A living will is a document that states your wishes regarding the use of life-sustaining treatment of you should become terminally ill or permanently unconscious. A living will spells out whether or not you want life-support technology used to prolong your dying and gives doctors the authority to follow your instructions regarding the medical treatment you want under these conditions.
"I've heard horror stories about a probate court that tied up the estate's assets for years. How can I make sure that my estate does not go through probate?"
First of all, you should remember that the horror stories are just that -- horror stories. They are the most grievous examples from among many different experiences. If you leave no will and your heirs all hate each other, the probate of your estate will very likely be a nightmare. But in Ohio, probate can be very simple if you leave a properly drafted will.
You may have heard that a living trust can avoid probate. A living trust works because none of your assets are in your name at death. If you have vigilantly transferred everything you own to the trust, the distribution of your assets at death will be handled under trust law, instead of under probate law. In some states, such as California, trust law is much simpler than probate law for this purpose. But in many states, including Ohio, the differences are minor. The state of Ohio is not interested in tying up your assets. Indeed probate cases in Ohio are required to be completed within six months, unless certain special exceptions apply. If you have a very simple estate, you may even qualify for a very simplified probate procedure known as release from administration.
Probate should be thought of more as a service that the state offers to help the heirs clear title to assets. Most banks and other institutions will not release assets or funds to the heirs of the account owner, because they are afraid of being sued if someone lies to them about being an heir. An order from a probate court will protect them from this liability. The Ohio probate system is designed to help the rightful heirs obtain such an order as easily as possible, while still preventing fraud by impostors.
Even if you have a fully-funded living trust, the distribution of your assets can still be delayed if your estate is large enough to owe estate taxes. Federal law holds your successor trustee and executor personally liable for any unpaid estate tax. Therefore it would be foolish for the successor trustee of your living trust to distribute the trust assets before making sure the IRS is satisfied with the amount of estate taxes paid. The IRS will, upon request, issue a "closing letter" which provides some protection to the trustee or executor, but the process of requesting and obtaining the closing letter can easily take over a year. If you have ever been told that an estate is tied up in probate, it is entirely possible that the probate court is not to blame at all; it's really the fault of the estate tax system. And avoiding estate tax, while a worthy goal, is very different from avoiding probate. A living trust does nothing to avoid estate tax that a properly drafted will cannot also do.
Probate horror stories are often caused by events outside the probate system. Estate taxes, will contests, poorly drafted wills or trust documents, family members who are unhappily surprised by the contents of a will or trust -- all of these things can and do make the process of distributing your assets long and expensive. Simply setting up a living trust to avoid probate without dealing with these other issues will not prevent your estate from suffering the expense and delay of the worst horror stories you've heard.
You may have seen an advertisement in the newspaper, or perhaps you attended a financial planning seminar that described revocable inter vivos trusts, also known as living trusts. A living trust works like this: You execute a document, called a trust agreement, that creates the trust. The trust agreement names you as the trustee and the primary beneficiary of the trust. As beneficiary, you are entitled to distributions of trust assets whenever you want them. You then transfer your assets to the trust, so that when you die, you own nothing that is subject to the probate process.
Some planners assert that everyone should have a living trust, while others believe that a will is all most people need. Before you make a decision to incur the extra cost and hassle of a living trust, you should know three things:
Can my estate avoid paying an executor's fee?
Executor's commissions are set by state law and are based, generally, on a percentage of the value of the assets of the estate. At present, the commission varies between one and four percent of the value of the assets (combined with the income on those assets) depending on the nature, amount and title of the assets at death. However, surviving spouses and other family members often serve as executors and may waive these commissions. If the executor is the sole beneficiary of the will, then an executor's fee may not be important to him, because it will come out of the same funds he would otherwise receive as a bequest. If your will leaves property to multiple heirs, any one of them might jump at the chance to be in charge, fee or no fee. Ohio law does not disqualify a beneficiary of the estate from serving as executor merely because he or she is a beneficiary.
A bypass trust, also known as a credit shelter trust, is a long-term planning device. If you leave property to someone in the form of a bypass trust, that property will not be subject to estate taxes when that person dies. (The property will still be taxed in your estate, however; to save tax in your own estate, other methods must be used.) A bypass trust is particularly useful for spouses who plan their estates together. By leaving property to each other in bypass trust form, they can guarantee that the property will only be taxed once between the two of them.
To effectively save taxes, a bypass trust must follow certain rules laid out by the IRS. Let's suppose your will sets up a bypass trust for your spouse, and you die first. In order to keep the trust from being subject to estate tax when your spouse dies, your will must place the following conditions on the trust:
Although a bypass trust can be very flexible in practice, it is critical that the trust be drafted with absolute precision. The IRS has specified the words that may be used in a bypass trust, and if these words aren't duplicated perfectly, the trust might not be excluded from tax in the second estate. Even the slightest drafting error can cost hundreds of thousands of dollars in taxes, so be sure your bypass trust is being drafted by an attorney who is knowledgeable about Ohio and federal tax law.
What is a life insurance trust?
A life insurance trust is a trust that is set up for the purpose of owning a life insurance policy. If the insured is the owner of the policy, the proceeds of the policy will be subject to estate tax when he or she dies. But if he or she transfers ownership to a life insurance trust, the proceeds will be completely free of estate tax. The proceeds will be exempt from income tax either way.
Given current federal estate tax rates of up to 45%, a life insurance trust can save hundreds of thousands of dollars in estate taxes. However, there are several drawbacks to such an arrangement:
Despite these drawbacks, many people find that the tax saving potential of a life insurance trust is worth the cost and hassle. It allows you to remove from your estate a significant asset that you are unlikely to want access to during your life. And it ensures that the life insurance proceeds go 100% to your beneficiaries, not to the federal government.
Many people wish to make lifetime gifts to their children in order to save estate taxes. As long as a parent gives his child no more than $12,000 per year, the gifts will be entirely excluded from gift or estate taxes. (That $12,000 limit increases regularly with inflation.)
The problem with gifts so large is that children do not have the legal capacity, or in many cases the maturity, necessary to handle so much money. You can solve the issue of legal capacity by appointing yourself as custodian of the funds you have given your child (such as by making the gift subject to the Ohio Transfers to Minors Act), but under a custodial arrangement, the child obtains access to all of the money upon turning 21. To many parents, this is still too young.
To keep the money out of a child's hands until he is, say, 28 years old, you must set up a formal trust. You would then make your gifts to the trust, and the trustee would invest the money. To conserve costs, you could even serve as trustee yourself. The trust documents would direct that the assets be distributed to the child when the child reaches age 28. Some people have the trust distribute the funds in steps: the child receives one-third when he turns 25, one-third when he turns 30, and the final third when he turns 35.
The one catch to all of this is that the $12,000 annual exclusion only applies to gifts in which the recipient has a "present interest" in the gift (as opposed to a "future interest"). In order to completely avoid gift or estate tax on the money you give to the child's trust, you must give the child some right that qualifies as a "present interest."
What qualifies as a present interest? Generally, the child has to have the right to take the money and spend it immediately. However, you can place significant restrictions on this right without losing the gift tax exclusion. A common method of doing so is to set up what is known as a Crummey Trust. It's named after the Crummey family, who set up such a trust. The IRS tried to deny them the annual gift tax exclusion, but they went to court and won.
A Crummey Trust does not give the child any rights to the income. It does, however, give the child the right to withdraw the amount of each gift for up to 30 days after each gift is made. Since the withdrawal right begins immediately after the gift is made, it is considered a present interest. If the child does not withdraw the gift within the 30 days, the withdrawal right lapses and the money remains in the trust until the child reaches the designated distribution age.
Of course, the parent must still convince the child not to withdraw the money during those 30 days. However, even if the child decides to withdraw the money, he can only withdraw the amount of the most recent gift, not the entire trust. And after that the parent can eliminate all future withdrawal opportunities simply by ceasing to make any more gifts. The property in the trust will still remain intact and growing until it's ready to be distributed.
What taxes will the beneficiary of my life insurance policy have to pay?
The beneficiary will not have to pay income taxes -- life insurance proceeds are exempt from the federal income tax if they are received as a result of the insured's death. Your estate may owe estate tax on the value of the proceeds, however. Without careful estate tax planning, your life insurance proceeds will be included in your taxable estate. Your estate will owe federal estate taxes if it is larger than the applicable exclusion amount (currently $2 million), after subtracting any amount received by your spouse. The federal estate tax rates are currently 45%.
What's the difference between an inheritance tax and an estate tax?
An inheritance tax is a tax imposed on the people (beneficiaries) who receive property from the deceased. The tax is calculated separately for each beneficiary, and each beneficiary is responsible for paying his or her own inheritance taxes. Those states that have inheritance taxes frequently tax spouses and children of the deceased at lower rates than other heirs.
An estate tax is a tax imposed on the deceased's estate as a whole. The executor fills out a single estate tax return and pays the tax out of the estate's funds. The heirs will only be held liable for the tax if the executor fails to pay it.
The federal government imposes an estate tax on all citizens and residents of the United States. It imposes no inheritance tax. Every estate gets an estate tax deduction for all property received by the deceased's spouse or left to charity, as well as a $1 million standard exemption for all other property. Thus, many middle class Americans will owe no federal estate tax.
The State of Ohio also imposes its own estate tax, with rates ranging from 6% to 7%, which is similar in many respects to the Federal estate tax. Every estate gets an estate tax deduction for all property received by the deceased's spouse or left to charity, as well as a $338,333 tax credit for all other property. Because the amount of the Ohio estate tax credit is lower than the $2 million federal estate tax applicable exclusion amount, many medium-sized estates may owe Ohio estate tax, even though they will not owe any Federal estate tax.
Willi Law Office, LLC
167 S State St Suite 150
Westerville, OH 43081-2282
Phone: (614) 890-0500
Fax: (614) 340-7103
The information you obtain at this site is not, nor is it intended to be, legal advice. You should consult an attorney for individual advice regarding your own situation.
Copyright © 2012 by WILLI LAW OFFICE, LLC Kaye P Willi, Attorney/CPA. All rights reserved. You may reproduce materials available at this site for your own personal use and for non-commercial distribution. All copies must include this copyright statement.