Avoiding Probate: Living Trusts Are Not The Only Way To Go

November 3, 2010 in Estate Planning

In the absence of any planning, your assets must be “probated” upon your death. That is, a probate case must be opened with the superior court, the court must thus determine who is entitled to receive your property and must approve the transfer of your assets to those individuals. Although the probate process in Arizona is relatively simple, it is still worthy of avoidance. It typically involves legal fees and will delay the distribution of your estate. Also, if privacy is a concern, a probate necessity makes information about your estate public information.

The most common and comprehensive vehicle for avoiding probate is the revocable living trust. If you transfer your assets to a revocable living trust during your lifetime, it will be the trust, not your estate, that owns the assets upon your death. The trust instrument will contain language, similar to language found in a will, which provides who will be entitled to distributions from the trust upon your death. The trust also will contain language that allows another individual (or perhaps a corporation) to serve as trustee should you become incapacitated. That will allow you to avoid a conservatorship in the event of your incapacity.

If you have a substantial estate, the revocable living trust almost undoubtedly will be the way to go. But what if your estate is not that substantial and you do not want to pay the attorney fees involved in establishing a living trust? There are alternatives.

The most common alternative is the joint titling of assets. For example, you want your house to pass to your son, so you title the house in your name and your son’s, as joint tenants with right of survivorship. Thus, upon your death, the house passes to him outside of the probate process. The same mechanism can be used on bank accounts, brokerage accounts and automobiles.

There is a pitfall associated with joint titling of assets, however. If your tenant (in this case, your son) has problems with creditors, his interest as a joint tenant can be seized. Also, the establishment of a joint tenancy is an irrevocable act. If you have a falling out with your son, you cannot undo the gift you made to him. Finally, if you were to title your residence in joint name, then sell the residence, you could jeopardize one-half of the exclusion from gain for which you otherwise would qualify.

There may be a better alternative. For real property, you may file a beneficiary deed. A beneficiary deed simply states who is entitled to the property upon your death. It is entirely revocable during your lifetime. Similarly, bank accounts and brokerage accounts may contain a transfer-on-death designation. Again, the designation is entirely revocable during your lifetime. It simply states who is entitled to the contents of the account upon your death. These vehicles avoid the risks associated with joint tenancies. Note that you are not required to name only one beneficiary on a beneficiary deed or transfer-on-death designation. For example, you could name all of your children, in equal shares.

In the case of very small estates, there is an exemption from probate for up to $50,000 in assets. That exemption sometimes is sufficient to avoid probate on those assets for which no probate avoidance device is appropriate.

Lastly, pay attention to beneficiary designations on life insurance policies, IRA’s and retirement plans. If you fail to name a beneficiary, your estate will be the beneficiary and a probate will be required. The beneficiary designations on IRA’s and retirement plans should be carefully considered, as there are significant income tax considerations associated with beneficiary designations. When considering beneficiary designations on life insurance policies, consider whether it’s possible the life insurance proceeds will cause your estate to be taxable. If that is the case, consider whether an insurance trust is appropriate.

Probate also may be required if you become incapacitated and a conservator must be appointed to manage your assets. Conservatorships can be expensive and should be avoided if at all possible. Again, the living trust is the most common vehicle for avoiding a conservatorship. There is one alternative, however, if you want to avoid the cost of establishing a living trust. A durable power of attorney, if worded correctly, will allow one or more individuals you name manage your assets in the event of your incapacity. Note that a durable power of attorney may be made effective only in the event of your incapacity or may be made effective upon signing. The advantage of having the power of attorney become effective only upon your incapacity is the avoidance of unintended use of the power by your agent. Ordinarily, however, that is not a concern. The advantage of having a durable power of attorney become effective upon signing is that it allows your agent to act on your behalf without having to prove that you are incapacitated.

To sum up, if a living trust is not appropriate for you, consider your alternatives. Quite often, through a combination of powers of attorney, beneficiary deeds, transfer-on-death designations, beneficiary designations and other measures, probate can be avoided without a living trust. In many cases, you can avoid costs and delay by employing those alternative measures.

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This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.

The Practical Side of Estate Planning

November 3, 2010 in Estate Planning

By Robert J. Lord

I like to view estate planning as having two components. One component, and the one to which all estate planners and their clients pay careful attention, is the tax component. Estate planners do a fine job on tasks such as maximizing the benefits of their clients’ unified tax credits and generation skipping tax exemptions, keeping life insurance proceeds out of the estate, and making sure that any amount passing to a so-called “QTIP” trust qualifies for the unlimited marital deduction.

The other estate planning component, which in many estates is far more important than the tax component, is the practical, or non-tax, component. The practical component includes such decisions as when automatic (i.e., mandatory) distributions of trust property are made to beneficiaries of the estate, who to name as trustee of the children’s inheritances, and whether direct bequests should be made to grandchildren. All too often, less attention is paid to this practical side of estate planning than is paid to the tax side of estate planning. Why is this? Probably because the failure to accomplish proper tax planning translates neatly into a hard dollar cost, whereas the failure to address practical considerations carries with it only an intangible cost. But is the emphasis on tax planning appropriate? In most cases, no. While it is obviously important to plan in the most tax efficient fashion, it is equally important (in most cases, more important) to make sure the estate is used in the desired fashion. After all, if Junior squanders his inheritance on fast cars and entertainment instead of using it to pay for college, the wonderful tax planning you implemented won’t mean terribly much.

With that as background, here are a few of the practical issues to consider when structuring your estate plan:

Should Your Spouse Be the Sole Trustee of Your Estate Assets Upon Your Death? Ordinarily, your estate plan will provide that upon your death at least a portion of your estate to be held in trust for the benefit of your spouse, with the remainder passing to your children upon your spouse’s death. In most cases, your spouse will serve as the trustee of that trust. In some cases, however, it may be appropriate to name a co-trustee to serve with your spouse, or not to name your spouse at all. For example, if there are children from prior marriages on both sides, do you want to take the risk that your spouse will use his or her position as trustee to divert the inheritance you intended to go to your children? If your spouse is a spendthrift, an independent trustee may help to ensure that he or she will not go through the trust too rapidly.

Should Your Children From a Prior Marriage Inherit Upon Your Death, or Only Upon Your Spouse’s Death? Most married couples provide in their estate plans for all of their wealth to be held for the benefit of the survivor of them and pass to children only on the death of the survivor. In some cases, that is not appropriate. For example, if you have children from a prior marriage and your second spouse is fifteen years younger than you and lives a long life, the receipt of an inheritance upon your spouse’s death will do little to benefit your children, as they will be in the last years of their lives at that time. In this situation, you should consider whether a portion of the estate should pass directly to your children at the time of your death.

How Should The Estate Be Divided When You and Your Spouse Both are Deceased? Most people treat their children “equally” in their estate plans. Whether that is appropriate raises philosophical questions that only you can answer. For example, if one child has children and the other does not, do you divide the estate into equal shares or do you adjust the shares such that that first child’s inheritance will buy the same lifestyle for that child and his or her children as the second child’s inheritance will buy for a single person? Is it appropriate to have wealth pass directly to your grandchildren, or should the wealth pass entirely to your children on the theory that they are in the best position to determine what is best for your grandchildren? There are no right or wrong answers to these questions.

When and Under What Circumstances Should the Children’s Inheritances Be Paid Out to Them? Many estate plans provide for the distribution of each child’s inheritance to that child in increments at specified ages, such that the child has received his or her entire inheritance by age forty. There are strong, in many cases, compelling, reasons not to structure your estate plan in this manner. If your child’s inheritance is held in trust, it is there when he or she needs it. If the inheritance is distributed to the child, it can be lost to the child’s irresponsibility, a creditor, or a divorcing spouse. Although there are disadvantages to leaving a child’s inheritance in trust indefinitely (ongoing trustee fees for example), in many situations those disadvantages are far outweighed by the advantages.

Who Should Serve as Trustee? Do you want an individual to serve as trustee, or would your beneficiaries be better served if you chose an institutional trustee. Each choice has its advantages and disadvantages. For example, an individual trustee, especially a relative, may be better suited to making decisions regarding distributions to the beneficiaries. An institutional trustee may be more reliable in terms of administrative matters and may be better suited to managing the investments of the trust. An institutional trustee, however, may be rigid in its decision making and typically will charge significantly higher fees than an individual.

What Limits Should Be Placed on the Trustee’s Discretion? Ideally, the person you name to serve as trustee will be one whose honesty is beyond reproach, who is a brilliant investor, and who would do exactly as you would wish in determining whether and when to make distributions to your children. However, we don’t live in a perfect world. Thus, you need to consider whether you want the trust agreement to force the trustee to make decisions consistent with your intent. For example, do you want to limit the amount that can be made available to a child for investment in a business? Do you want to limit the types of investments into which the trustee may enter? Do you want to preclude the trustee from opening a margin account?

Who Should Inherit in The Event of a Common Disaster? Who will inherit if you, your spouse and all your descendants are wiped out? Although the likelihood of this situation arising hopefully is remote, it does happen. You should consider whether there are friends, relatives, or charities who you especially would want to inherit from you in this situation.

Obviously, these are not the only practical issues you will want to consider when creating your estate plan. The important point to remember is not to get lost in the tax planning. It’s important, but there’s more to a good estate plan than tax avoidance.

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This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.

Pre-Nuptial Agreements – Just In Case It’s Divorce That Does Us Part

April 28, 2005 in Contracts

Pre-Nuptial Agreements are being signed by more and more couples. They are not limited to couples dealing with financial inequality, or couples that have a lot of wealth. With half or more of all ending in divorce, Pre-Nuptial Agreements have become widely accepted as smart financial planning tools.

What is a Pre-Nuptial Agreement?

It may not be romantic to think about this way, but marriage essentially is a legal contract between two people. With regard to your property, the provisions of your marriage contract are governed by the laws of the state in which you live — and these laws determine how assets will be divided in case you divorce (or die) — unless you and your spouse decide you want to write your own marriage contract instead. That is where a Pre-Nuptial Agreement comes into play.

As its name implies, a Pre-Nuptial Agreement is an agreement between the couple who are contemplating marriage as to (i) what property is separate, pre-martial property, (ii) the character of property acquired during the course of the marriage, (iii) the division of property and marital obligations and such matters as spousal maintenance in the event of separation or divorce, and (iv) the handling of financial aspects of the marriage, such as payment of living expenses and preparation of income tax returns. A Pre-Nuptial Agreement can promote the well-being of the marriage, as it reduces the uncertainty each spouse may feel about financial matters.

Who should have a Pre-Nuptial Agreement?

“Pre-nups” have gained in popularity in recent years. Why? Until the 1960s, most couples married young with visions of building a life together from the bottom up. Typically, neither party brought much property to the union. Today, young Americans wait longer to marry, often after accumulating financial worth. Also, the rising divorce rate translates into more second marriages, which often involve children from previous marriages. Consequently, more people contemplating marriage have reason to be careful, in case things don’t work out.

Consider the following to determine whether a Pre-Nuptial Agreement may be for you:

  1. Do you have children from a previous marriage for whom you’d like to provide?
  2. Are you responsible for other family members, such as elderly parents or a disabled sibling?
  3. Are you the owner of or partner in a business? (In the event the marriage terminates, your spouse may have a claim to part of the business.)
  4. Will you inherit assets from your family that you would prefer to have remain in the family (not shared with the spouse) in the event of your divorce or death?
  5. Will one of you bring substantially more assets to the marriage?
  6. Will your spouse be giving up her career or acting primarily as support for you in your career or business as part of the marriage, and if so, what will be his or her compensation for doing so if the marriage ends?
  7. Do you or your fiancée have debts for which you wouldn’t like the other to be responsible?
  8. Will you or your spouse be supporting the other through college or schooling likely to lead to a lucrative line of work?
  9. Do you foresee a large increase in future income?

What does a Pre-Nuptial Agreement do?

A Pre-Nuptial Agreement in Arizona accomplish three basic things:

  1. It defines what constitutes separate property and what constitutes community property.
  2. It defines what constitutes separate debt and what constitutes community debt.
  3. It allows a couple to set terms for spousal support.

How is a Pre-Nuptial Agreement prepared?

The process for creating a Pre-Nuptial Agreement is fairly simple. You and your potential spouse decide what works for you and what stays with whom in the event your marriage doesn’t work out. The deal you strike will generally be respected by the law, but remember, this is a legal contract to which American contract law applies, and a divorce court can and will overturn you private agreement if it finds that:

  1. The agreement is likely to promote divorce — that is, it gives one or both parties a monetary incentive to leave;
  2. The agreement was written with the intention of divorce;
  3. One of the parties was coerced into signing the agreement; or
  4. The disclosure by one party was inadequate.

Perhaps the most important ingredient of a solid Pre-Nuptial Agreement is honesty. Both parties must FULLY disclose their assets. If it turns out either person has hidden something, whether or not intentionally, a judge can toss out the contract.

A Pre-Nuptial Agreement should be signed well in advance of the wedding. This avoids the appearance of coercion, which will cause an agreement to be invalid.

It’s best to do things formally. Without a formal contract, you could end up like director Steven Spielberg. Mr. Spielberg’s ex-wife got half of what he earned during their four-year marriage because their pre-nuptial agreement was scribbled on a napkin and she wasn’t represented by a lawyer. This “informality” cost Mr. Spielberg $100 million.

Things to Remember:

If you are considering a Pre-Nuptial Agreement, it is important to remember three things:

  1. Discuss the agreement early in the relationship. Don’t wait to say “pre-nup” until right before you say, “I do.”
  2. Be honest. Don’t try to hide your thoughts, feelings or assets.
  3. Hire separate attorneys so you both have good representation.

Couples should review their Pre-Nuptial Agreements every few years. Pre-Nuptial Agreements are written defensively, so after a certain number of years of wedded bliss, some of their provisions should be revisited.


Time have changed. Pre-Nuptial Agreements have a place in many marriages, especially second marriages. If you think you may need a Pre-Nuptial Agreement, don’t be afraid to raise the subject. A well conceived Pre-Nuptial Agreement won’t destroy a marriage – it will help protect it.

This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.

Choosing You Real Estate Ownership Vehicle

August 19, 2004 in Tax News

On too many occasions, I have been asked by clients to help them solve problems attributable to the vehicle through which they chose to acquire real estate. Although sometimes such problems can be mitigated, there certainly is no substitute for good front-end planning. This article discusses a few of the many situations where choosing the right ownership vehicle at the time of purchase can prove beneficial when real estate is sold.

Ownership of Real Estate Used in a Business. With the recent rise in the popularity of office condominiums, ownership of real estate by business owners certainly has increased, perhaps dramatically. It is important, therefore, to be aware of a very common tax planning mistake often made by business owners who acquire real estate.

Here is the situation: John Smith operates his business through a corporation, Smith, Inc. John locates the ideal building for his business and causes Smith, Inc., to purchase the building. The business thrives and the building triples in value. John allows his key employee, Carl, to become a shareholder in Smith, Inc. At some point, a potential buyer makes a very attractive offer to purchase the building. John and Carl now face a difficult tax situation. Smith, Inc., will be required to pay tax, at regular corporate rates, on the gain from the sale. If, after paying its corporate income tax, Smith, Inc., distributes the remaining sales proceeds, John and Carl will be required to pay tax on the distributions they receive, this time at long-term capital gain rates. The combined corporate and individual tax rate for John and Carl likely will exceed forty percent.

What could John have done differently? If John had purchased the building through a limited liability company, he then could have caused the limited liability company to rent the building to Smith, Inc., with the following advantages: First, and foremost, the effective tax rate upon the sale of the building would be dramatically lower. Second, the rent paid by Smith, Inc., would reduce its taxable income, thereby decreasing the need to pay compensation to John and Carl in order to avoid corporate level tax. Although the rental income received by the LLC would be taxable to John and Carl, rental income, unlike compensation, is not subject to Social Security or Medicare tax. Third, at the time John chose to allow Carl to become an owner in the business, he would have had the flexibility to retain 100% ownership of the building. That could prove especially valuable for retirement planning purposes. Fourth, if the business subsequently floundered, creditors of Smith, Inc., generally would not be able to seize the building in order to satisfy their claims, as they could if the building were owned by Smith, Inc.

Joint Tenancy With Right of Survivorship? In many Arizona real estate transactions, it seems, married couples take title as joint tenants with the right of survivorship. Almost always, that is not the best choice tax wise. When a married couple owns real property as joint tenants, it is assumed that each spouse owns his or her joint tenancy interest as sole and separate property. Under current estate tax law, the cost basis of property owned by an individual is “stepped up” to fair market value upon the individual’s death. In other words, the unrealized gain on the property effectively is eliminated. This gain elimination applies not only to an individual’s sole and separate property, but also to community property in which the individual has an interest. Thus, by titling property in joint tenancy rather than as community property, a married couple may forfeit the ability to achieve complete elimination of capital gain upon the first of their deaths.

Here is an example of how this works: Suppose husband (H) and wife (W) purchase a rental property for $200,000. In the years preceding his death, H and W claim $100,000 of depreciation on the property. At the time H dies, the property has a value of $400,000 and an adjusted cost basis of $100,000. If the property were titled as community property or community property with right of survivorship, the entire $300,000 gain would be eliminated upon H’s death. If H and W took title to the property as joint tenants with right of survivorship, however, only $150,000 of gain would be eliminated upon H’s death.

Anticipating the Future Like-Kind Exchange. Ordinarily, when two or more individuals purchase investment real estate, they choose to own the real estate through a limited liability company or partnership. For the most part, that is perfectly appropriate. There is one potential pitfall to be considered, however. If it is possible that upon the ultimate sale of the investment real estate, some of the owners would desire to enter into like-kind exchanges, whereas others would desire to cash out, the limited liability company or partnership could be problematical. For example, suppose George and Henry each contribute $100,000 to a limited liability company that purchases an investment property for $200,000. After the property has doubled in value to $400,000, George and Henry decide to sell. George desires to reinvest his share of the proceeds through a like-kind exchange, whereas Henry desires to cash out. If the limited liability company sells the property and distributes $200,000 to Henry, however, the entire gain now is taxable, even if the remaining $200,000 is reinvested.

Here’s an alternative: George and Henry simply take title to the property as tenants in common. When it comes time to sell, each can sell his tenancy in common interest to the buyer. George can enter into a like-kind exchange and defer up to 100% of his share of the gain. Henry can cash out and recognize his share of the gain. A word of caution: The IRS may treat tenants in common as having formed a partnership for income tax purposes. You, therefore, should consult your tax advisor before employing this structure.

Conclusion. When purchasing real estate, the choice of ownership vehicle should be considered carefully. The best ownership vehicle is not necessarily the one that is most easily implemented at the time of purchase. Rather, it is the vehicle that will yield the best results while the property is operated and when it ultimately is sold.

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This article contains only general information and is not to be relied on as legal advice. For advice on your individual situation, consult a lawyer in your jurisdiction. No attorney/client relationship arises from use of this article.