ESTATE PLANNING FOR DIGITAL ASSETS

In an increasingly paperless world, we live much of our lives online.  We conduct business online, we communicate electronically and we manage our finances through e-mail and websites.  As a result, most people today have accumulated significant “digital assets” and information that require special consideration in your estate plan. 

Lack of a Paper Trail and Death or Disability 

When a person dies or becomes disabled, one of the first things his or her Executor, Agent, or family members must do is determine the assets and liabilities of the estate.  In a paper-based world, that generally means reviewing the deceased’s mail, desk drawers and filing cabinets to look for tax returns, bank and brokerage account statements, bills, check registers, and loan documents.

 In a digital world, however, it is not unusual for people to conduct many of these transactions online.  In many instances, they do not leave a paper trail.  Many people receive statements by e-mail, pay bills online, and use programs like QuickBooks to track and reconcile their bank accounts and other financial records.

 Without careful planning, it may be difficult or even impossible for your representatives or loved ones to locate your assets or identify your creditors.  Even if they do, they may not be able to gain access to or manage your accounts without your user name, password and other security information (at least not without following time-consuming procedures or seeking a court order).

If you have deposits made directly to your accounts or if bills are automatically debited from your accounts, how will your representatives find out about these transactions so that they can settle your financial affairs? 

Furthermore, many family photographs and videos now reside only in a digital format – from the moment they are recorded they are never printed and only exist electronically.  These photos may become some of your most cherished family heirlooms.  You should provide your representatives information where to locate these photos and videos.

Create a Record

To ensure that none of your digital assets or debts fall through the cracks, it is critical to create a detailed record of these items, including website addresses, account numbers, usernames, passwords and other security information one might need to access and manage your accounts.

Your record should include e-mail accounts you use to receive statements or other financial information.  If you use an online bill paying service, list creditors that you pay through the service, especially those whose bills are automatically debited from your bank account.

After you create your list, the question becomes, “What do I do with it?”  Leaving a copy at home or in your office could be risky because of the possibility that someone could steal the list and use your usernames and passwords unlawfully.

You could store the list on your computer in a password-protected file – or use an “electronic wallet” program that stores passwords and other sensitive information.  You would then need to give the master password to a family member or some other trusted person, something you may not be ready to do.  Additionally, if the computer is stolen or the hard drive crashes, the information may be lost.

Another option is to keep the list in a safe deposit box.  This can be inconvenient if you follow recommended digital security practices, including changing your passwords regularly.  If you do leave it in your safety deposit box, you should allow access to the safety deposit box by one or more trusted individuals.

Not surprisingly, several companies have developed online solutions to this problem.  Sometimes referred to as “virtual safe deposit boxes”, these services store all of your usernames, passwords and other electronic data on a secure website in an escrow-like arrangement.  They can also store digital copies of important paper documents, such as insurance policies, wills, trusts, deeds and mortgages.  After you die, your designated representatives can retrieve the information, typically by presenting identification and a death certificate.  One website to review is the Digital Beyond at www.thedigitalbeyond.com.

Reduce the Amount of Work During a Difficult Time

Documenting your digital assets relieves your family of the difficult and often impossible task of tracking down these assets themselves during an already difficult time.  Ask your estate planning advisor about whether a virtual safe deposit box makes sense for your situation.

Your online accounts hold two types of value – economic and sentimental.  Both types of asset need to be considered carefully in building a proper digital estate plan.

If you have any questions regarding the above article or need assistance with your estate plan, please call us at (206) 621-1600 or e-mail Gary Gill at garygill@pugetlaw.com.

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Federal Estate Tax Law Changes for 2011 and 2012

On January 1, 2011, as we welcomed the new year we also welcomed the largest exemption from federal estate taxes ever for married couples – a whopping $10 million exemption.

President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act on December 17, 2010. This new law provides changes to the rules governing federal estate taxes, gift taxes and generation-skipping transfer taxes for the 2010, 2011 and 2012 tax years.

SUMMARY OF THE TAX LAW CHANGES

For deaths occurring in 2010, the decedent’s heirs will have the choice of applying the 2011 federal estate tax (making use of the “unlimited step up basis”) or applying the 2010 unlimited exemption (making use of the “modified carryover basis”). The tax basis choice of rules determines how the heirs calculate their taxable gain when they sell property they have inherited. In general, for the vast majority of families, the better choice is the 2011 rules; the $5 million exemption is so large that more than 99.5% of estates will not owe any tax.

Here is a summary of what the new law provides for the estates of decedents who die in 2011 or 2012:

Sets new and unified estate tax, gift tax and generation-skipping transfer tax exemptions and rates. For 2011 and 2012, the federal estate tax exemption will be $5.0 million and the estate tax rate for estates valued over this amount will be 35%. The estate tax has also become unified with federal gift and generation-skipping transfer taxes such that the gift tax exemption and generation-skipping transfer tax exemption will be $5.0 million each and the tax rate for both of these taxes will also be 35%.

Offers “portability” of the federal estate tax exemption between married couples. In 2009 and prior years, married couples could pass on two times the federal estate tax exemption by including “Credit Trusts” (also called “AB Trusts”) in their estate plan. The new law eliminates the need for Credit Trust planning for federal estate taxes (however, see below for Washington state estate taxes) by allowing married couples to add any unused portion of the estate tax exemption of the first spouse to die to the surviving spouse’s estate tax exemption. This will effectively allow married couples to pass $10 million on to their heirs free from estate taxes with absolutely no planning at all. Note that portability was not applied retroactively to January 1, 2010, and is only available for deaths that occur during the 2011 and 2012 tax years.

Definition of Portability of the Estate Tax Exemption.  In simple terms portability of the federal estate tax exemption between married couples means that if the first spouse dies and doesn’t use up all of his or her federal exemption from estate taxes, then the exemption that the deceased spouse didn’t use will be transferred to the surviving spouse’s exemption so that he or she can use the deceased spouse’s unused exemption plus his or her own exemption when the surviving spouse later dies.

Definition of Generation Skipping Tax.  A generation skipping tax is a tax that is assessed on property that is passed from one generation to a generation that is two or more levels below the generation of the person who is making the transfer.

For example, a transfer of property from a grandparent to a grandchild while the child of the grandparent is alive would be subject to the generation skipping transfer tax. In addition, a transfer from one person to an unrelated person who is 37 1/2 years or more younger than the person making the transfer is subject to the generation skipping transfer tax.

Definition of Gift Tax: A gift tax is a tax assessed on the value of property that is gifted from one person to another. The person who makes the gift is the one responsible for paying the gift tax and reporting the gift to the IRS on Form 709 while the person who receives the gift will not need to report the gift as part of their income.

In 2011, federal law exempts the first $13,000 of gifted property to each individual from the federal gift tax. This dollar amount is referred to as the “annual exclusion from gift tax.”

Gifts to spouses who are U.S. citizen are exempt from gift taxes due to the unlimited marital deduction. In 2010, gifts made to spouses who are not U.S. citizens were exempt up to the first $134,000 and this amount has increased to $136,000 in 2011.

STATE OF WASHINGTON ESTATE TAX

The State of Washington has its own estate tax separate from the federal estate tax. The state estate tax has been in place since 2005.  Currently, there is a $2 million exemption in the State of Washington, with a 10% tax that climbs up to 19% at $9 million and above.  If a decedent has a gross estate or a taxable estate plus taxable gifts of $2.0 million or more, the estate is required to file a Washington State estate tax return.  If the decedent has a gross estate or taxable estate plus taxable gifts of $5.0 million or more for 2011, the estate is required to file a Washington State estate tax return and include a copy of the filed federal estate tax return.

If a married couple’s combined estate is valued at $2.0 million or more, their Last Will and Testaments should include a Credit Trust and Marital Trust to 1) preserve some or all of the $2.0 million State of Washington exemption of the first spouse to die and 2) delay the payment of State of Washington estate taxes on any amounts in excess of the $2.0 million.  Retirement accounts and life insurance death-benefit values are included when valuing a person’s estate for both federal and state estate tax purposes.

If you have questions regarding the above or need assistance with your estate plan, please call us at (206) 621-1600 or email Gary Gill at garygill@pugetlaw.com.

Creating a Testamentary Trust For Your Children

Do you have a viable financial plan in place if you die and leave your minor children behind?  You should review the status of your assets and your life insurance – how much money will be available?  Is this amount adequate or is additional life insurance coverage needed until your children are grown?  If you have minor children, even leaving them all of your assets and life insurance benefits is simply not enough.  Someone must handle the money that will be left to your children.  This should be a person who will invest and spend the money as you would under the same circumstances, and more importantly someone you choose.

Many parents provide for the children’s financial future through a Testamentary Trust (or through a children’s trust within a revocable living trust).  A testamentary trust is a trust created by the terms of a Last Will and Testament and does not become effective until your death.  It is literally a trust within a Will.  A testamentary trust differs from an inter vivos trust or living trust.  Such trusts come into being during your lifetime.  A testamentary trust is not funded until after death.  There is no need to transfer title to any assets during your lifetime.  The testamentary trust only goes into effect if you die before a child reaches the age the parent or parents have designated for him or her to receive all of the trust assets.

The person you name to invest and distribute the assets in a testamentary trust is called the trustee and your child is the beneficiary.  The trustee is usually the person you appoint as the guardian to your children, but it can be someone else you appoint instead.  The trustee is bound by the terms of the trust and has a fiduciary duty to act in the best interest of the beneficiary.  The trustee cannot mishandle the property or use the property for his or her own benefit.  You can state at what age you wish the trustee to distribute all or part of the principal to your children (e.g., one-half at age 25 and the remainder at age 30).  You can also designate your child as a successor trustee once the child reaches an appropriate age.

What Happens if you do not have a Plan in Place?

If you as a parent do not designate someone to handle your children’s assets in your Wills or your revocable living trusts, the court will have to make the appointment without direction from you.  If the court appoints a guardian or custodian to manage your children’s affairs, that person will be supervised by the court and will have to seek court approval for major expenditures.  The funds will be divided equally among the children – for administration by the guardian or custodian.  The remaining assets will be distributed to each child when he or she turns 18 unless otherwise directed by the court.

In Washington, the courts generally have four options when directing the distribution of estate funds to a minor if you die without a Will or without adequate provisions for a minor child.  The four options are as follows:

            A.        Blocked Account.  The money may be placed with a bank or trust company (insured financial institution) in an account for the benefit of the minor beneficiary.  Withdrawals may be made only upon court order.  When the minor beneficiary reaches age 18, the funds are distributed outright to the beneficiary.

            B.        Guardianship.  Prior to the closing of the probate, a guardian may be appointed for the minor and the property is then distributed to the guardian to administer as a guardianship estate.

            C.        Custodial Account.  The property may be distributed to a custodian for the minor under the Uniform Transfer to Minors Act.  The court will appoint the custodian if one is not named in the Will.  The court will then set the parameters for investment and distribution decisions from the custodial account.

            D.        Irrevocable Trust.  On occasion, the court may direct the transfer of the property to a court established trust for the benefit of the minor.  A guardian ad litem is appointed by the court to review the appropriateness of a trust and the possible terms of the trust.  By court order, the court approves the terms of the trust and the age at which the remaining assets in the trust are distributed outright to the beneficiary.  The court retains jurisdiction over the trust with the trustee providing annual reports to the court.  Many times, the court will extend the life of the trust past the minors 18^th birthday to up to 25 years of age.  At that time, the trust terminates and the beneficiary receives the remaining assets outright.

Advantages of a Testamentary Trust

• A testamentary trust can postpone payment of an inheritance well beyond age 18, in some cases lasting for the lifetime of a child.  The trust can provide for changed circumstances, such as educational, business, or travel requirements.

• You are able to pick the trustee.

• Unlike a guardianship or custodial account, a testamentary trust generally need not be subject to court supervision.  This reduces the cost, complexity, and difficulty associated with managing the child’s estate.

• Unlike guardianships and custodial accounts, parents can decide exactly what standard should govern how the trust assets are managed and invested.  Furthermore, parents are given flexibility in how the trust will provide for their children.  This ability to customize the trust enables the trustee to make financial decisions similar to the way a parent would if the parents were still living.

• A testamentary trust can specify alternative beneficiaries if the child is no longer living by the termination date.

• Finally, a testamentary trust can be optimized to decrease taxes and expenses.  A guardianship does not have the same flexibility.

Options with Testamentary Trusts

Many parents would prefer for their assets to be held in trust for their children until the children reach 25 years of age or older.  Often parents prefer to have a combined pool of assets for the children, instead of separate equal shares.  This can account for the different needs of the children.  A testamentary trust can be established as a “pot trust,” (sometimes referred to as a “pooled trust”) meaning that assets can be pooled for the use of multiple beneficiaries.  A pot trust is particularly advantageous when the parents’ estate is not large enough to justify a division into separate trusts for each child.  Moreover, a pot trust can provide for greater expenses incurred by one child (such as a sickness or education) without wiping out that child’s inheritance.  On the other hand, testamentary trusts can also be divided into separate trusts for each child if the parents so choose or the circumstances warrant.

These goals can be achieved through a testamentary trust or a revocable living trust, but not through a custodial account or guardianship supervised by the court.

Often, parents who have a testamentary trust pass non-probate assets into a trust.  This is an effective and efficient approach.  The proper designation of beneficiaries in a life insurance policy or on a retirement plan can transfer the assets first to the surviving spouse.  If the spouse does not survive, the second beneficiary can be the trustee of the testamentary trust, thereby sending the funds directly into the trust for the benefit of your children.

If a trust is not established to receive the life insurance proceeds, and if the life insurance beneficiary designations are not properly established to fund the trust, the court will be obliged to appoint a guardian or custodian to handle the children’s funds.  This is often more cumbersome, more expensive, and less compliant with the parents’ wishes than a trust (and handpicked trustee) would be.

In many circumstances, a testamentary trust is the best answer to a parent’s need to provide certain financial protections for their children should both parents die prematurely.

Call the Law Office of Gary E. Gill, P.S. at (206) 621-1600 if you need further information regarding this subject or estate planning in general.

Federal Estate Taxes

Visit the Law Office of Gary E. Gill, P.S. at http://www.pugetlaw.com

On January 1, 2010, an unprecedented event occurred: Congress allowed the federal estate tax and generation-skipping transfer tax to completely disappear. Will Congress reinstate the federal estate tax in 2010 or will they do nothing and simply allow the estate tax to reappear in 2011?

The United States estate tax is a tax imposed on the transfer of the “taxable estate” of a deceased person, whether such property is transferred via 1) a Will or Trust, 2) through intestate succession, or 3) otherwise made as an incident of the death of the owner, such as the payment of life insurance benefits or paid-on-death financial accounts.  The amount that one can pass “estate tax free” depends on the tax law in place in the year of one’s death.

Gift and Estate Taxes

The following table compares current rates and exemptions with those from 2009 and those scheduled to take effect next year unless Congress changes the law.

Year	Lifetime Gift Tax Exemption	Total Gift and Estate Tax Exemption*	Generation Skipping Tax (GST) Exemption	Gift, Estate, and GST Taxes Top Rates
2009	$1 million	$3.5 million	$3.5 million	45%
2010	$1 million	Unlimited	Unlimited	35%
2011	$1 million	$1 million	$1 million	55%

*The estate tax exemption amount is reduced for lifetime taxable gifts.               

Estate Taxes in 2010

It sounds like a great deal for the children of ailing wealthy parents.  For 2010, there is no federal estate taxes levied on the estates of people who die in 2010.  Of course, this may be too good to be true.  By letting the tax lapse, Congress has created some unintended consequences and increased the chances that you may owe taxes on an inheritance. Yes, the result of the repeal of estate tax in 2010 is that some people of lesser means may owe capital gains taxes on inherited assets. What’s more, since many Wills and trusts are written on the assumption that the estate tax exists, a Will that made sense last year (or any other year, for that matter) could result in your surviving spouse getting a reduced amount of your estate.

The current repeal of the federal estate tax law may hold up for the rest of this year, but some tax experts expect legislators, at some time later this year, to reinstate the tax and make it apply retroactively for 2010. If they do, that would mean estate inheritances received in 2010 when the law is not in effect could still be taxed.  We can expect constitutional challenges to new estate laws if applied retroactively.

The Basics

The following are some of the basics related to the federal estate tax law and how to protect yourself and your heirs, at least until Congress takes action.

• Both the estate tax and the generation-skipping transfer tax (on assets given to grandchildren) were repealed at the end of 2009.
• Both taxes are scheduled to return in 2011 at the unfavorable rates that applied 10 years earlier. The amount that is exempt from each of these taxes will then be $1 million, and the tax on the rest will be 55 percent.
• There is still a gift tax if you give away more than $1 million during your lifetime, but the tax rate has been reduced from 45 percent to 35 percent.
• Heirs will now have to use the original price paid for an asset when computing their tax liability, instead of the value upon the owner’s death. This change of “cost basis” could be very expensive, and difficult, for heirs. For example, if you inherit shares of Microsoft that your parents accumulated over many years, you might be stuck hunting for all their transaction slips and adjusting for stock splits along the way (a potential nightmare). And when you sell any of the shares, you may owe capital gains tax on the appreciation. Each estate can exempt $1.3 million of gains from this carryover basis rule, as it’s called. Another $3 million exemption applies to assets inherited from a spouse.

What Might We Expect?

Many estate planners expect Congress to restore the taxes retroactively, and to put back in place the system that applied in 2009: a $3.5 million exemption for estate tax and generation-skipping transfer tax, with a 45 percent rate for these two taxes as well as the gift tax.  Given the revenue needs of the federal government, it is difficult to guess what estate tax legislation Congress may pass.

If Congress passes retroactive legislation, past court cases suggest that restoring the tax this way is legal. But people with enough at stake may bring lawsuits arguing that a retroactive tax is unconstitutional. The sooner Congress acts, of course, the fewer the number of people with an incentive to bring such cases.

Possible Steps to Take

The following are some issues to consider:

1)         Locate records of assets that are subject to capital gain taxes

You will do your loved ones a favor by organizing your records to show the cost basis of assets they might ultimately inherit.  It might be worth gently asking your parents if they happen to have kept transaction slips for stock shares they still hold.  Many people who were not wealthy enough to put them in the estate tax danger zone could be affected by the carryover basis rule. It is such a bookkeeping headache that it is unlikely to stick, but you should prepare just in case it does.

2)         Are there “tax formula clauses” in your estate planning documents?

Review your Wills and revocable living trusts to see if they include phrases such as “that portion”, “that fraction”, or “that amount” (without saying what it is). These are signs of attorneys trying to take maximum advantage of the estate tax exemption, which kept increasing. In 1999, it was $650,000 and by 2009 it had reached $3.5 million.

Instead of naming a specific sum that will go into a trust, many documents refer to an amount up to the exemption amount or express the sum as a percentage of whatever the limit happens to be when the person dies. This is good standard practice, but in a year without an estate tax, make certain the document reflects your intent. It is possible that under your current arrangement, less money would go to your spouse than you would like or too much may go to grandchildren. Consult your attorney about whether amendments may be necessary.

• Use of Credit Trusts for Estate Tax Planning for Married Couples

The use of a Credit Trust can reduce or eliminate the payment of estate taxes at the death of the surviving spouse.

Here is how a Credit Trust works: Assume your Will includes a formula clause that would allocate up to the maximum tax-free amount to the trust if you die before your spouse.  The trust distributes your assets as you specify in the trust document — say to your spouse and family members while your spouse is alive, and then pays what is left to family upon the death of your spouse.

By placing the assets in trust, rather than leaving them to your spouse outright, you ensure that neither the assets nor any appreciation on them will be considered part of your spouse’s estate.  The assets held in the trust are, therefore, not subject to estate tax when the surviving spouse dies.

If your remaining assets go to your spouse, the tax on this portion, called the marital share, is not eliminated, but rather will be postponed until the second spouse’s death.  In most cases, no tax will be assessed when you die, because assets inherited from a spouse are entitled to an unlimited marital deduction.  Any money that remains of the marital share will be taxed when the second spouse dies.

But what happens if you pass away in 2010 and there are no estate taxes?  Depending on how a formula clause is worded, it is possible that everything will go into a Credit Trust.  This could lead to an unintended consequence.  As an example, if the trust is not set up to make payments to your spouse (for example, if it only benefits your children from a previous marriage), your spouse will receive nothing.   Another example would be even if the trust does benefit your spouse, all the money will be locked up in the trust, and your spouse will not receive anything outright.

If your estate plan now suffers from this defect, your Will can be amended to fix the problem.

3)         Watch out for state estate taxes

If you are considering moving to another state or dividing your time among two or more locations, consider the estate plan implications.  Approximately half the states have a separate estate tax, which applies not only if you live in one of these states, but also if you own real estate there.  These taxes apply whether or not there is a federal estate tax.

When you change your home state, it’s important to pull up roots and establish new ones.  Otherwise, if your former state has an income tax or estate tax, it may chase you, or your estate, for taxes.  In a worst-case scenario, you could wind up owing taxes to two states.

All states will honor a Last Will and Testament that is valid in the state where it was signed.  Specific terms drafted for one state, however, could be problematic in a new one. You do not necessarily have to have a new Will prepared if you do move, but you should have an attorney in the new state review your Will and any other estate planning documents.

4)         Do you have the resources to transfer/gift large sums of money while you are alive?

These gifts leave less for the government to tax, and if the assets increase in value after you have passed them along, the appreciation is estate-tax-free. But people in a position to do this run up against the $1 million lifetime gift tax exemption ($2 million for married couples). Most people are reluctant to make gifts so large that they will incur gift tax.  For those who are comfortable with the idea, the gift tax is now 35 percent, so in theory this is a good time to make gifts. The risk, however, is that the previous tax rate, which was 10 percent higher, could be restored retroactively. Thus, you cannot make gifts secure in the notion that the lower rate will apply.

5)         Would you like to provide a financial cushion for your grandchildren?

Normally, when you give assets directly to grandchildren or set up a trust to do so, you need to plan for the generation-skipping transfer (“GST”) tax. This tax applies on top of estate tax and gift tax. With the repeal of the GST tax for one year at the start of 2010, advisers are proposing a variety of techniques to maximize gifts to grandchildren.  How they will be affected by a law that takes effect retroactively remains unclear.  I would proceed with caution. 

Give your Estate Plan a Checkup

For all the discussion regarding the estate tax repeal, this tax affects very few people.  In 2009, less than 1 percent of the population needed to be concerned about estate taxes.  Regardless of your net worth, you still need an estate plan.  Estate planning goes far beyond taxes.

Whether or not taxes were a concern for you in 2009 or might be again — either later this year or in 2011 — make a New Year’s resolution to give your estate plan a check-up.   You should be sure that you have all the basic estate planning documents to provide for you not only at your death but also during your life.  If you have a spouse or partner, provide for him or her financially.  You should name a guardian for your children who are minors or have special needs and leave any bequest to them in trust in the event something happens to you.

Review Beneficiary Designation Forms

Retirement accounts and life insurance policies are considered as assets when calculating your estate for estate tax purposes.  Typically, it is recommended that these assets do not pass through your Will or Revocable Living Trust.  If you have life insurance, make sure you have properly completed the beneficiary designation form, naming the beneficiaries who will receive the death benefits.  Beneficiary designation forms for your retirement accounts should also be completed and coordinated with the rest of your estate plan. Make sure the forms include both primary and alternate beneficiaries.  Generally, you should not name your estate as beneficiary — that could cause your heirs to lose important income tax benefits.

Build a Legacy

Even with the uncertainties with the federal estate tax laws, there is no reason to delay thinking about the legacy you would like to leave — as examples, by providing everyone in your family with the best possible education, developing a succession plan for the family business, keeping a vacation home in the family or making meaningful gifts to charity.  Most important, estate planning is a way to take care of yourself and the people who are important to you.