- Please reference “Your path to financial independence” topic for discussion regarding legacy planning tools and strategies.
- Alternatives to probate may include transfers via contract to named beneficiaries (e.g., named beneficiaries for life insurance contracts, annuity contracts, IRAs, SEPs, SIMPLEs, employer sponsored retirement plan accounts, pay on death bank accounts or Totten trusts, transfer on death investment accounts), transfers via state property interest laws using co-ownership titling with survivorship features (e.g., joint tenants with right of survivorship or tenancy by the entirety), and / or transfers via state trust laws (e.g., revocable or irrevocable living trusts).
- Community property versus common law property statutory regimes:
- Community Property Agreements (CPAs): Married couples and registered domestic partners domiciling in Washington State or Idaho may wish to consider implementation of a Community Property Agreement (CPA) to complement testaments (wills) as a simple and low cost alternative to probate if all property will be transferred to the surviving partner upon death. Important limitations may apply.
- Basis in assets held as community property: The entirety of basis (i.e., both halves of basis) in assets held as community property steps-to fair market value under Section 1014 upon death of the first decedent spouse. This treatment applies exclusively to assets held as community property. Notably, spouses in community property states may hold assets as separate property under certain circumstances.
- The creditors’ claim procedure for probate may restrict the statute of limitations for creditors’ claims following death (this procedure may also be available to non-probate estates, as within the State of Washington). Professionals whose estates may be subject to claims by creditors for malpractice (e.g., physicians) or errors and omissions may desire this protection for their estates and beneficiaries.
- Basic tools to minimize federal transfer tax liabilities (estate, gift, and generation skipping transfer taxes): Annual gift tax exclusion amounts for lifetime gifts of a present interest (applicable to gift tax and generation skipping transfer tax, or GSTT), basic exclusion amount and applicable credit for estate and gift taxes (election for portability of the deceased spousal unused exclusion, or DSUE, amount applies), basic exclusion amount and applicable credit for GSTT (election for portability of the DSUE amount does not apply), unlimited marital deduction (applicable to donee or surviving U.S. citizen spouses) or spousal super annual exclusion amounts (applicable to lifetime transfers to donee non-U.S. citizen spouses), unlimited charitable deduction, qualified transfers (direct payments of tuition to qualifying educational institutions on behalf of a student or direct payments of qualified medical expenses to healthcare providers on behalf of a patient), election of spousal gift splitting on IRS Form 709 or gifts of community property (applicable to gift tax and GSTT), dividing gifts amongst multiple donees, “superfunding” of Section 529 college savings plans (qualified tuition programs, or QTPs), transfers to political organizations.
- Use of family limited partnerships (FLPs): FLPs benefit from potentially substantial valuation discounts and annual gift exclusions to transfer assets via limited partnership interests from general partners to limited partners. General partners retain management rights, unlimited liability, and a small partnership interest. Limited partners retain limited liability, large partnership interests, have no management rights (lack of control), and generally have transferability restrictions on their limited partnership interests (lack of marketability). Some creditor protections may be afforded by FLPs.
- Use of family limited liability companies (FLLCs): Legacy planning benefits are similar to those offered by FLPs. By default, multi-member LLCs are taxed federally as partnerships, though may elect to be taxed as S corporations or C corporations. However, key differences exist between FLLCs when compared to FLPs in management rights afforded to members, affecting member-managed FLLCs and, to a lesser extent, manager-managed FLLCs. Additionally, limited liability protection is afforded to all members of FLLCs, in contrast to unlimited liability retained by general partners in FLPs.
- Use of “Family Dynasty” 529 plans. Important limitations may apply regarding implementation, intergenerational transfer tax liabilities (e.g., gift taxes and generation skipping transfer taxes), and intergenerational misallocations of 529 account funds intended for qualified education expenses (i.e., non-qualified distributions of 529 account funds by subsequent account owners).
- Use of dynasty trusts or generation skipping trusts (e.g., established as perpetual trusts in South Dakota). Appropriate trust structures may vary depending on individual circumstances and needs of clients and families (e.g., beneficiary defective inheritor’s trusts, or BDITs).
- Basis planning: Section 1014 allows for step-to fair market value in basis for assets upon death of the decedent (including elimination of potential depreciation recapture). Additionally, a default long term holding period applies to potential subsequent capital gains upon disposition by beneficiaries of inherited assets regardless of the decedent’s and beneficiary’s actual holding periods. Consequently, if a decedent’s gross estate will not be subject to transfer tax liability (e.g., gift taxes, federal and state estate taxes, generation skipping transfer taxes, inheritance taxes), highly appreciated assets with low adjusted basis or assets with significant appreciation potential may benefit from inclusion in the decedent’s gross estate (e.g., bequeathing at death or lifetime gifting with interests retained by the donor within 3 years of the donor’s death) rather than lifetime transfer. Notably, this does not apply to Income in Respect of a Decedent (IRD) assets (e.g., IRA assets, employer sponsored retirement plan assets, annuity contracts, U.S. savings bonds) or reversionary death-bed transfers of assets acquired by decedents via gift within one year of the decedent’s death.
- Income in Respect of a Decedent (IRD) assets (e.g., IRA assets, employer sponsored retirement plan assets, annuity contracts, U.S. savings bonds) are assets with deferred income tax liability. Basis in IRD assets does not step-to fair market value under Section 1014 upon death of the decedent. Consequently, income recipients (the decedent’s estate and / or beneficiaries) are subject to income tax liability on distributions in excess of the original owner’s carryover basis. Income recipients (the decedent’s estate and / or beneficiaries) may offset income tax liability by deducting the decedent’s estate tax liability attributable to the IRD asset as a miscellaneous itemized deduction from adjusted gross income (split pro rata for multiple beneficiaries).
- Costs of complex estate planning tools and strategies must be weighed against their potential benefits. For example, costs, energy, and time committed to the process of estate planning for avoidance of probate may equal or exceed costs, energy, and time required by the probate process. Similarly, costs, energy, and time committed to the process of estate planning for minimization of transfer taxes (e.g., gift taxes, federal and state estate taxes, generation skipping transfer taxes, inheritance taxes) may equal or exceed costs, energy, and time consumed by transfer taxes. Laws and regulations are subject to changes at the discretion of legislators; thus, any estate plan will need to be amended regularly to accommodate changes in laws and regulations. The more complex an estate plan, the greater the expenditures, energy commitments, and time commitments involved in updating and amending the estate plan.
Limitations of the unlimited marital deduction
If the first to die spouse bequests property with large appreciation potential and / or wishes to ensure the disposition of property to specific individuals
Bentley Makkar
December 18, 2024
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