A vast majority of people believe they do not require estate planning and that it is only for the wealthy. Estate planning is for everyone, not just the wealthy and it is a plan a person makes for the management and administration of their property during their lifetime and after their death.
When a person dies without an estate plan, the courts will be forced to make crucial decisions for the deceased such as: the distribution of the deceased properties, appointment of guardians (for the deceased minor children) and personal representatives, dissolution of business, etc. This process is very expensive and can lead to disputes among the members of the deceased families. Estate planning entails the preparation of will or codicil, setting up trusts, bequeathing gifts to persons or entities and/or granting authority to do certain acts by way of power of attorney.
Estate planning is the arrangement a person makes during their lifetime for the management, distribution and/or disposal of a their property during the person’s lifetime and/or after death. Assets that can make up an individual’s estate include real properties (such as buildings and lands), intellectual properties, cars, insurance, shares/stocks, bank accounts and other personal properties.
Forms of Estate Planning
1. Wills and Codicils
The Last Will and Testament is a legal document that expresses how the properties of a testator (the party making the will) should be distributed and administered after the death of the testator. The testator expresses his wishes through a Will or Codicil and appoints executors and/or trustees to carry out the intentions of the will. In a will, the testator may make several arrangements such as: the distribution of their assets (which includes all personal and real properties), distribution of residue (the remainder of the testator’s assets that is not specified in the will), appointment of executors and/or trustees to manage and distribute the properties of the testator, the appointment of guardians (where any of the testator’s children is a minor), establishment of trusts, funeral arrangements and other instructions of the testator.
A Codicil is an addendum to a will, that is, it is an addition or supplement that explains, amends, or nullifies part of an already executed will. The codicil is also ambulatory, that is, it takes effect only after the death of the testator and it is executed in the same manner as the will.
Validity of a Will or Codicil
For a Will or Codicil to be valid, the following must be present:
• It must be in writing.
• The testator must have the capacity to make the will or codicil. The testator must be at least 18 years old at the making of the will.
• The will must be made voluntarily. The testator must have written the will without coercion or fraud.
• At the making of the will, the testator must be a person of sound mind, illustrating that he understands the extent of his properties and the effects of making a will.
• There must be at least two witnesses who will attest to the making of the will. At times, for a will to be valid, at least two persons are required to attest a will. This requirement varies in some other jurisdictions where only one or more than two witnesses may be required to validate a will.
• Signature of the Testator: The testator’s signature must be appended or acknowledged in the presence of at least two witnesses.
• Signature of the witnesses: The witnesses must sign (attest) the will in the presence of the testator.
The authenticity of a will or codicil is determined by a legal process which is called probate. After the demise of the testator, the custodian of the will (that is a bank, lawyer or any private person) is required to take the will to the probate registry. The probate is a court supervised process that proves the authenticity of the will to be valid and accepted as the last will and testament of the deceased and grants powers to the executors named in the will to fulfill the tenets of the will. On the other hand, when a person dies without a will, the family and dependents of the deceased will apply for letters of administration. The letter of administration is the power granted to a person to administer and distribute the properties of the deceased in accordance to the state laws of intestacy and succession.
A trust is a process whereby a party called the grantor transfers properties to another called the trustee to hold and manage the properties on behalf of the grantor’s beneficiaries. A trust can be set up by the grantor’s last will and testament, in which case, it is called a testamentary trust and it can also be set up during the grantor’s lifetime, in this case, it is called a living trust. The establishment of trusts gives the trustee the powers to distribute the property of the grantor without applying for probate or any court ordered process hence, it reduces estate taxes and saves time.
3. Deed of Gift
A Deed of Gift is a gratuitous arrangement that voluntarily transfers the ownership of a property from the owner (called the donor) to another (called the donee) without any consideration or compensation from the donee. Examples of gifts that can be transferred are real properties such as land or building and personal properties of the grantor. Under the law, a minor has no the legal capacity to grant gift. However, minors can accept gifts through their legal guardian.
A deed of gift once delivered to the donee is irrevocable that is, it cannot be changed or reversed except the donor lacks the legal capacity to grant the gift; the gift was granted under duress, misrepresentation or mistake surrounding the circumstances or the gift was transferred with an intention to evade tax or breach the law.
4. Power of Attorney
The power of attorney is an instrument of delegation which allows a party (called the donor) appoint another party (called the donee) to act on behalf of the donor. Usually, the donor delegates powers to the donee where the donor is unavailable to perform the acts delegated, incapable of performing the delegated tasks due to ill health or when the donee’s expertise is required for the proper execution of the delegated tasks.
A Power of Attorney may confer either general, specific powers or both powers to the donee:
• General Powers: These are powers that are broadly provided to cover the subject matter. For example, a power given to the donee “To do all that the donor can lawfully do”. This does not specify what the donee is authorized to do; it rather gives the donee broad powers to do anything the donor can do lawfully.
• Specific Powers. These are powers given in respect to specific or particular acts, thereby limiting the acts the donee is authorized to do. Examples of specific powers are: power to collect rent, issue notices and manage the real properties of the donor, execute contracts on behalf of the donor, etc.
A power of attorney is further classified as follows:
• Revocable Power of Attorney. If a power of attorney is revocable, the donor can withdraw the power at anytime and for any reason.
• Irrevocable Power of Attorney. This is the power of attorney that cannot be withdrawn or cancelled at anytime. It is either irrevocable for a fixed period or irrevocable for a valuable consideration or coupled with interest.
When a power of attorney is irrevocable for a fixed period, it cannot be withdrawn until the period stated in the document has elapsed, usually not more than 12 months. When a power of attorney is for a valuable consideration, the donee is given monetary compensation as consideration for the instructions he/she will carry out on behalf of the donor. Also, if the power of attorney is coupled with interest, the donee has an interest, a right or title over the property which is the subject matter in the power of attorney and the power of attorney cannot be cancelled or withdrawn until the donee recovers his interest in the subject matter.
The Benefits of Estate Planning
For the management of an individual’s property in the event of incapacity
In circumstances where a person is unable to manage their properties or finances due to severe illness or unavailability, an estate plan sets helps a person properly determine how their assets should be managed. A power of attorney, personal directives through letters of instruction and trusts can be effective tools for proper estate management.
For proper distribution of assets
Estate plan is very beneficial for accurate distribution of an individual’s assets. Wills, codicils, deeds of gifts and trusts enables an individual determine how their assets will be distributed to their beneficiaries after their death to prevent disputations in future. Without an estate plan, the court will determine how the assets of a deceased will be distributed.
For the protection of beneficiaries
An estate plan invariably protects the interest of beneficiaries by ensuring that their shares are properly specified and preserved. If an individual has a child who is a minor, the individual can designate guardians and trustees who will oversee the financial and other needs of the minor. On the other hand, if the individual’s children are adults, but are unable to manage finances or assets, the individual can create a trust to protect the children from making bad decisions.
For a speedy and efficient transfer of an individual’s assets
The deed of gift and trusts are very speedy and cost effective ways to transfer one’s assets to a beneficiary. Without proper estate plan, the process of transfer of assets may be extremely cumbersome. Estate planning helps an individual to identify cost effective and peaceful way to transfer their asset to their beneficiaries either during their lifetime or after their death.
To minimize cost and avoid disputes.
An estate plan will specify how an individual’s assets will be managed and distributed to beneficiaries thereby leaving no room for speculations and confusion. Hence this will prevent disputations and invariably save time and money.
6. To minimize estate taxes.
The significant loss of a part of one’s estate to the payment of taxes is a factor that should motivate people to establish an estate plan. Through strategic planning, people can substantially reduce or eliminate taxes by setting up trusts as part of their will, living trusts or bequeathing gifts to their beneficiaries during their lifetime. It is important to note that not every form of estate plan is suitable for everyone. Each form of estate planning has its distinct and unique features and people’s. If an individual desires a speedy and cost effective process of property transfer, it’s important to consider the various forms of estate plan that will help the individual achieve their desired purpose. For example, executing a deed of gift or setting up trusts depending on the individual’s preference can be preferred to making a will because of the lengthy process of obtaining probate.
Choosing the appropriate estate plan can ensure simple, tax efficient and organized transfer of assets to beneficiaries; it removes uncertainties and prevents disputes. When preparing or updating your estate plan, you will need to have a basic understanding of the different types of taxes that can affect your estate: gift taxes, estate taxes, inheritance taxes, generation-skipping transfer (or GST) taxes, and income taxes.
The gift tax is probably the most ignored tax that can affect an estate. Currently, the federal tax code exempts up to $15,000 per year in gifts made by any individual to any number of other individuals. This is referred to as the annual exclusion from gift taxes. Once you make a gift over $15,000 to the same person in any given year, you’ll be making a taxable gift, and you’ll incur gift tax.1 However, instead of paying the tax immediately, the 2021 federal tax code gives you a lifetime gift tax exemption of $11,700,000 that can be used to offset your taxable gifts. Taxable gifts made during the course of the year need to be reported on IRS Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.
Federal and State Estate Taxes
For decedents who died in 2021, the federal estate tax applies to estates that are valued at more than $11,700,000, which is referred to as the federal estate tax exemption. Current law provides that the federal estate tax exemption will continue to be indexed for inflation in future years.
State Inheritance Taxes
As of the tax year 2020, there are six states that collect a separate inheritance tax, which is a state tax imposed on certain beneficiaries who receive a deceased person’s property. In all of these states, assets passing to the deceased person’s surviving spouse and charity are exempt from the inheritance tax, while in several of these states assets passing to the deceased person’s descendants are also exempt.
State laws change frequently, so it is best to consult with a qualified estate planning attorney in your state to determine whether your assets will be subject to a state estate tax or a state inheritance tax after you die. Also, if you own personal effects or real estate outside of your home state and the other state has an estate tax or an inheritance tax, then there may be an estate tax or an inheritance tax due on your out-of-state property after your death.
Generation-Skipping Transfer Taxes
For decedents dying in 2021, the generation-skipping transfer tax (GST) applies to transfers of more than $11,700,000 that “skip” one or more generations. “Skipping” refers to either a transfer that is made to a relative who is two or more generations below your generation (for example, a grandparent to a grandchild) or to a non-relative who is more than 37 1/2 years younger than you. Current law provides that the GST exemption will be indexed for inflation in future years.
Some states that still impose their own separate state estate tax also assess a separate generation-skipping tax. However, as with state estate taxes and inheritance taxes, it is best to consult with a qualified estate planning attorney in your home state to determine whether your state has its own generation-skipping tax.
For deaths, the decedent’s heirs had the choice of subjecting the estate to federal estate taxes or applying the modified carryover basis regime. What modified carryover basis means is that instead of the beneficiaries of an estate or trust receiving an asset with a full step-up in basis to the date-of-death fair market value, the beneficiaries received the lesser of the fair market value of the property or the decedent’s original basis, which could be adjusted following specific basis adjustment rules. Depending on the modified carryover basis of an asset, the beneficiaries could owe capital gains taxes when the inherited asset is later sold.
For deaths occurring in any year, during the course of settling an estate or trust after someone dies, the estate or trust assets will undoubtedly earn interest until they can be distributed out of the estate or trust to the ultimate beneficiaries, and if certain types of assets are sold (such as stocks and bonds), the sale may result in a capital gain, even after taking into consideration the step-up in basis. Aside from this, certain types of accounts have built-in income tax consequences referred to as “income in respect of a decedent” (or IRD) when the owner dies, such as non-Roth IRAs, 401(k)s, and annuities. Thus, while many estates and trusts may not be affected at all by gift, estate, inheritance, or generation-skipping transfer taxes, the majority will be affected in some way or another by income taxes. Income earned by an estate or trust is reported on IRS Form 1041, U.S. Income Tax Return for Estates and Trusts, for federal income tax purposes, and the estate or trust may also need to file a state income tax return for estates and trusts.
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