704-and-other-burdensome-rules-201717601.html
This was not surprise, as a prior blog post noted. So there is a window that is wide open for discount planning, and this planning will be useful whether or not the estate tax is repealed. This is because even if there is repeal (i) it will be done through reconciliation, meaning the estate tax very likely will reappear in ten years and (ii) the gift tax will remain.
Republican Opposition to Estate Tax Repeal Emerges
Reports are emerging that several Republicans oppose elimination of the estate tax. http://www.foxbusiness.com/features/2017/10/05/senate-gop-hits-resistance-on-estate-tax-repeal-from-republicans.html In addition, there are also reports that the Trump administration is thinking of removing it from the tax reform package. https://www.reuters.com/article/us-usa-tax-estate/white-house-weighs-abandoning-estate-tax-repeal-in-republican-tax-push-idUSKCN1BU2YS Regardless, the path to tax reform is a complicated one and most experts do not think it is possible to get a bill to the President by the end of the year.
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.
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.