Chapter 4

There are many ways for property to be disbursed. Property can be given before death as a gift, at death through a will, or at some specified time through a trust document. These are not the only ways to move property from one person or entity to another, but they are the most common forms.

Although gift giving is generally an effective tool for estate planning, gifts can also sometimes be taxable. Naturally, no one should give away property that they may need to live on in the future. Since future events may be uncertain at best, extensive gifts should be limited.

GIFTS:

A gift is generally considered to be any gratuitous transfer of property. The Donor is the person who gives the gift. The Donee is the one who receives the gift. Taxation occurs when the value of the gift is over a certain dollar figure.

There are three conditions that must be met to qualify a transfer of property as a gift:

1. The transfer of property must be for less-than-adequate consideration. This means that the gift given was not compensated for by the donee in any adequate fashion. Say, for example, that Mr. Jones gives his son, Howard, a parcel of property. In return, Howard thanks his father and promises to be a good son. Howard's verbal thanks is not adequate monetary compensation. Therefore, the land is a gift.
2. The donor must actually deliver the gift to the donee. In other words, if Mr. Jones merely promised Howard the land, but never actually transferred the title, no gift was given.
3. The donee must lastly, accept the gift. If Howard refused his father's gift of land, the transaction cannot be completed. Say, for instance, that the land Mr. Jones wishes to give to his son was barren and of little value for any practical use. Once transferred, Howard would be responsible for the property taxes on that parcel of land. If Howard did not want to pay property taxes on property he had no use for, he might decide to refuse the gift.

Sometimes a gift transfer is not completed for technical reasons. A sick person may gift property to transfer at his or her death. If that person recovers from their illness, the gift transfer may not complete itself for a long time, or perhaps, due to changes, never occur.

A gift of cash issued by check is not complete until that check is cashed. If the check becomes lost in the mail the gift transaction cannot be completed.

Transfer of US government bonds occurs under federal law rather than state law. Under federal regulations, the gift transfer is not complete until the registration has been changed to the donee.

Gifts given through a revocable living trust are Incomplete Gifts in Trust. The donor has the right to change his or her trust at any time. Only death actually completes the gift transfer assuming the donor did not revoke the gift during their lifetime. An irrevocable living trust would complete the gift transaction before death. In an irrevocable trust, the donor gives up all further control on the property.

Gifts given through revocable living trusts are considered to be

Incomplete Gifts in Trust because the donor

has the right to change his or her trust at any time.

There are several types of gifts. Direct Gifts are probably the most common. As the name implies, property is simply transferred to another. This often happens when a money transaction begins as a loan. For example, Sam Jones loans Howard $40,000 for a down payment on a new home. Howard signs a note agreeing to pay his father back. After consideration, Sam decides not to require that Howard pay him back, so he cancels out the note Howard signed. That $40,000 now becomes a gift.

Third Party Transfers involve three people or three groups of people. Typically, the first party provides a gift to the second party who agrees to provide a service to a third party. The third party is the Donee. The first party is the Donor.

Indirect Gifts are more common than we might realize. For instance, Howard is fired from his job, so his father pays Howard's life insurance premiums for him. That is an indirect gift. An indirect gift also occurs when property rights are shifted.

Life insurance is often an indirect gift. This happens when the insured buys a policy on his or her own life and:

Retains no reversionary interest;

Makes the beneficiary irrevocable; and

Names a beneficiary other than his own estate.

Life insurance is often an indirect gift.

To illustrate this, let's say that Janet Jones owns a policy on her husband, Sam Jones. Janet makes the beneficiaries her grandchildren. When Sam dies, the IRS could argue that the death benefit was a gift. In other words, Janet gave that money to her grandchildren. Therefore, it may be taxed as a gift.

There are gratuitous transfers that are not considered by the IRS to be gifts. Since services given are not considered to be property, one could give their time or services without fear of a gift tax. Transfers in the regular transaction of business are also not considered to be gifts.

SHAM GIFTS:

A Sham Gift is also not considered to be a gift. This means that the transfer of property was done solely to shift the income tax burden from a person in a high tax bracket to a person in a lower paying tax bracket. The donor would still be liable for any tax due.

There are also some gifts that are exempt from gift taxes. The first one listed here is no surprise: political donations to organizations (not individuals) for use by that organization. Another exemption is money or other property given in payment of someone's medical care. Also tuition paid to an educational institution is exempt. Properties transferred between husband and wife during a divorce settlement is never considered as a gift.

When a value needs to be placed on a transferred property for gift tax reasons, the value is determined by the date of the transfer. If a parcel of property purchased ten years ago is gifted today, then today's market value would be used. If the donee must pay property tax, then the gift value is reduced by the amount of the tax.

If the donor is personally liable for a mortgage on the parcel of property, the value is still for the entire amount of the land. The balance owing on the property does not reduce its gift tax liability. If the donee pays off the mortgage and will have no ability or right to recover the amount of the outstanding mortgage, then the value will be based on the donor's equity only. Only if the donor pays for the mortgage will the full amount be considered the gift value.

Only if the donor pays for the mortgage

will the full amount be considered the gift value.

In other words, Sam Jones gifts a parcel of land to his son, Howard Jones. There is a mortgage owing on the property of $25,000. The entire value is considered to be $40,000. If Sam pays off the mortgage, Howard was gifted the entire amount of $40,000. However, if Howard pays off the mortgage, then the gift amount is the equity value or $15,000.

When life insurance and annuities are transferred within the first year of the policy, the gift amount is the entire amount of premium paid during that policy's existence. A single premium or paid-up policy is valued at its replacement value.

The replacement value is based on the insured's age at the time of the transfer. If the policy is in the premium paying stage, it is valued roughly at the policy's cash value and the unearned premium on the date of transfer.

BENEFICIARIES:

One of the primary elements of any will is the designation of beneficiaries. There are four types or groups of beneficiaries:

1) Preferential

2) Primary

3) Secondary

4) Tertiary

The basic purpose of wills is generally to provide property for the benefit of people and charities. We are using "charities" in a broad sense. It may refer to churches, hospitals, schools, etc. Other than providing people and charities with a testator's property, a will is merely a format to disperse personal assets.

When selecting beneficiaries, many things may be considered. Some beneficiaries naturally come to mind with no considerations involved. This would certainly include the spouse and often the children as well. Even when the selection is easy, however, how the proceeds are given may require other considerations. For example, if a child has a short life expectancy, a lump sum gift might be better than a monthly allotment.

Testators seldom realize the number of options they have when passing on their estate to others. Revocable living trusts have become very popular in recent years and they certainly have their place in estate management. However, there are other less expensive and less confusing ways of passing assets on, especially cash assets. Some examples include:

Annuities. This financial vehicle is never given the attention it deserves. Annuity contracts offer multiple options. When passing on a cash gift, one is usually chosen with no guaranteed number of payments. The beneficiary receives a specified dollar amount each month or annually until the money is used up. This is not the only payment option, but it is the most commonly used one. It may be set up to annuitize upon the death of the grantor, paying out payments to the beneficiary as designated in the contract or it may be given without stipulating any specific payout option, leaving that up to the beneficiary's discretion.

Bank Accounts. The will can direct the executor to establish a savings account in the name of the designated beneficiary with instructions to pay a specified amount each month. This savings account can also list a beneficiary should the person receiving the payment die before the funds are exhausted.

Trusts. Revocable and irrevocable trusts have become popular to distribute asset accumulations. A trust can manage assets that are not liquid, which often makes them an ideal vehicle when estates contain more complicated items. Trusts are often utilized when there is little need for one, but when the need does exist, they are an excellent choice.

Whatever avenue is taken, the will should direct that the distribution be put into effect as soon as legally feasible after their death.

When the distribution does not need to be given over a period of time

and a lump sum settlement is to be made,

this can simply be stated in the will with no other vehicles utilized.

When the distribution does not need to be given over a period of time and a lump sum settlement is to be made, this can simply be stated in the will with no other vehicles utilized. Many testators do not believe they need to try to control the flow of assets, preferring to simply give them outright in a lump sum. Lump sums may enable a beneficiary to accomplish what could not be accomplished otherwise. For example, a lump sum inheritance might enable a beneficiary to put a down payment on a home.

PREFERENTIAL BENEFICIARIES:

Preferential Beneficiaries are those people who, in the eyes of the law, have legal rights to designated portions of an estate, or at the least, to be mentioned in the will as proof that they have not been forgotten. This is not the same thing as the Primary Beneficiary. A Preferential Beneficiary is recognized by law, whereas a Primary Beneficiary may not necessarily be.

In common law states, the wife's portion, as required by law, was traditionally called Dower. Upon her husband's death, she becomes a Dowager. The husband's reciprocal interest in his wife's estate is called Courtesy. These portions, protected by law, are between one-third and one-half of the total estate. Both terms have generally been replaced by what may be called Statutory Share of the surviving spouse.

The husband's reciprocal interest in his wife's estate is called Courtesy.

A husband or wife who was willed less than required by their particular state's law may elect to take their statutory share despite the will's division. Therefore, a spouse who decides to cut out their legally married partner will find themselves unable to do so.

Many states also demand that other beneficiaries (children) be remembered, although not necessarily left anything substantial or equal. Many testators simply leave as little as one dollar to a particular child.

PRIMARY BENEFICIARY:

A Primary Beneficiary is the first beneficiary listed on an insurance policy and, for this reason, it might be thought that it is simply the first person indicated to receive benefits. Legally, a primary beneficiary is a member of the immediate family. Primary beneficiaries may include parents and siblings, though not necessarily. The first and foremost primary beneficiary is the spouse of the deceased. Second only to the spouse are the children. It is generally felt that all children should be treated equally. That is not to say that a testator may not divide his or her property as he or she sees fit. However, a teenager that is a problem today may be a model adult five years later. A will written to exclude that child today may be regretted five years later. Therefore, it is normally recommended that all children be treated equally in a will or trust. The question then becomes hinged on the word "equally." What is equal treatment?

A Primary Beneficiary is the first beneficiary listed

on an insurance policy and, for this reason, it might be thought

that it is simply the first person indicated to receive benefits.

Legally, a primary beneficiary is a member of the immediate family.

Equal does not necessarily mean equal divisions of an estate. Say, for example, that one child marries at 18 years of age and becomes self-supporting while another child attends college for four to eight years. That college education might be considered to be part of their inheritance. That may be especially applicable in smaller estates, where there is less to go around.

Equal treatment can often be measured in terms other than dollars. A child who is disabled physically, mentally or emotionally would need to be treated differently than a sibling who was employed with a bright future ahead of him. Even though the disabled child would receive the bulk of the estate, it is still fair and equal treatment since the estate is balancing out the children's future.

Often, an estate which seems partial to one child might actually be an exchange for past services. Say, for instance, that one unmarried (or even married) child took care of the parents during their last years of life. Leaving that child the bulk of the estate is fair and equal because it is repaying her for past years of service.

When estates attempt bequests to grandchildren, it is often difficult to keep it equal and fair. If the estate goes to the grandchildren Per Stirpes, it is impossible to keep it equal. Per Stirpes means the grandchildren will get their parent's share if the parent becomes deceased. One child of the deceased may have only one offspring of their own, while another child of the deceased may have several. Therefore, equality is not possible. Even with this inborn inequality, Per Stirpes is still the general method used in wills and tends to work well.

Another method is by specific bequests. This means that the will specifically states what each grandchild will receive. This is often seen when grandparents have favorites among their grandchildren and wish to recognize those favorites.

In a Per Capita distribution, each grandchild would share equally. Large gaps in the grandchildren's ages can cause some problems in this type of distribution method. The testator's youngest child may not be much older than the oldest grandchild, in some cases. Therefore, as the testator's children die, the grandchildren would inherit in a trickle effect.

A common part of families today are stepchildren. With second and third marriages on the rise, many families now have "mine, yours and ours." This can also apply to finances. This can especially be true if trusts have been established by deceased parents or grandparents. Adopting each others' children sometimes proves the most desirable step to take, although that may not always be a possibility if divorce, rather than death, was the factor that split the family. Adoption may still not equal out a trust, however, where the terms are typically quite specific.

Second and third marriages bring up a fear when drafting a will:

divorce. Many times parents do not feel comfortable

being "fair and equal" in their will in regards to stepchildren.

When a trust is in effect which expressly benefits some of the children, but not others, in a family made up of "yours, mine and ours," children will likely sense at an early age that some of them "have," while others "have not." This does sometimes strain the relationships, but need not do so if openly discussed. In such situations, it is extremely difficult to draft a will that is fair and equal to all, since finances may already be unequal. Second and third marriages also bring up another fear when drafting a will: divorce. Many times parents do not feel comfortable being "fair and equal" in their will in regards to stepchildren. There is no easy answer to this problem, but it is often solved by separate wills with each spouse being private in their decisions, which is, after all, their right.

SECONDARY BENEFICIARY:

Secondary Beneficiaries include brothers, sisters, aunts, uncles, cousins and may also include special friends. When dealing with secondary beneficiaries, there is no attempt (nor should there be) to be fair or equal. Generally speaking, when portions of an estate are given to secondary beneficiaries, there are good reasons why sharp distinctions are made. It may be due to special affections or to services given. It may even be due to specific financial needs of certain individuals, which the testator wishes to address in some way.

TERTIARY BENEFICIARY:

Tertiary Beneficiaries are the third class of beneficiaries and it includes charities, projects, organizations, and people where there is no push of duty. It is common for the bequest to be a small token amount with the intent to be more of a formal mention in the will, rather than a substantial property transfer. Only a minority of wills contains fairly large bequests given to Tertiary Beneficiaries. It may seem to happen more often than it actually does because these are often bequests, which end up in the local newspaper.

There is a good reason why Tertiary Beneficiaries do not generally get large estates willed to them. A person who has a fair sized estate is likely to give to charities while they are alive; not after they are dead. Giving to charities allows a tax credit, which is why it makes more sense to give to charities while one is still living. Such advice is likely given to the testator by both his or her attorney and accountant.

When giving assets to charities through a will,

it is wise to put as few restrictions as possible on it.

When giving assets to charities through a will, it is wise to put as few restrictions as possible on it. Too often restrictions placed on a will today poorly apply 20 years later when the testator dies. In the past years, it was popular, for instance, to stipulate that funds go to research for a specific disease, such as small pox or polio. By the time the testator actually dies, the money may have been much more beneficial for more people had it merely been restricted in the will or trust to medical research in general.

Sometimes a charity may even go out of business. In many towns, there are organizations (the Cleveland Foundation was the first) established to administer and disburse funds, as donors have directed, to worthy charities and groups. A general directive is all that is needed. For example, a testator might simply say that he or she wants their money to benefit wayward boys or girls. That organization will then apply the money to a group working with boys and girls at the time of the testator's death. Usually, a bank is the trustee when these organizations are utilized.

There should be no vagueness when it comes to beneficiaries. Even when it comes to a husband, wife or children, full names need to be used and the relationship to the testator stated. For example: Mary Beth Jones; wife. This is especially true when it comes to beneficiaries outside of the immediate family. There may be two aunts with similar names. To simply say "My aunt, Bess" could cause much confusion. Does the testator mean their Aunt Betsy (often called Bess) or her Aunt Elizabeth, also often called Bess. Even if immediate family members are quite sure the testator meant Aunt Betsy, the courts may decide otherwise.

When giving to charities, names must certainly be clear. This is especially true now, with so many charities appearing to copy the names of well known organizations. If giving to a broad charity, the exact division of that charity should also be stated for clarity if a particular area was desired by the testator. There have been court battles over large estates when the charity named was vague. These court battles can go on for years and cost thousands of dollars in attorney and court fees.

It is unusual for property to be easily divided without any unusual circumstances or desires arising. Most people find the need for some sort of exceptional provision in their will. It would be impossible to have one will drafted that everyone could use universally.

EXCEPTIONAL PROVISIONS:

The most common circumstance is the desire to reward someone who is not related and normally would not be considered a beneficiary. This may be the nurse who cared for the testator prior to death or a dear friend who gave support while family members did little for the testator.

Special rewards are commonly tied to particular performance. For example, the nurse may be required to sign a contract to work for the duration of the testator's illness (until death arrives). The friend may be required to perform certain duties that the testator is unable to perform.

PROPERTY TRANSFERS:

Property can be transferred at death several different ways. Insurance policies transfer through contract designation. In other words, through a listed beneficiary. In fact, anything listing a beneficiary will usually operate independently of a will or a living trust. State laws will distribute property when no will was left or discovered.

In some states, spouses can use a community property agreement to leave all property to each other. Often, this is the only document needed when all property will be given between a husband and a wife.

There are several types of property that will pass directly from the decedent to another person by contract. As mentioned, insurance policies are included in this category. Of course, if no beneficiary designation were listed in the contract, the asset would still follow probate proceedings. Property owned jointly with right-of-survivorship passes also by contract.

If no beneficiary designation were listed in the contract,

the asset would still follow probate proceedings.

Property owned jointly with right-of-survivorship passes by contract.

Investments involving survivor benefits of joint-and-survivorship annuity or survivor benefits of a life annuity pass by contract designation. Qualified employee retirement plans typically also list a beneficiary in their death benefits. Benefits under Antenuptial-Postnupital agreements list beneficiaries and lastly nonqualified employee benefit plans with a designated beneficiary. In short, any vehicle which lists a beneficiary will generally pass outside of the probate proceedings through a contract designation. That is the best reason to always try to list someone's name rather than simply stating "estate" under a beneficiary listing.

Property which by-passes probate is simply called Non-probate Property. It is no surprise that property going through probate is called Probate Property. The Gross Estate includes all rights to all property, both probate and non-probate. The Probate Estate is all property which will go through the probate process.

To Recap: The gross estate includes all property in the estate, even if it does NOT go through the probate proceedings. The probate estate includes only that which WILL go through the probate proceedings.

Probating a will proves that the will is valid. It will include only the property covered by that will. Each state governs the laws concerning probate.

Probate laws do vary from state to state and will occasionally change in any given state. What is true for California may not necessarily be true in Oregon or Wyoming. Therefore, it is best to try to use attorneys in the state where probate will occur for the best results.