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The Types of Probate Administration

In the State of New Jersey, probate is handled by the Office of the Surrogate (also known as the Surrogate’s Court) established in each county. Unlike many states, the probate process is very simple. Filing requirements and appearances before probate judges are generally atypical.

Notwithstanding, it is imperative to understand the probate process in New Jersey from the planning and administrative perspectives. Although the Office of the Surrogate generally enforces few requirements regarding the administration of an estate, a competent professional should adhere to a variety of steps in order to ensure that the interests of the estate and its personal representative are properly asserted. The purpose of this article is to discuss the manners in which filing an estate is initiated in the Surrogate’s Court.

The probate process handles the administration of an individual’s assets at the time of his or her death. It is imperative to understand not only what the probate process covers but what it excludes. Contrary to popular opinion, the executor under a Will or the administrator of an intestate estate does not handle all of a decedent’s assets. There are a variety of assets which are not subject to probate. These include the following:

– Contract assets (e.g. retirement plans, individual retirement accounts, annuities and life insurance policies).
– Transfer on death (TOD) and payable on death (POD) accounts. (typically, bank accounts and brokerage accounts which have affirmative designations as to post-mortem beneficiaries).
– Property held jointly with a right of survivorship. (With the exception of the aforementioned contract assets, such title can be established for virtually any asset.)
– Assets which are owned by a living trust.

A fair number of estates can actually avoid the probate process if all assets fall into the aforementioned categories.

Many individuals choose to retitle or designate all of their assets to avoid probate – often because of unwarranted fears about the probate process. However, this is typically an unnecessary and short sighted strategy. In New Jersey, the probate process is quite simple. In addition, probate is usually necessary even if all assets are retitled because frequently there are final pension checks or Social Security checks as well as personal effects and automobiles which are owned solely in a decedent’s name. Finally, for individuals who have substantial assets, the retitling or designation of all assets to avoid probate can actually waste tax planning opportunities.

In general, the probate process is initiated with the establishment of a personal representative for a decedent’s estate. A representative is typically appointed in one of six (6) ways:

1. Administrator of a small estate.
2. Executor of an estate under a Will.
3. Administrator of an intestate estate.
4. Administrator C.T.A. of an estate pursuant to a Will.
5. Administrator appointed by the Superior Court
6.Administrator for personal injury litigation.

1. Administrator of a Small Estate. There are a variety of estates which are very small in nature. Recognizing that it is unnecessary to require bonding or unnecessary probate fees, New Jersey statutes allow for the appointment of a small estate administrator in certain circumstances. In the event there is a surviving spouse, a surviving spouse may apply, pursuant to an affidavit provided by the Surrogate’s Court, to act as administrator if the size of the estate is less than or equal to $20,000. N.J.S.A. 3B:10-3. In the event there is no surviving spouse, an heir of an estate may qualify as personal representative if the size of the estate is less than or equal to $10,000. N.J.S.A. 3B:10-4. In these circumstances, a decedent’s heirs may administer an estate without the requirement of a bond and with a reduced filing fee. The estate is typically not subject to a requirement of an accounting either.

2. Executor of an Estate under a Will. The traditional manner in which a personal representative is appointed is through a decedent’s Will. In this case, this representative is referred to as an executor. In the event an individual dies with a valid Will, the Will may be admitted to probate, pursuant to N.J.S.A. 3B:3-2, if the named executor produces the original Will, certified copy of a death certificate, prerequisite filing fee and one of the Will witnesses to sign an affidavit verifying the authenticity of the Will. Pursuant to N.J.S.A. 3B:3-4, the requirement of a witness is waived if the Will is self-proving.

Officially, a death certificate can be obtained by the township in which a decedent was a resident at the time of his or her death. However, death certificates are traditionally ordered and provided by the funeral director who handles the burial or cremation of the decedent. Prior to filing for probate, it is imperative that the proposed personal representative review the death certificate for accuracy. Inadvertently, there are times when an individual’s address is mistakenly given as a vacation home or nursing facility rather than the actual residence. Moreover, there are sometimes typographical errors and mistakes made on these forms. Once the death certificate has been released, it can be corrected by a form of affidavit. N.J.S.A. 26:6-14.

The original Will must be delivered to the Surrogate. It must be unaltered. A photocopy of the Will can be admitted only upon approval of the Superior Court. Rule 4:82. If the original Will cannot be found, there is a legal presumption that it was revoked by the testator. This presumption can be revoked by clear and convincing evidence that the document was not revoked, and, in fact represented the decedent’s wishes. In re Lawrence’s Will 138 N.J.Eq. 134, 47 A.2d 322 (1946).

Probate of a Will cannot occur until 10 days after the death of the testator, but the application to probate a Will may be filed at any time after death. N.J.S.A. 3B:3-22. Probate of a Will may be accomplished in one of two ways: (1) Common Form Probate and (2) Solemn Form Probate. Common Form Probate is an ex-parte procedure in which the executor appears in the Surrogate’s Court without notice to anyone. Solemn Form Probate occurs when a Verified Complaint and Order to Show Cause to admit a Will to probate is filed. Solemn Form Probate is typically used when a caveat has been filed by an individual who wishes to contest the Will. As such, the only means to discharge the caveat and have a Will admitted into probate is to file an application for its admission.

Under either scenario, before an executor can be appointed, he or she must execute a variety of forms. Rule 4:80-11. First, the proposed executor must execute a Power of Attorney which empowers the county surrogate to accept service of process in any cause of action in which the estate or the executor is a party. In essence, the Power of Attorney states that the surrogate is authorized to accept service of process in the event an individual or entity sues the estate and personal service upon the executor cannot be affected. In this rare event, upon receiving service, the surrogate then mails a copy of the process to the fiduciary at the address given in the Power of Attorney. The proposed executor must also file a qualification affidavit indicating that he or she is ready, willing and able to administer the estate according to law.

Upon the submission of the foregoing, the surrogate will issue Letters Testamentary which is the formal document acknowledging that the Will has been admitted to probate and that the executor has been appointed as the personal representative of the estate. In order to accomplish the objectives of estate administration, the executor must obtain a number of short certificates which are miniature forms of the Letters Testamentary. These forms are proof to a third party, such as a financial institution, that the executor is lawfully empowered to handle the assets in the decedent’s estate.

3. Administrator of an Intestate Estate. In the event an individual dies without aWill, the estate is subject to intestate succession. Distribution is governed by the intestacy statutes of the State ofNew   Jersey. N.J.S.A. 3B:5-1 et.seq. The appointment of an administrator is similar to the appointment of the executor. Rule 4:80-1. Obviously, because there is no Will, the only document which needs to be filed is a death certificate. Qualification and Power of Attorney forms, similar to those executed by the executor, are also filed. Unlike most Wills, an administrator must obtain a surety bond before receiving Letters of Administration and Short Certificates.

There is a statutory list of priority for those individuals to serve as administrator. N.J.S.A. 3B:10-2. Obviously, a spouse has priority followed by adult children. Afterwards, the priority stretches out to relatives, such as parents, siblings and other more distant relations. In order to qualify for Letters of Administration, an individual must not only request an appointment but seek the renunciation, in writing, if any individual has equal or statutory priority to serve.

Interestingly enough, N.J.S.A. 3B:5-1 provides that an administrator may be appointed after five days rather than the ten day period required for a Will.

In the event renunciations cannot be acquired, Letters of Administration may be granted if the applicant produces proof that sufficient notice of application has been given to any and all prospective heirs. The notice, in order to be sufficient, must be no less than 10 days for residents of the State of New Jerseyand no less than 60 days for persons residing outside of New Jersey. Rule 4:80-3. However, a surrogate may reduce the aforementioned time periods. In the event an objection is filed in response to these notices, an administrator may only be appointed by an application to the Superior Court through the form of Verified Complaint and Order to Show Cause.

4. Administrator C.T.A. Administration with theWill annexed is obtained when an individual has a valid Will but where no named executor is available to act. N.J.S.A. 3B:10-15. Theoretically, this can occur in the rare instance where a Will has dispositive provisions for the decedent’s estate but fails to appoint an executor. A more typical case would be when an executor, as well as any alternate executor, has died, become mentally incapacitated, renounced, or otherwise failed to serve under theWill. In this situation, an individual applying for Letters of Administration would be required to file a bond. However, distribution of the estate would be made pursuant to theWill rather than pursuant to the intestacy statute.

5. Administration Established by the Superior Court. For a host of reasons, the Superior Court may appoint an administrator of an estate. Rule 4:84-3. In the event of a Will contest, an appointment of an administrator may be made subsequent to the filing of the Complaint and prior to the ultimate determination of the validity of the Will. An appointment can also be made when heirs of law cannot agree upon an administrator for an intestate estate. The Superior Court may also make an appointment in the event there is a need to remove a personal representative due to allegations of fiduciary abuse or neglect. In all of these circumstances, the Superior Court may appoint not only an heir or the named executor, but also an independent administrator.

6. Administrator for Personal Injury Litigation. In the event a suit for wrongful death is brought on behalf of a mistake, an administrator for such purposes must be named. This individual is referred to as the administrator ad prosequendum. Pursuant to N.J.S.A. 3B:10-11, this administrator can be appointed in one of three ways: (1) by the surrogate’s court in the county in which an intestate decedent resided; (2) if a decedent resided outside a state, the surrogate’s court of the county wherein the accident occurred and death resulted; and (3) by the Superior Court. In any event, the individual who received Letters of General Administration can also receive these Letters of Administration as well. This form of administration only applies to intestate estates. An executor under a Will has the obligation right to pursue the wrongful death action on behalf of the estate.

Taking the First Step: Filing an Estate in Probate Court

CHALLENGING THE WILL AND IMPROPER LIFETIME GIFTS

Historically, probate litigation revolved around two primary areas: (1) guardianships and (2) will contests. However, the type and scope of such litigation has increased due to an increasing elderly population. Due to this increase, many individuals are executing estate planning documents at an older age and at times when they are becoming physically and/or mentally frail. In addition, many individuals, for a variety of reasons, are making substantial lifetime gifts of property. Finally, many older individuals are delegating complete authority over their finances to one of their children which, at times, has invited serious inquiry over the exercise of such authority.

In short, will contests alone may often be ineffective. If all or most of an individuals assets have been given away or misappropriated during lifetime, a will contest could become a fight over nothing. Thus, it is imperative to know the law regarding the propriety (or lack thereof) of lifetime transfers.

Gifts can be made by one of three sources: (1) an individual, (2) an agent under a durable power of attorney, and (3) a guardian. Gifts are made for a variety of reasons including, but not limited to, the desire to minimize estate taxes, the desire to minimize exposure to long term care costs, and simple benevolent intent.

When an individual makes gifts, which are subsequently disputed, the two main causes of action are lack of donative intent and undue influence. Many of the other grounds that can be utilized in a will contest, such as fraud, forgery, duress, and coercion, can be asserted as well.

The standard for donative capacity is generally seen as broader than that for testamentary capacity. The courts of the State have held that improvident giving may be construed as indicative of mental incapacity. See Pascale v. Pascale, 113 N.J. 20 (1988). A reading of this case indicates that valid gifting must have four elements: (1) an act constituting actual or symbolic delivery of the subject matter of the gift, (2) an intent to give, (3) an acceptance of the gift, and (4) the donor’s relinquishment of ownership and dominion over the subject matter of the gift. Contests to set aside lifetime giving should reflect, where applicable, that the donor could not meet this test.

Undue influence can be raised as to lifetime giving as well. In a will contest, a presumption of undue influence arises when both a confidential relationship exists as well as suspicious circumstances. In the case of lifetime gifts, this presumption arises when there is a confidential relationship and a person in that relationship has gained an advantage due to that confidence. (See In Re Dodge, 50 N.J. 192, 227-28 [1967]; Pascale v. Pascale, 113 N.J. 20 [1988]).

(a). Gifts by an Individual

When an estate planning attorney is assisting an individual in lifetime transfers, the same precautions utilized in screening testamentary capacity and undue influence in a will contest should be utilized. If litigation arises, the attorneys contesting or defending the gifts should explore the records of the attorney to ascertain whether or not any of these steps were taken.

(b). Gifts by Agents Under Powers of Attorney

Theoretically, gifts can be made under a power of attorney. However, there are a number of concerns which should be analyzed. First, the attorney should a general durable power of attorney. Specific powers, such as banking powers of attorney or real estate powers of attorney, do not specifically authorize gifting. Gifting should be acceptable if a general durable power of attorney is utilized. However, the mere fact that a document known as a “power of attorney” or “general durable power of attorney” is executed does not mean that gifting is allowed. In addition, the law generally prohibits self dealing by individuals acting as agents under such powers.

When preparing a power of attorney, an attorney should carefully draft powers regarding gifting or creation of trusts on behalf of the principal. Such powers should discuss not only the fact that gifts can be made, but to what extent, for what purpose, and to what class of donees. Since spouse and children are typically the agents under such powers, the document should relieve the prohibition against self dealing.

The aforementioned level of detail should be analyzed when an individual has gifted under a power of attorney. The general position of the Internal Revenue Service, which has been supported by case law, is that gifts for tax planning purposes cannot be undertaken under a general durable power of attorney unless specific language is included. As such, litigating attorneys should be reasonably able to assert that the absence of such provisions in a power of attorney used to make gifting should void said gifts.

(c). Gifting By Guardians

Guardians frequently believe they have unlimited power. As such, gifts may be made by a guardian. However, gifts must be made subject to two specific sets of rules. First and foremost, the statutory law of this State clearly mandates that gifting must be made pursuant to an order of the court. N.J.S.A. 3B:12-49 and 3B:12-50 clearly indicate that the court holds jurisdiction over transfers of the ward’s property. In addition, N.J.S.A. 3B:12-58 clearly states that gifting can be done only so long as the guardian can demonstrate to the court that the ward will be protected and that the individuals or entities which would be receiving gifts are the objects of the affection of the ward. Second, any gifting must be made pursuant to the requirements of In Re Trott, 118 N.J. Super 436 (Chancery Div. 1972). The Trott case, in relevant part, states that any gifting must be made proportionate to beneficiaries under the ward’s existing will or dispositive plan. In the absence of a will, trust or other dispositive writing, the gifts will be made pursuant to the intestacy statute.

Thus, it is imperative that an estate planning attorney acquire court approval prior to undertaking any gifting. In addition, it is imperative for a litigating attorney to ascertain whether or not the court order has been acquired in any gift contest. In addition, the litigating attorney may be able to challenge a gift not only on the absence of an order, but on an order that was rendered without adequate notice to any interested parties, which would include will and intestate beneficiaries.

Special Estate Administration Issues

There are a myriad of issues that can confront an estate upon a Decedent’s death. Any professional who is attempting to assist in the administration of the estate must, at the very least, recognize how to spot these issues and to deal with them.

1. Determining the Continuation of Decedent’s Business
Special issues arise when a decedent is the owner of a business. In this regard, this section excludes individuals who own interests in large corporations. This section addresses issues which involve individuals who own sole proprietorships as well as interests in partnerships, limited liability companies and S corporations.

When the business owner dies, the first decision which must be made is whether the business should be continued, discontinued or liquidated. In the event the decedent was a sole proprietor or sole interest holder under a limited liability company or S corporation, it is likely that the business will be either discontinued or liquidated. If there are surviving partners or active members in a limited liability company or S corporation, the business may well continue.

2. Steps to Take in Dealing with Simultaneous Death
“Simultaneous death” is the concept that applies when two or more individuals, who were beneficiaries of each other’s estate, die at the same time. In essence, N.J.S.A. 3B:6-3 provides that, property that would have passed to intestate beneficiaries, “shall be divided in as many in equal portions as there are successive beneficiaries and these portions shall be distributed respectively to those who would have taken in the event that each designated beneficiary had survived.” Furthermore, N.J.S.A 3B:6-4 treats property, held either jointly with right of survivorship or as tenants by the entirety, by converting same into a tenancy in common in the event multiple owners die simultaneously.

N.J.S.A. 3B:6-5 provides that life insurance proceeds pass to the contingent beneficiary if the primary beneficiary dies at the same time as the decedent.

The aforementioned provisions apply solely to intestate matters. In each and every instance, simultaneous death is defined by a beneficiary failing to survive a decedent by 120 hours. Once 120 hours elapses, the property is considered vested in the beneficiary even if he or she has not received same.

Notwithstanding the foregoing, this law is superceded by any lawful provision within a will, living trust, deed or contract of insurance. Such documents may lengthen or shorten the aforementioned period of time for survival. It may also make a presumption regarding one party predeceasing the other in the event of a simultaneous death.

After making this initial determination, one must inquire whether a buy/sell agreement exists. This agreement may also be known as a partnership agreement, shareholders’ agreement or operating agreement (for LLC’s). These agreements serve three important purposes. First, they may control valuation for Federal estate tax (IRC Section 2703). However, such valuation may not be acceptable for New Jersey Inheritance Tax purposes. Second, they detail the terms and conditions by which an individual’s shares will be transferred upon death. Third, operating control or administrative functions may be altered, pursuant to the terms of an agreement, as a result of death.

In the event surviving partners, members or shareholders are to buy out a decedent or his/her estate, buy/sell life insurance may have been obtained and likely used for the purchase of the business interests from the decedent’s estate by the surviving business members. In the event such life insurance does not exist, or is not satisfactory to pay the decedent’s estate, the agreement should specify the terms and conditions by which the business is to be sold and purchased.

In the absence of one of the aforementioned agreements, the transfer of business shall be made pursuant to the Will. In administering an estate, an executor should note whether instructions exist in the Will as to the disposition of the business. If no such instructions exist, the executor generally has the authority to act on behalf of the decedent in deposing of the decedent’s business interest.

For tax purposes, a professional appraisal of the business interest should be obtained. Despite the terms and conditions of a buy/sell agreement, the New Jersey Department of Treasury shall require an independent appraisal for New Jersey Inheritance Tax purposes. In the event the business interests pass from one generation to the next within a family, it is often mandated that the appraisal come from an individual or entity other than the accountant which is employed routinely by the business. In making these evaluations, a qualified appraiser or forensic accountant should explore whether discounts can be obtained for lack of marketability or minority interests when appropriate.

3. Filing for Partition of Undivided Interests in Property
Commonly, both personal representatives and beneficiaries think that the job of an executor or administrator is to liquidate all the estate assets and to distribute checks to the heirs. However, beneficiaries are entitled to “in kind” distribution as well. Pursuant to N.J.S.A. 3B:23-1, there are two forms of in-kind distribution. First, a specific devisee under a Will, is entitled to specific bequests made to him or her. Second, whether a particular asset is not covered by a Will, or in the event of intestacy, an estate beneficiary may request an in-kind distribution if three conditions are met: (1) the person has not previously demanded payment in cash, (2) the property distributed in kind is valued at fair market value as of the date of its distribution (not date of death), and (3) no residuary devisee has requested the asset in question remain a part of the residue of the estate. In the event all of these conditions are met, an in-kind distribution may be made. Of course, this distribution can be made outright if it falls within the percentage to which the beneficiary is entitled under the decedent’s estate. In the event it exceeds such interest, an executor or administrator may distribute same if the beneficiary is willing to pay the difference between his or her interest and the fair market value of the asset. In this event, or in the event another residuary devisee makes the request that an asset remain part of the residue of an estate, a court order should be obtained authorizing the distribution.

On occasion, two or more heirs or devisees may be entitled to distribution of undivided interests in the real or personal property of an estate. Typically, such situations encompass the interests in real property. In such an event, an action before the probate court may be initiated for partition. This action may be commenced not just by the personal representative, but by any of the beneficiaries of the estate as well. This application should be made prior to the formal or informal closing of the estate. It should be undertaken by way of an Order to Show Cause and Verified Complaint.

The aforementioned Order to Show Cause shall demand that notice to all interested heirs or devisees be provided. In the event any beneficiary devisee is a charity, the Attorney General for the State of New Jersey shall be notified as well.

If possible, the court shall partition the property in the same manner as provided by law for civil actions of partition. In the event the court determines a partition cannot be made without prejudice to the owners and which cannot be conveniently allotted to any one particular party, the court may direct that the property be sold.

4. Petitioning the Court for Instructions
A properly drafted Will not only appoints an executor, but provides that executor with a set of instructions to complete their job in the administration of the estate. Unfortunately, the instructions given in Wills are not always clear. There are typically two reasons for poor instructions. First, many people are using software programs and the Internet to prepare Wills. Arguably, the quality of the software programs and Internet programs leave a bit to be desired. Moreover, many lay people do not have a clear understanding of probate laws. Thus, the attempt to save a few dollars in estate planning costs can frequently lead to the creation of deficient estate planning documents. Second, many attorneys, frankly, draft poor Wills.

Recognizing that an executor is responsible for proper distribution, an executor wishes to ensure that he or she is not accused of making a mistake as to distribution after same has been made. As such, in order to remedy the deficient instructions of a poorly drafted Will, an executor may petition the Court for directions.

Specifically, Rule 4:89-1 states, “If an account is to be settled, the plaintiff in the complaint may apply to the Court for directions as to the distribution of the estate.” Rule 4:89-2 states, “In actions for distribution, the complaint shall state: (e) When letters, if any, are granted to a fiduciary; (b) the names and addresses of all persons interested, specifying which of them are minors or mentally incapacitated persons; and in actions for the distribution of an intestate’s estate, the manner and degree in which the next of kin severally stand related to the intestate; (c) the balance in the fiduciary’s hands for distribution, so far as the same may be known; and (d) shall have annexed to the complaint a copy of the Will or other instrument, if any, pursuant to which distribution is to be made.”

In light of the foregoing, it is clear that the issue of instructions is one which is limited to wills and trusts. Intestate estates typically are not involved in this matter, as distribution is governed by the intestate statutes.

Medicaid Planning by New Jersey Guardians

The issue of whether or not guardians can undertake Medicaid planning on behalf of their wards has come to the forefront of New  Jersey probate litigation in the past two decades. Commencing in 1995, many of New  Jersey’s Superior Courts began to recognize and permit guardians to transfer assets in order to expedite their wards’ eligibility for Medicaid benefits.

Unfortunately, decisions in this area were not uniform, and applications for such relief could be granted or denied by the personal or political feelings of the county probate judge. For several years, no statute or regulation existed to authorize this planning, nor was there any written opinion from the Appellate Division or state Supreme Court to provide direction to the Superior courts. Fortunately, a decision from the Appellate Division was rendered in 1998 which validated this form of estate planning by guardians.

A. Background
1. Statutory Backdrop
N.J.S.A. 3B:12 establishes that a guardianship is a “protective arrangement.” Derived from Anglo-Norman legal traditions, the court acts under the doctrine of parens patriae over wards in a guardianship setting. While guardianships are nominally established to protect the person and the estate of mentally incapacitated individuals, the primary purpose of the guardianship power has been to prevent persons from becoming public charges or squandering their resources to the detriment of their heirs. Brakel and Rock, The Mentally Disabled and the Law, at 250 (Rev. Ed. 1971); Casasanto, Michael D.; Simon, Mitchell; and Roman, Judith, A Model Code of Ethics for Guardians, New Hampshire, 1989.

Clearly, guardians cannot undertake Medicaid planning without court approval. A guardian may reasonably expand or distribute the ward’s assets for the benefit of the ward, as well as those legally dependent upon the ward, and to pay for the necessary expenses for services by third parties on behalf of the ward without court approval (See N.J.S.A. 3B:12-43, 46, and 47, respectively). Most powers, however, must be conferred by the court, which has the authority to both expand and limit powers to guardians. (N.J.S.A. 3B:12-37, 49 and N.J.S.A. 3B:14-24)

The power to make gifts lies in N.J.S.A. 3B:12-58, which states:
If the estate is ample…, the guardian for the estate of a mental incompetent may apply to the court for authority to make gifts to charity and other objects as the ward might have been expected to make.

On the other hand, statute and case law prohibits self-dealing. Because assets transfers almost always benefit the guardians, there is some legal tension which needs to be resolved. Until recently, most courts declined to accept applications by guardians for Medicaid planning because of this tension and political beliefs that typically focused on the propriety of replacing private funds with public funds to pay for custodial care.

2. Early Cases

Prior to 1995, few cases addressed the ability of a guardian to make inter vivos transfers for estate planning purposes. The primary case, which addressed estate planning by guardians, was In re Trott, 118 N.J. Super 436 (Chancery Div. 1972). In Trott, the court recognized that a guardian could make annual gifts in an amount not to exceed the annual limit subject to a gift tax. The court recognized that the guardian could prudently deplete the assets of an estate, to some degree, to minimize or eliminate such assets over the amount of the unified credit. There was no question that the remaining income and assets were more than ample to meet all conceivable needs of the incompetent until his or her death. In this decision, the court noted a line of cases and statutes in other states authorizing planning in such a way to minimize current or prospective state or federal income, estate, and inheritance taxes. Most succinctly, the Court noted that a guardian should be authorized to act as a reasonable and prudent person would act in the management of his or her own estate, unless there is any settled intention of the incompetent, while competent, to the contrary. Id. at 441.

In 1993, this doctrine was successfully extended by Gary Mazart, Esq., in an unreported opinion from Essex County, In re William J. Borrows, a/k/a Jeff Borrows (Docket No.: 12,336-4). In this case, the ward was involved in an accident and sustained personal injuries. His parents, who became his guardians, commenced litigation to recover damages for those injuries and that lawsuit was settled for the sum of $120,000. After payment of counsel fees and costs, the guardian successfully obtained court approval to have the net settlement proceeds placed in a supplemental needs trust which would preserve the ward’s eligibility for Medicaid benefits. Although transfers to third parties were not made in this case, this opinion clearly recognized that a guardian could undertake Medicaid planning on behalf of a ward.

3. Breakthrough Cases

Starting in 1994, the court system began to recognize the ability of a guardian to transfer assets to third parties, such as spouses and children, in order to expedite the eligibility of a ward for Medicaid benefits. The seminal Medicaid planning case was In re Klapper, (reported in the New York Law Journal on August 9, 1994 on page 26). In Klapper, the guardian/son of an incompetent obtained authorization to transfer some of the ward’s assets to his own family so that she could become eligible for Medicaid sooner and so that she could also continue her practice of supporting his family. The court found that, while competent, Mrs. Klapperdid provide almost $1,600.00 per month to her son’s family in addition to other substantial gifts. The New York Mental Hygiene Law Section 81.21 authorizes the making of gifts, although this statute did not explicitly discuss making gifts of all or a major portion of a ward’s assets for Medicaid planning purposes. The court noted that this was a case of first impression on this “novel” issue, and in deciding this case, the court noted provisions of the Mental Hygiene Law (Section 81.21(e)) which authorized the guardian to convey or release contingent and expected interests in property and to renounce or disclaim any interest by testate or intestate succession or by inter vivos transfer. The court noted these provisions were instructive since they enunciated the concept that the guardian does not need to accept the “spend down” of assets, but may release them.

The New York court authorized the above mentioned transfers, finding that, although there would be a period of ineligibility for Medicaid, the amount of assets remaining could be calculated so that they would be sufficient to pay for her care during the period of Medicaid disqualification. The court also noted that the proposed disposition would be made to the donees in a pattern consistent with Mrs. Klapper’s Will.

The Klapper case was expanded in the Matter of Beller, published in the New York Law Journal on August 1, 1994. In this case, Mrs. Beller’s son sought authorization to transfer a substantial portion of his mother’s assets to himself and to his three sisters for the purpose of Medicaid planning. The significance of this case was that there was no showing of previous gifts. Nevertheless, the court found that the plan was consistent with Mrs. Beller’s testamentary plan. The court noted that Mrs. Beller, if competent:

would not reasonably choose to “spend down” almost all of her assets in payments to the nursing home before applying for Medicaid when the law provides a manner for her to preserve a portion of her estate for the benefit of her son and the issue of her other son. The court finds that a competent, reasonable individual in the position of Dorothea Beller-Maltzman would be likely, under these circumstances to transfer part of her assets to her son and the issue of her other son.

The above mentioned holding was affirmed In The Matter of Cooper, 618 N.Y.S.2d 449,1162 Misc.2d 840, 1994 WL614331. In Cooper, the court noted:

While one may choose to debate whether the authority of one to engage in Medicaid planning is sound public, social or fiscal policy, less open to debate is the conclusion that the codified rules and policies to which Justice Leone referred to In the Matter of Klapper, Supra, authorized, if not encouraged, such Medicaid planning.

The statutes referred to are the New York state’s rights authorizing transfers by guardians through court approval and statutes setting forth a determination of the Medicaid penalty.

The court also noted that, under the Doctrine of Substituted Judgement, the guardian, through the court, could take such financial actions as the incapacitated person would have done if he or she had the capacity to act. Id.at 501. As the court stated:
In order to effectuate this policy, an incapacitated person should be permitted to have the same options available to him or her with respect to transfers of his or her property that are available to competent individuals. To deny a guardian the authority (where the requirements of the Mental Hygiene Law Section 81.21 are otherwise met) to make such transfers of the incapacitated person’s assets will result in denying that person the opportunity which is available to all competent persons of this State that require long term nursing home care and who have assets they desire to give to their families, simply because he or she is incapacitated and is unable from a cognitive standpoint to make such transfers by himself or herself. Such a result would be a direct contravention of the express intention of Article 81. Therefore, the court finds that Medicaid planning is a proper objective for a proposed disposition of an incapacitated person’s property. Id at 502.

In essence, Klapper opened the door to transfers to third parties, Beller expanded the authority by foregoing a requirement of previous gifting, and Cooper noted the court’s proper role of determining whether the ward would undertake this planning if competent, rather than debating the propriety of Medicaid planning.

B. New Jersey Development
In New Jersey, Medicaid planning, in the guardianship context, can be broken into four categories of cases: (1) establishment of supplemental needs trusts in personal injury actions, (2) inter spousal transfers, (3) gifts to children and other non-spousal beneficiaries, and (4) miscellaneous Medicaid transfers.

1. Establishment of Supplemental Needs Trusts
As set forth above, recognition has been given, at the Superior Court level, to place proceeds from personal injury litigation into a supplemental needs trust to preserve eligibility for Medicaid benefits. However, it is imperative for any practitioner to acquaint themselves with the revised trust requirements which were promulgated by the New Jersey Division of Medical Assistance and Health Services over the past two years before undertaking this planning.

2. Spousal Transfers
The federal and state Medicaid regulations recognize the need for protection against spousal impoverishment. To that end, community spouses of institutionalized individuals have been granted a variety of property rights. Without penalty, community spouses may transfer a residence and an automobile in their name, as well as personal effects. They are also entitled to the Community Spouse Resource Allowance (CSRA) and the Minimum Monthly Maintenance Needs Allowance (MMMNA).
Even prior to the breakthrough cases in New York, many Superior Courts authorized guardians to transfer the interest of an institutionalized individual in his or her residence to his or her spouse.

Authorization for a guardian to protect other rights of the community spouse was granted in Atlantic County in the case, In re Winfred H. Zepfel (Docket No.: 85711, decided May 26, 1995). This case occurred prior to New Jersey’s abolishment of the Miller Trust in 1995. In this matter, the institutionalized spouse received Social Security and pension in excess of the state’s income cap. To protect the community spouse, the court allowed the guardians to execute a Miller Trust on behalf of the ward and transfer life insurance policies and other assets of the ward into the name of the community spouse, as well as the interest in the marital residence. This decision enabled the community spouse to maximize his CSRA. More importantly, by executing the Miller Trust, the institutionalized spouse was immediately eligible for Medicaid, which, in turn, granted the benefit of extra income, through the MMMNA, to the community spouse.

3. Gifting to Non-spousal Beneficiaries
Prior to 2006, the most popular forms of asset transfers to non-spousal beneficiaries were: (a) large asset transfers and (b) “half-a-loaf gifting.” Since 2006, as discussed later, the latter option does not exist.

Prior to 1995, New Jersey courts universally prohibited guardians from making asset transfers to non-spousal beneficiaries. Lacking any written authority, practitioners, who attempted to receive court authority for such transfers, were rebutted with the argument that it was bad public policy to deplete private assets so that public funds could pay for institutional care. Within one year after the New York trilogy of cases, a flurry of applications for Medicaid planning were approved in New Jersey courts.

Perhaps, the breakthrough case in New Jersey was In the Matter of Edna M. Key (Docket No.: 5344, decided May 5, 1995). In this Cumberland County case, the guardian successfully persuaded the court to allow gifts of up to 55% of the total value of the ward’s property. In his application, the guardian demonstrated that the remaining assets, as well as the income of the ward, would pay for the ward’s nursing home care during the period of ineligibility created by the asset transfers. Most importantly, the Honorable William L. Forester, J.S.C., recognized, in his Order, that “making gifts for Medicaid planning purposes is a legitimate step to be taken by the guardian in this matter.”

The next breakthrough occurred In the Matter of Albert M. Wallace (Docket No.: CP-063-95, June 16, 1995). In this Camden County case, the Honorable John B. Mariano, J.S.C., allowed, with broader language, asset transfers for Medicaid planning. In this case, the ward owned assets in excess of $400,000. The significance of the court’s decision was two-fold: (a) it placed no restrictions on the type, method, or amount of transfers, and (b) it recognized that there should be no need for a guardian, who undertakes Medicaid planning, to return to court for approval to transfer the ward’s real property.

4. Miscellaneous Medicaid Transfers
In addition to the aforementioned cases, a variety of techniques exist to protect or expedite eligibility for Medicaid benefits. In Bergen County, the guardian successfully persuaded the court to allow the transfer of a ward’s residence, without Medicaid penalty, to her “caregiver” son (In the Matter of Evlyn Stutcki, decided August 18, 1995). Similarly, in Burlington County, a house was deeded without transfer penalty, to a “caregiver” brother (In the Matter of Alvin J. Hellmig, Jr., decided March 22, 1996). Other cases have created authority for the transfer of life estates and even gifting to non-relatives.

D. The Labis and Kerri Decisions

Although there were a variety of successful applications for medicaid planning, numerous petitions were declined in different Superior Courts although the relief requested was substantially identical to the approved applications. Fortunately, the propriety of medicaid planning by guardians was finally recognized in 1998 by the Appellate Division. In the Matter of Manuel Labis, 314 N.J. Super. 140 (App.Div. 1998), the Appellate Division reversed a lower court rejection of a petition to transfer the interest of an institutionalized ward to his spouse in their marital residence. In its reversal, the court noted that medicaid planning is a legitimate form of estate planning and a guardian should have the right to engage in same on behalf of his ward.

In 2004, the authority of a Guardian to undertake Medicaid planning was clarified in the case, In Re Keri, 181 N.J. 50 (2004). Whereas Labis dealt merely with an interspousal transfer, Kerri dealt with a proposed half-a-loaf gift between a mother and child. By ruling that this plan was appropriate, the New Jersey Supreme Court gave approval to the concept of any form of Medicaid planning permitted by the Medicaid Laws.

E. Planning under the DRA

On February 8, 2006, President Bush signed into law the Deficit Reduction Act of 2005 (“DRA”) With the DRA came sweeping changes to Federal Medicaid law, which substantially affects the rights of individuals to preserve their assets in the event they require long-term care. The major changes promulgated by the DRA are:

1. The look back period went from three years to five years.
2. The penalty period for uncompensated transfer (gifts) commences when a person is institutionalized and is otherwise eligible for Medicaid rather than when the gift is made.
3. Equity in the home will be countable if it is over $500,000.00, unless a state decides to increase that amount of $750,000.00.
4. Annuities may be countable if they are irrevocable, non-assignable, actuarially sound and have equal payments with no deferral or balloon payments. In addition, the state must be named as a remainder beneficiary. It must be the primary remainder beneficiary unless there is a spouse or child who is either under 21 or disabled.

In light of the foregoing, Medicaid planning by Guardians has become somewhat limited. Many of the foregoing transfers are still permissible, such as interspousal transfers of a marital residence, transfer of a residence to a care-giver child and transfers to disabled children. However, it is doubtful that half-a-loaf gifting may be undertaken. Based on the pure text of the law, it appears that a Court may only be comfortable in allowing gifts between generations when such preserve assets for the entire five year look back period.

Establishing Effective Fiduciary Relationships

A frequently contentious area in the elder law arena is the establishment of effective fiduciary relationships. Such relationships are frequently established through powers of attorney, living trusts and other inter vivos documents. Problems frequently arise when writings, establishing these relationships, are poorly drafted and when fiduciaries are not properly selected. Such problems are further compounded when no legal direction is either sought or given after the establishment of such relationships.

Increasingly, legal challenges are asserted against a fiduciary for breach of fiduciary duty. At times, such challenges accurately attack a fiduciary who may have intentionally misappropriated the funds of the individual to whom he or she owes a duty of care and trust. However, many causes of action are raised over simple areas such as poor communication with interested parties and shoddy record keeping.

In this day and age, an elder law practitioner must recognize that establishing effective fiduciary relationships does not start and end with the drafting of pedestrian legal documents. An attorney must understand that his or her obligation, in this field of law, must encompass the following areas:

(a) drafting effective documents including powers of attorney and living trusts, understanding their difference as well as their merits and shortcomings;
(b) assisting in the intelligent and complete selection of fiduciaries and contingent fiduciaries;
(c) providing on-going representation to either the principal and the fiduciary, ensuring that the fiduciary is able to do their job, yet remaining cautious of any potential conflicts of interest;
(d) apprising the fiduciary of planning opportunities such as tax and Medicaid planning; and
(e) representing a fiduciary in litigation over negligence and abuse.

Types of Fiduciary Relationships
The term, “fiduciary”, connotes a relationship established and based on trust. Certainly, there are a host of fiduciary relationships which can be established, such as guardians for minor children, as well as a host of relationships with trust departments at banks and brokerage houses. In the estate planning and elder law arena, the primary list of fiduciaries includes:

(1) Executor under a will;
(2) Administrator of an intestate estate or C.T.A. under a will;
(3) Trustee under a will;
(4) Trustee under a revocable living trust;
(5) Trustee under a sophisticated estate planning trust such as a Grantor Retained Annuity Trust, Grantor Retained Annuity Trust, Qualified Personal Residence In Trust, Irrevocable Life Insurance Trust, Charitable Remainder Trust or Charitable Lead Trust;
(6) Trustee under a sophisticated elder law trust such as a Miller Trust, Income Only Trust, Third Party Special Needs Trust, Self-Settled Special Needs Trust, Pooled Trust or Spousal Annuity Trust;
(7) Conservator of an Individual’s Person and/or Property;
(8) Guardian of an Individual’s Person and/or Property;
(9) Agent, either as a proxy or health care representative pursuant to an advanced directive; and
(10) Agent under a power of attorney, most notably a general durable power of attorney.

Establishment of Fiduciary Relationships
Which Documents to Utilize
When representing any competent client, an attorney should prepare at least three estate planning documents:
(1) Will – to dispose of the client’s assets after his or her death;
(2) Advance Directive – to provide guidance to third parties as to medical decisions which may need to be made in the event of the client’s incapacity, especially in regards to the issue of withdrawal or withholding of life-sustaining treatment; and
(3) General Durable Power of Attorney – to provide the ability for a third party to manage the financial (and, if properly drafted, personal) affairs of the client in the event of disability.

In this day and age, it is arguably malpractice not to suggest that a client have each of these three documents as a bare bones estate plan. In an era where approximately 40 to 50% of our aging population will require some level of long term care, the effectiveness of the best drafted will or trust can greatly diminish if lifetime fiduciary planning is not undertaken.

Certainly, other documents, such as those mentioned in the preceding section, will need to be drafted to respond to the understandable needs of clients to minimize or avoid exposure to probate, death taxes and long term care costs. In order to identify and respond to these needs, it is imperative for an elder law practitioner to acquire accurate and complete information from his or her clients at the outset of the attorney-client engagement. Such information must include the client or clients’ personal and medical background as well as a listing of assets, income and significant liabilities.

Drafting Documents
One of the greatest shortcomings of attorneys, when representing estate planning or elder law clients, is the over reliance on simple form documents. Attorneys must recognize that our clients have spent a lifetime earning their estate. As such, our document preparation on their behalf must honor that commitment and exceed sloppy forms.

Without question, there is a value to forms. Attorneys should not have to reinvent the wheel each time he or she meets with a new client. However, forms should be used as a model and only good forms should be used in any system.

Arguably, the most important document for many of our clients is a general durable power of attorney. This document authorizes one or more individuals to make personal and financial decisions on behalf of our client. Unfortunately, many attorneys use one or two page forms which are generic in nature. Forms need to be customized and expanded in order to meet the needs of our client base. It must be impressed that the power of attorney asks a host of financial, medical and business institutions to rely on the representations and actions of a third party who is purportedly acting in the best interests and on behalf of our client.

As our society increasingly sees more government regulation and litigation, many of these institutions have becoming cautious in accepting powers of attorney and more frequently insist on detailed language that corresponds to the action the agent therein wishes to take on behalf of the client. Moreover, the ability to plan for a client who has become disabled may be limited if a power of attorney is not thorough. The Internal Revenue Service has consistently taken the position that it will not recognize gifts given through a power of attorney absent express language within the power of attorney authorizing same or a state statute which allows an inference on behalf of gifting. Without express language allowing an agent to participate in gift giving, many states take the position that gift giving, to the extent it includes an agent, is self-dealing and voidable. This position is certainly ironic in light of the fact that the agent typically appointed by a client is a spouse, adult child or other potential estate heir.

In light of the foregoing, it is clear that powers of attorney should be carefully drafted. They should contain language which covers the following areas:

SECTION 1. TRIGGERING EVENT
This section should discuss whether the power of attorney is effective immediately or springing.

SECTION 2. ASSET POWERS
2.1. Power to Sell Specific Real Estate
2.2. Power to Sell
2.3. Disposal of Proceeds of Sale
2.4. Use of Credit Cards
2.5. Power to Invest
2.6. Securities and Brokerage Accounts
1.8. Power to Execute Further Powers of Attorney
1.9. Power to Exercise Rights in Governmental Securities
1.10. Power to Demand and Receive
2.11. Compromises and Discharges
2.12. Exercise Elective Share Rights
1.13. Power with Respect to Employment Benefits
1.14. Power with Respect to Banks
1.15. Power with Respect to Legal and Other Actions
1.16. Power to Borrow Money
1.17. Powers with Respect to Trusts
1.18. Power to Renounce and Resign from Fiduciary Positions
1.19. Power to Disclaim, Renounce, Release or Abandon Property Interests
1.20. Power with Respect to Insurance
1.21. Power with Respect to Taxes
1.22. Power to Manage Real Property
1.23. Mortgages and Deeds of Trust
2.24. Power to Make Loans
2.25. Power to Make Gifts
2.26. Catastrophic Illness Power
2.27. Managing Agency Accounts
1.28. Employ Consultants
1.29. Power to Operate Businesses
2.30. Partnership
2.31. Power to Provide Support
2.32. Pets
2.33. Deal with Environmental Hazzards
2.34. Closely Held Business Interests

SECTION 3. STANDARD OF LIVING
3.1. Maintain Standard of Living
3.2. Protect or Dispose of Property
3.3. Power to Make Advance Funeral Arrangements
3.4. Power to Change Domicile

SECTION 4. INCIDENTAL POWERS
4.1. Resort to Courts
4.2. Hire and Fire
4.3. Sign Documents, Etc.
4.4. Power to do Miscellaneous Acts
4.5. Waiver of Confidentiality
4.6. Delegation of Authority
4.7. Appointment of Successor

SECTION 5. THIRD PARTY RELIANCE
5.1. Third Party Liability for Revocation and Amendments
5.2. No Liability to Third Parties for Reliance on Agent
5.3. Authorization to Release Information to Agent

SECTION 6. DURABILITY PROVISIONS
This section should state that the power of attorney will not be affected by the principal’s incapacity.

SECTION 7. ADMINISTRATIVE PROVISIONS
7.1. Compensation of Agent
7.2. Nomination of Agent as Conservator and Guardian for Principal
7.3. Alternate Agents as Alternative Conservator/Guardian
7.4. Waiver of Certain Fiduciary Responsibilities
7.5. Agent to Continue if Guardian/Conservator Appointed
7.6. Severability
7.7. Governing Law and Applicability to Foreign Jurisdiction
7.8. Definitions
7.9. Revocation, Removal, Amendment and Resignation
7.10. Counterpart Originals
7.11. Photocopies
7.12. Separation or Divorce
7.13. Temporary Unavailability of Agent
7.14. Appointment of Ancillary Agent
7.15. Agent’s Resignation
7.16. Agent’s Death, Incapacity or Reisgnation
7.17. Accounting

Selection of a Fiduciary
Selecting a fiduciary is an extremely important task. Unfortunately, many people make poor choices in fiduciary selection. Although the management of an individual’s personal, medical and financial care is one that requires complete trust and competence from a potential agent, people make selections on the most inane reasons. Unfortunately, many attorneys merely ask the name and address of a proposed agent rather than inquiring into the individual’s capabilities. For example, in a living will, the health care proxy or health care power of attorney ought to be someone that has the best medical background and/or can make a medical decision to remove life-sustaining treatment. Moreover, an individual that is entrusted to handle finances through a power of attorney, will or trust document must have some level of financial common sense and high degree of integrity.

People, however, frequently make appointments to documents, when appointing children, on the following grounds:
A. Age (e.g., “He or she is the oldest.”)
B. Gender (e.g., “He is the man of the house.”)
C. Proximity (e.g., “She lives closest to me.”)
D. Feelings (e.g., “I don’t want to hurt her feelings.”)

Certainly, if one were to open a financial enterprise, they would never hire anyone based on these qualifications. When someone selects a fiduciary, they need to treat it as if they were hiring a chief financial officer of their company. Obviously, legal, financial and accounting backgrounds are not necessary. However, it is imperative for the client to know that they need to appoint someone based on “high integrity and common sense.”

Post-Document Representation
After the establishment of a fiduciary relationship, many attorneys conclude their representation of the client. However, it is just as important to counsel a fiduciary on their obligations to their principal as it is to set up the relationship. Typically fiduciaries are family members who are likely not acquainted with the legal standards to which they are subject.

It is both an opportunity and an obligation to counsel clients on your availability to assist the fiduciaries they appoint. Obviously, issues of potential conflict of interest must be disclosed and resolved. However, most clients want their fiduciaries to utilize the services of the attorney who drafted their estate planning or elder law documents. Such services are typically limited to representing executors and trustees in post-mortem matters. Such limitation avoids and wastes the opportunity for lifetime representation.

Lifetime representation is extremely important for the client and beneficial to the attorney who provides ongoing representation. When a client becomes disabled, either his agent under his power of attorney or trustee under his living trust should be counseled about the steps they must take in managing and administering assets. This level of service is helpful in two areas: (1) the client needs to be protected during his or her lifetime, and (2) the fiduciary needs protection after the client dies.

The client obviously needs protection. If the fiduciary mismanages or wastes the assets of his or her principal, the principal’s quality of life will be impaired. It is uncanny, though, to see how many people merely “wing it” when it comes to handling assets as a fiduciary. It must be clearly counseled that a fiduciary must handle such assets with care. Although the fiduciary may wish to invest his or her own finances without professional help, they need to be apprised of the common law standards as to asset management as well as the Prudent Investor Act. Especially in moderate to larger estates, communication with a financial professional is essential.

The fiduciary needs protection as well. After the death of a client (and sometimes even during lifetime), the actions of a fiduciary may be questioned by the heirs of the client’s estate. A fiduciary needs to be able to promptly and effectively address such questions when they arise. Unfortunately, many fiduciaries, if not counseled, keep extremely poor records.

Countless attorneys can recall countless instances where fiduciaries fail to keep receipts, bank statements and other financial records. Such shortcomings are often compounded by the fiduciary making checks payable to themselves or to “cash” to pay for expenses of the client. When these shortcomings occur, delays occur in providing answers to family members and other heirs. Such delays frequently arouse suspicions of wrongdoing which, in turn, can be translated into actions to remove or surcharge the fiduciary. The cost of such litigation has an extremely high financial and personal cost. Since most of these actions involve fighting among siblings, the tensions are even more exacerbated.

Attorneys must counsel the fiduciaries to keep and maintain any and all financial records no matter how trivial they may seem to be. They must also counsel the fiduciaries to avoid or minimize payments to self and to “cash”. If such payments are truly necessary, they must be substantiated by receipts.

Bookkeeping should be recommended as on ongoing obligation. If questions are asked or if litigation arises, detailed entries from fiduciaries can be translated into effective communications with heirs as well as proper accountings.

An effective advocate should consider providing the following services to his or her clients, and their fiduciaries:
(1) Ongoing tax preparation;
(2) Periodic meetings to review trust or other fiduciary decisions;
(3) Bookkeeping; and
(4)Bill Payment.

Such services may sound risky or outside the practice of law. However, they can ensure that clients are protected. Although an attorney will typically be utilized for support for a fiduciary, an attorney can also serve as a fiduciary as well.

One of the more important tasks an attorney should do is remind his or her clients, as well as their fiduciaries to contact the attorney for help during lifetime crises as well as after death. The assistance of an attorney for Medicaid and tax planning during lifetime is just as important, if not more important, than assisting with the administration of a client’s estate.

Representation in Litigation
As indicated previously, representation of a fiduciary in litigation over his or her performance is sometimes necessary. If called upon to undertake such representation, an attorney must ensure that no conflicts exist with the individual who established the fiduciary relationship or any family member or other interested party.

The most effective response is a quick response. If clients have kept records in the manner set forth above, quick discovery can nip family complaints or litigation in the bud. If such records are not available, the attorney should make a sober decision as to whether or not to accept representation. If litigation commences and an attorney discovers wrongdoing, it can be very difficult to either withdraw from representation or make necessary disclosures to interested parties. If an attorney decides to undertake the representation, immediate steps should be taken to obtain all necessary documents, either through subpoenas or other forms of written requests, to provide an accurate accounting as promptly as possible. Many financial institutions are slow to respond to requests for information so requests need to be made at the outset of representation. As indicated previously, delay in providing disclosure can frequently translate into an impression that the fiduciary has committed wrongdoing.

Conclusion
As set forth in this article, any elder law or estate planning attorney must realize that effective establishment of fiduciary relationships involve careful document preparation and selection of potential agents. Moreover, representation should extend beyond the creation of legal documents. If steps, such as the foregoing are followed, the interests of clients, fiduciaries and their attorneys will be well served.

Effective Utilization Of Insurance And Retirement Accounts In Special Needs Planning

Estate planning for parents with disabled children is a very delicate and important proposition. During their lifetime, parents are able to provide emotional and financial support to their children. This support greatly enhances the needs-based government benefits, which are frequently utilized by the disabled, such as Supplemental Security Income (SSI) and Medicaid.

When parents pass away, these special children lose emotional support, which can never be regained. Without proper planning, they can not only lose financial support, but their government benefits can be jeopardized as well.

Estate planning on behalf of disabled children typically takes five forms:

  1. Disinheritance;
  2. Outright bequests;
  3. Putative bequests to siblings;
  4. Support trusts; and
  5. Special needs trusts.

With rare exception, the special needs trust is the only strategy to utilize.

Many individuals disinherit their disabled children based upon poor advice. They love their children very much, but are very concerned with preserving needs-based government benefits. They are told that inheritances will disqualify their children from these benefits. Unfortunately, this advice is inaccurate, because proper planning can preserve these benefits. In most instances, disinheritance is ill-advised. As any reasonable individual knows, our federal and state governments have taken an increasingly adverse position preserving the health and well-being of the disabled. In light of the fact that government eligibility continues to tighten for needs-based programs, it is not speculative to foresee a society in which drastic cutbacks in programs were made that may imperil the well-being of the disabled. Thus, disinheritance is unwise.

On the other hand, outright bequests are often disastrous. In most states, an individual cannot qualify for needs-based public benefits if their assets exceed $2,000. Outright bequests typically will disqualify an individual from these benefits. As such, the inheritance will be used to supplant SSI, Medicaid, HUD or group housing, and any other needs-based benefit. The more significant the needs of the individual, typically will lead to a rapid depletion of the inheritance.

Many parents believe a preferential distribution to a non-disabled child would hope that he or she will use assets to care for the disabled child. For example, Mr. and Mrs. Smith have three children—Susie, who is disabled, John, and Sarah. Instead of dividing their estate three ways, they give two shares to Sarah and one share to John. Their hope is that Sarah will use one of these two shares to provide for her disabled sister. Unfortunately, Sarah does not manage money well, or if she is subject to divorce or creditors, these funds can be compromised. Also, Sarah could predecease Susieand these funds could be completely unavailable.

More and more individuals, attorneys and other professionals recognize the need for trusts to protect the disabled. Unfortunately, most of them do not know how to do it properly. Far too often parents execute wills in which a trust is established with language stating that funds will be utilized for the “health, education, maintenance, and support” of their disabled children. This type of trust, known as a support trust, automatically disqualifies disabled children from needs-based benefits. The individuals who draft these trusts recognize the need to protect the disabled, but are completely unaware of the rules that need to be followed to preserve benefits. Of course, it should be noted that families that are very affluent may benefit from using the support trust, as it allows for a broader range of distributions on behalf of a disabled individual. The basic rule of thumb is that the assets in the trust, and the income generated therefrom, must clearly provide for the child to the extent that needs-based benefits are unnecessary.

In the vast majority of cases, a special needs trust is warranted. A special needs trust can be established as part of a will, but more often is preferably established as a standalone document. A standalone document cannot only absorb the inheritance by the parents, but from other family members or friends who may wish to contribute in their estate plans to the disabled child. The special needs trust follows very strict guidelines, which assert, among other conditions, that: (1) this trust is to supplant rather than replace government benefits; (2) it can be utilized to pay third parties rather than the beneficiary directly; and (3) is managed at the absolute discretion of the trustee. The establishment of special needs trusts allows the disabled child to maintain his or her needs-based government benefits and have a fund available to enhance his or her quality of life.

In order for a special needs trust to be properly established and maintained, two steps needs to be undertaken. First, the trust itself needs to be properly established. Second, the assets of the parents need to be positioned to fund this trust.

The mere establishment of the trust is not enough. On far too many occasions, there have been parents who have established valid special needs trusts on behalf of their children. However, upon their passing, probate assets, such as individually held financial accounts and real property, will pass into the trust, but non-probate assets, such as retirement plans, IRAs, annuities, and life insurance, will not.

Many individuals don’t recognize that many assets pass outside of the will. Typically, wills and trusts are set up years after beneficiary designations have been ascribed to non-probate assets. Thus, there are typically two areas of concern that are seen with non-probate assets when the parents of disabled children die. First, the parents will exclude the child as a beneficiary based on the aforementioned assumption that no proper planning could be undertaken. Second, the parent will use the child as an outright beneficiary. These mistakes are typically made because the parents wish to take care of their children, but are not properly advised by the financial advisor or insurance salesman and establish the aforementioned accounts or policies for them.

A similar situation exists with what is known as the poor man’s estate plan. Basically, individuals, in an effort to avoid probate (often times unnecessarily), establish paid on death designations on bank accounts and EE Bonds. They also will establish a similar transfer on death designation on brokerage accounts. In all of the aforementioned instances, whether it’s the contract assets or TOD/POD accounts, outright bequests will pass directly to the disabled child, regardless of the terms and conditions of the will and/or special needs trust.

It is imperative to coordinate non-probate assets into an estate plan. Quite frankly, this not only affects planning for parents with disabled children, but individuals with taxable estates who wish to minimize federal and state death taxes, as well as individuals who wish to leave a portion or all of their bequests to charity. In the present instance, there are certain steps that need to be undertaken to ensure that special needs trusts are properly funded and that assets do not go outright to a disabled child.

First, for any asset that has a transfer on death or paid on death designation, such designation should be removed. By doing so, the assets will flow through the estate and eventually into the special needs trust. Second, a special needs trust may be a partial or complete beneficiary of a life insurance policy. There are generally no catches to this planning. Third, the special needs trust can be made a beneficiary of a retirement plan, 401k, or an annuity as well. In doing so, one should try to coordinate the tax-deferred characteristics with the overall planning objectives of the individuals who wish to implement the plan.

In many instances, there can be adjustments made to a parent’s estate plan where certain assets may be preferable to go to the disabled child’s trust, whereas other may be more preferable to go to non-disabled beneficiaries. For example, the aforementioned parents, with one disabled child and two non-disabled children, have an aggregate estate of $3 million. Five hundred thousand dollars is in life insurance, $800,000 is in retirement plans, and the rest is in brokerage accounts and real property. In most instances, it would make the most sense that the two non-disabled children be named as beneficiaries of the retirement plans. In doing so, we very frequently can roll the retirement plans into inherited IRAs in their own names; thereby allowing them to take required minimum distributions over the course of their actuarial life expectancies. This allows for a very positive deferral of income taxes. To compensate, the special needs trust can be the beneficiary of the life insurance. There are no income tax consequences in doing so.

Of course, if this step is undertaken, the two non-disabled children will see $400,000 each while the disabled child receives $500,000. If the parents wish to treat their children equally, language could be placed inside their wills or living Trusts to authorize the fiduciary to equalize the distributions of the three beneficiaries, by taking into account assets which were received outside of probate.

The foregoing demonstrates the special issues involving special needs children. Proper planning is often complex. However, it can be successfully undertaken. With proper legal documents and proper titling of assets, parents can effectively provide for their disabled children.

Closing the Estate

A. FINAL ACCOUNTING
Pursuant to N.J.S.A. 3B:10-23, the Executor under a Will or the Administrator of an intestate estate is obligated to settle and distribute a decedent’s estate “as expeditiously and efficiently as is consistent with the best interest of the estate”. After marshaling the estate assets, paying the decedent’s debts and paying an unnecessary death taxes, the Executor or Administrator should take prompt action to close the estate. In order to do so, the Executor or Administrator typically accounts to the estate beneficiaries.

An estate can be closed in one of four fashions: (1) the mere release of funds by the Executor or Administrator to estate beneficiaries; (2) the release of estate distributions to estate beneficiaries after the execution of a Release and Refunding Bond upon which there is a waiver of any form of accounting; (3) distribution to estate beneficiaries after said estate beneficiaries execute a Refunding Bond and Release upon submission of an informal accounting; and (4) an Order obtained by a Court of competent jurisdiction after a Verified Complaint and Order to Show Cause are filed for approval of an Executor’s or Administrator’s account.

Theoretically, it is possible for an Executor or Administrator merely to make distributions to estate beneficiaries with no paperwork whatsoever. However, an Administrator would typically not be discharged by the Surrogate’s Court unless Refunding Bonds and Releases are signed and filed. (A copy of this form is attached in the Appendix). The requirement of bond may continue to be imposed and costs of discharging the bond would be borne by the Executor who would subsequently have to obtain Refunding Bonds and Releases or a Court Order discharging the requirement of bond at his/her own expense. Although an Executor typically doesn’t not usually have to concern himself/herself regarding the requirement of bond, an Executor constructively waives the protection of a Refunding Bond and Release by not having such bond(s) executed prior to distribution. No competent professional would ever allow a client to close an estate in this manner.

It is theoretically possible for beneficiaries of an estate to execute Refunding Bonds and Releases without requesting any accounting or information from the Executor or Administrator. In doing so, the beneficiaries of an estate are exhibiting, to a degree, blind faith. However, the execution and filing of said bonds effectively closes out the estate and discharges the Executor or Administrator from his/her position without further liability.

Although it is possible to resolve the closing of an estate without an accounting, the case law of the state clearly details its right to an accounting and the expectations of estate beneficiaries regarding the handling of an estate. (A copy of an accounting is attached in the Appendix). Specifically, the courts of this state have described the duty of an Executor or Administrator as follows:

“It is elementary that the Executor is under a peremptory duty to account for the assets of the estate coming to his possession or knowledge; and if, through failure of the fiduciary duty, he is unable to do so, he is chargeable with their full value. It is a primary duty of one exercising such trust functions to gather in the assets of the estate; and while it is incumbent upon him, in the discharge of this duty, to use only such care, skill, diligence, and caution as a man of ordinary prudence would practice in like matters of his own, it is also held to the upmost good faith.” In re Brueck’s Estate, 124 N.J. Eq. 62, 63 (E&A 1938).

In fulfilling a fiduciary relationship, the fiduciary, at all times, should be governed by a “prudent person” standard.Id.@63; In re Accounting of Koretzky, 8 N.J. 506, 524 (1951). Where the fiduciary fails to fulfill his/her obligation, “the parties of interest, may, by an exception, challenge the account in respect of the sufficiency of the charges made, and the Executor may be surcharged with the reasonable consequences of his failure of duty.” Brueck, supra at 63.

An accounting may be filed in an “informal” or “formal” manner. An informal accounting is a general summary of the assets obtained by the Executor/Administrator, as well as income received and spent by the estate, disbursements made by the estate, distributions made by the estate, and proposed final distributions. In many instances, an informal accounting will summarize classes of expenditures rather than make line-by-line itemizations.

A formal accounting is typically generated in one of three circumstances: (1) a complex estate in which the beneficiaries as well as the Executor or Administrator agree upon the production of same; (2) where required by the Charitable Trust Section of the Attorney General’s Office; and (3) when agreement cannot be reached upon an informal account by estate beneficiaries and the Executor or Administrator thereby can only be discharged by an Order by a court of competent jurisdiction.

In complicated estates, it is frequently necessary to generate a formal accounting to ensure that all parties feel that there has been proper disclosure regarding the handling of an estate. Theoretically, a formal accounting can be generated for even the smallest estate. However, may estates resolve without a formal accounting for the cost of the preparation of same. If all parties agree, the formal accounting can be used to close out an estate. In this instance, a Court Order is not necessary. Refunding Bonds and Releases will suffice.

In many instances, the Charitable Trust Section of the Attorney General’s Office may require a formal accounting in order to conclude an estate. By statute, Notice of Probate must be sent to the Charitable Trust Section whenever a charity is a beneficiary under aWill. If there is a specific bequest, the Charitable Trust Section does not require an accounting, however, when a charity or charities are remainder beneficiaries under an estate, the State can require a formal accounting. When the State requests a formal accounting, the State also requests that the attorney, representing the estate, submit an Affidavit of Services for fees and costs incurred.

Most frequently, a formal accounting is filed when the Executor or Administrator is unable to obtain Refunding Bonds and Releases from all beneficiaries notwithstanding good faith attempts to obtain same through the use of an informal accounting. In this event, the only way in which an Executor or Administrator can be discharged from his/her duty is to obtain a Court Order. In order to do so, the Executor or Administrator must file an Order to Show Cause along with a Verified Complaint for approval of accounting. At the very least, the Verified Complaint will seek an Order from the Superior Court (Chancery Division/Probate Part) (a) approving the Executor’s or Administrator’s account, (b) approving the legal fees and costs incurred; (c) approving the Executor’s or Administrator’s commissions; and (d) discharging the Executor or Administrator from any further liability from the estate or its beneficiaries. In the case of intestate administration, the Complaint should also see that any surety bond be discharged upon distribution to the estate beneficiaries.

Upon approval of a final account, the surety bond can be discharged in one of two fashions. First, the beneficiaries will be given one final opportunity to execute a Refunding Bond and Release. If any Refunding Bonds and Releases remain unexecuted, an application can be made to the court to have said beneficiary’s share paid into the court and acquire an Order discharging the bond upon doing so.

An Order to Show Cause and formal accounting may be filed by an Executor or Administrator at any time once the estate is ready to be distributed. However, a beneficiary of an estate may not compel an Executor or Administrator to account until after the expiration of one year after the appointment of the Executor or Administrator unless special cause is shown before the Superior Court.

A formal accounting generally includes information in the following areas: (1) a general statement made as to corpus, income, and balance on hand; (2) receipts of principal or corpus by the beneficiary; (3) gains and losses on sales or other dispositions of capital assets; (4) disbursements of principal or corpus; (5) distributions of principal or corpus to estate beneficiaries; (6) principal balance on hand; (7) receipts of income; (8) disbursements of income; (9) distribution of income to estate beneficiaries; and (10) reserves held and proposed schedule of distribution.

When an account is filed in court, a representative from the Surrogate’s Office will review the account in detail. The Surrogate’s Office will assess a fee for the audit of the account. After this audit is made, a memorandum is written to the probate judge as well as, in many instances, to the attorney who prepared the account as to any questions or concerns the Surrogate has regarding the account itself. In some jurisdictions, if the account has considerable questions or does not comply with the before stated format, the Complaint and Order to Show Cause may be returned for correction. Nevertheless, after the correction Order, at times even without, an Order to Show Cause will be executed whereafter notice must be given to all interested parties regarding the hearing date. The Order to Show Cause will contain language which sets forth the date by which exceptions to the account and answers to the Complaint must be filed by any protesting party.

On the return date of the Order to Show Cause , the Court theoretically can hear arguments regarding the accounting and exceptions and take testimony. At the Court’s discretion, a discovery schedule can be set regarding interrogatories and depositions by the fiduciary and/or contesting estate beneficiaries. After the plenary hearing, the probate judge can either accept the account in its entirety or agree to alter the account as to certain exceptions.

In making a final determining regarding the account, the probate judge will make a determination as to the appropriateness of the fiduciary commissions as well as legal fees and costs incurred on behalf of the fiduciary. Although such fees are typically paid by the estate, the Court does have some discretion. First, a Court can modify the Executor’s fees. Second, the Court can take two sets of action as to legal fees. First, the Court can adjudicate the appropriateness of legal fees and costs requested.

Additionally, the Court can determine which party should be responsible for the payment of such fees and costs. Although such fees and costs would typically be paid by an estate, the Court can surcharge the Executor or Administrator if there exists evidence of gross negligence or fraud. On the other hand, the Court can surcharge the accepting party for the fees and costs incurred in filing an accounting if the Court finds that requirement of an accounting and cost of the proceeding were generated in bad faith.

B. DISTRIBUTION OF ESTATE TO BENEFICIARIES
Distribution of an estate typically takes four forms: (1) distribution of non-probate assets, (2) distribution of specific pecuniary bequests, (3) distribution of specific (but illiquid) bequests, and (4) residuary distributions.

In general, non-probate assets are not even handled by the Executor or Administrator of the estate. Such assets cannot be counted in the Executor’s or Administrator’s commission structure. However, if an Executor or Administrator has knowledge of the existence of non-probate assets, information regarding said assets should be distributed to the beneficiaries of same.
Non-probate assets typically take three forms. First, non-probate assets could be contract assets such as life insurance, annuities, individual retirement accounts, and other forms of retirement plans. Such assets are paid to the named beneficiaries of said accounts or policies. Said accounts or policies are only paid to the estate if there is no named beneficiary. Assuming that there is a named beneficiary, the Executor or Administrator should supply a certified copy of a death certificate to the beneficiary so that he/she may claim the proceeds from said accounts or policies. If no beneficiary is named, the Executor or Administrator shall provide not only a certified copy of the death certificate but a short certificate of the Letters Testamentary to the financial institution holding said asset and will refer that asset to be retitled or paid over to the estate.

Second, an individual may own transfer-on-death (TOD) or paid-on-death (POD) accounts. These are accounts historically held with banks. However, they have also been utilized on government savings bonds as well. Over the past decade, many brokerage house offices have employedTODdesignations. In order to claim such assets, theTODor POD beneficiary needs to supply a certified copy of the death certificate. An Executor or Administrator should provide a copy to said beneficiary, although they have no legal obligation to do so. Such beneficiary can certainly obtain a copy of the death certificate at the municipality where the decedent resided at the time of his/her death.

Third, assets can pass by right of survivorship. In financial accounts, there is a designation of joint tenants with right of survivorship. With such accounts, death certificates are produced by a surviving account holder and, thereby, assets are passed from one party to another.

In the case of real property, it is not necessary to transfer the ownership of property by deed from the estate of the deceased owner to the surviving owner. When the property is later sold or otherwise conveyed, the incident of the deceased party’s death merely needs to be noted in the deed recital.

Notwithstanding the foregoing, many financial institutions will only release one-half of the aforementioned assets until a waiver is obtained by the State ofNew Jersey. If the beneficiaries are Class A beneficiaries (i.e., spouse, parent, children, or other lineal descendants), the assets are typically released immediately if a Form L-8 is executed at the financial institution which, in turn, will request the waiver from the State. If more remote relatives, friends, other individuals or entities are named as beneficiaries, the entirety of the asset will not be released to the beneficiary or surviving account holder until a waiver is received by the State ofNew Jerseysubsequent to the filing of a New Jersey Transfer Inheritance Tax Return.

For distribution purposes, two forms of bequests are handled by the Executor or Administrator. Specific pecuniary bequests are precise distributions of cash. Those bequests should be paid as soon as is feasible after death. Typically, such bequests should be paid once the Executor has sufficient cash to handle such bequests along with any typical liabilities of the estate, including funeral expenses, administration expenses, debts and taxes. Pursuant to N.J.3B 23-11, “General pecuniary devises shall bear interest beginning one year after the first appointment of a personal representative until payment, unless a contrary intent is indicated by theWill, or unless the Court, for good cause, raises the imposition of interest. The annual rate of interest on general pecuniary devises shall equal the average rate of return, to the nearest whole or one-half percent, for the corresponding proceeding fiscal year terminating on June 30th, of the State of New Jersey Cash Management Fund (State accounts).” Notwithstanding the foregoing, an Executor or Administrator should forego payment of such a devise if it appears that there are significant liabilities pending against the estate especially if such claims are subject to litigation.

All other bequests, including residuary bequests, should be made as promptly as possible. However, neither an Executor nor an Administrator need to distribute any such bequest until he/she receives a closing letter from the Internal Revenue Service and the New Jersey Transfer Inheritance Tax division releases its closing letter and waivers. In general, complete distributions are not made until such closing letters and waivers are received. On the other hand, an Executor or Administrator may make partial distributions before he/she receives the closing letter and waiver if he/she determines that sufficient funds exist to pay any contingent liabilities.

One of the benefits of making partial distributions is the shift of income from the estate to the beneficiaries. In making a partial distribution, the Executor or Administrator of the Estate can send a Form K-1 to the beneficiaries who, in turn, can claim estate income on their own individual Form 1040. This option is almost always preferable to having the estate income taxed by the estate at significantly higher estate tax rates. In determining whether or not such partial distribution should be made, the Executor or Administrator should weigh the following factors: (a) the needs of the beneficiaries, (b) potential deterioration or loss of value of estate property, and (c) income tax ramifications from shifting estate income. If the Executor or Administrator decides to make a partial distribution, he/she should treat all beneficiaries impartially by making pro-rata distribution of their shares under the intestacy statute.

In general, there is no set time by which an Executor or Administrator must close an estate and distribute the estate assets. It must be done pursuant to the reasonable person standard. If an estate is taxable, the Executor or Administrator should wait until the federal closing letter and/or state closing letter are received. In the event an estate is subject to both federal and state tax, the Transfer Inheritance Tax Branch will not release a state closing letter until the federal closing letter is received by its office.

After the aforementioned steps are taken, the Executor or Administrator shall ensure that all final estate expenses are paid including Executor’s commissions and professional fees.

Occasionally, an aggregate estate is not expected to cover the decedent’s debts, administration expenses, taxes and bequests. In that situation, the shares of estate beneficiaries must be abated. Pursuant to N.J.3B:23-12, shares should abate in the following order: (1) property passing by intestacy, (2) residuary devises, (3) general devises and (4) specific devises. N.J.3B:23-12 further states that abatement within each classification is in proportion to the amount of property each of the beneficiaries would have received if full distribution of the property had been made in accordance with the terms of theWill.

C. DISCHARGE OF FIDUCIARY
An Executor or Administrator can be discharged in one of two fashions. First, Refunding Bonds and Releases, as discussed heretofore, are executed by all estate beneficiaries and filed with the Surrogate. By doing so, the fiduciary ensures that he/she has been released by any further liability by the estate beneficiaries and exacts the recognition of pro-rata distribution to any liabilities that may be discovered or presented to the estate at a later date. If such Refunding Bonds and Releases cannot be obtained, a Court Order will suffice. If a surety bond has been required, it can be discharged by the Order, Judgment, or evidence of filed Refunding Bonds and Releases.

Charitable Planning

For high net-worth individuals and couples, there are a variety of transfer techniques in order to minimize exposure to death taxes. These include, but are not limited to Disclaimer Trusts, Credit Shelter Trusts, Applicable Exemption Trusts (a/k/a Credit Shelter Trusts), and Q-TIP Trusts. These Trusts, effective for use with married couples, can be utilized in Wills and Revocable Living Trusts. To further minimize potential payment of estate and inheritance taxes, a variety of other techniques may be employed. These techniques focus on major lifetime gifting. They include, but are not limited to:

A. Annual exclusion gifts. Each year, an individual may currently give $13,000.00 per donee and, with the consent of a spouse, $26,000.00 per donee;
B. Lifetime exemption gifts. Substantial gifts, over the annual exclusion amount, may be made if a donor pays gift taxes and survives three years although an exclusion of $1,000,000 for aggregate lifetime gifts may be used;
C. Gifts to Remove Appreciation. Gifts may made to remove appreciation from a donor’s estate;
D. Education. Unlimited payments of qualified tuition expenses may be made if paid directly to the educational institution;
E. Medical. Unlimited payments of medical expenses may be made so long as said payments are made directly to the provider and to the extent they are not covered by insurance;
F. Spousal. Inter-spousal gifts using the unlimited marital deduction;
G. Leveraged Gifts. Gifts may be made through Trusts which include, but are not limited to, a Qualified Personal Residence in Trust (QPRT) and Grantor Retained Annuity Trusts (GRAT);
H. Life Insurance to Others. Gifts of existing life insurance outright to owners other than the insured;
I. Life Insurance to Trust. Gifts of life insurance premiums through the use of an Irrevocable Life Insurance Trust; and
J.Charitable gifts.
The focus of this article will be the utilization of charitable giving in estate planning. Charitable planning has a variety of benefits including personal satisfaction, lifetime income tax minimization and post-death estate and inheritance tax minimization. Charitable planning takes a variety of forms ranging from simple lifetime checks to charitable organizations through the utilization of more complex Charitable Lead Trusts or Charitable Remainder Trusts.

Various sections of the Internal Revenue Code apply to transfers to charitable organizations. Unless otherwise indicated, all citations within this article will be to the Internal Revenue Code of 1986 and the regulations issued thereunder. The most notable sections, in understanding and implementing charitable planning, include:

A. Section 170 – Income Tax Deductions for Charitable Transfers;
B. Section 2055 – Charitable Transfers Deductible for Estate Tax Purposes;
C. Section 2522 – Charitable Transfers Deductible for Gift Tax Purposes;
D. Section 501 – Defining Tax Exempt Organizations;

E. Section 509 – Defining and Describing Private Foundations; and
F. Section 664 – Describing CharitableSplit Interest Transfers.

A. OVERVIEW OF THE WEALTH TRANSFER
CHARITABLE TAX DEDUCTION

Transfers that qualify for a charitable deduction can be utilized for income, estate and/or gift tax purposes. Generally, transfers, that qualify for the charitable deduction, are made to a tax exempt organization. These organizations are described in detail in Section 501. The most relevant provision is Section 501(c)(3), which describes what is commonly thought of as a charitable organization: a corporation, community chest, fund or foundation organized and operated for religious, charitable, scientific, testing for public safety, literary or educational purposes or to foster a national or international sports competition or for the prevention of cruelty to animals or children, no part of the net earnings of which inure to the benefit of any private shareholder or individual, or substantial part of which is carried on propaganda or attempting to influence legislation and which does not intervene in or participate in any political campaign. In addition to public charities, the charitable deduction can be employed by entities commonly known as private foundations. These entities, defined in Section 509(a) are those which are not included in the definitions covering public charities. See Section 509(a)(1)-(4).

RevRul59-310, 1959-2 CB 146 sets forth the prevailing definition for charity in determining whether a private or public organization qualifies as an appropriate recipient by which a donor can request or assets a charitable deduction. This ruling states, in relevant part “charity in the legal sense of the term includes benefits which are for an indefinite number of persons and are for the relief of the poor, the advancement of religion, the advancement of education, for erecting or maintaining public buildings or works or otherwise lessening the burdens of government.”

Charitable deductions are allowed for transfers to qualified and identifiable recipient organizations. In general, there are four types of these organizations:

1. Charitable Corporations and Associations – if they are to or for the use of corporations/associations “organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes,” See Section 2055(a)(2).
2. Government – if said transfers are to or for the use of the United States, any of its states, the District of Columbia, counties, cities, towns and other political subdivisions so long as the transfers are solely and exclusively for public purposes. See Sections 2055(a)(1), 2522(a)(1) and 178(c)(1).
3. Trusts/Fraternal Organizations – if the transfers are used “exclusively for religious, charitable, scientific, literary, or educational purposes or for the prevention of cruelty to children or animals…” See Section 2055(a)(3). It is important to note that these organizations are disqualified for purposes of charitable deductions if they participate in propaganda, lobbying, or participation in political campaigns. It should also be noted that said organizations may undertake activities above and beyond that for charitable purposes. However, deductible transfers must be exclusively used for charitable purposes.
4.United States Veterans Organizations – if there is no use of the net earnings for the benefit of a private shareholder individual. See Sections 2055(a)(4) and 2522(a)(4).

In order to qualify for a charitable deduction, a charitable interest must meet certain criteria:

1. It must be or an ascertainable interest;
2. It must comply with proper reporting requirements; and
3. There must be substantiation of the transfer.
An interest is certainly ascertainable and simple to recognize of an outright gift or a donor’s or decedent’s interest in property. However, when property is transferred in Trust or for both a private and charitable purpose Reg Sections 20.2055-2(a) and 25.2522(c)-3(a) state that the deduction will only be allowable if the charitable interest is ascertainable at the time of the contribution and can be severed from the private interest. Examples of deductible and ascertainable interests include: undivided portions of a donor or decedent’s entire interest in a type of property, remainder interest in residence and farms, qualified conservation contributions and a remainder interest in a Trust, a charitable lead interest or a charitable gift annuity.

As to reporting, charitable transfers during lifetime must be reported for income tax purposes on an individual’s personal income tax return provided that the individual taxpayer itemizes his or her deductions. Charitable transfers for decedents are reported on Schedule O of the federal estate tax return, known as the Form 706.

Proper reporting entails proper substantiation. Proper substantiation follows the following set of rules:

A. As to charitable contributions of money, a taxpayer is required to maintain a canceled check, receipt or letter acknowledging the contribution from the donee.
B. For contributions of property other than money, a taxpayer must keep a receipt or letter from the donee noting the date of the donation, the location of the donation and a description of the contribution. In the event the donor wishes to claim a deduction greater than $500.00, he or she must also keep written records regarding the acquisition of the property including the date and manner of its acquisition as well as the cost or other basis of property held for less than twelve months before the contribution. If the claim deduction exceeds $5,0000.00, a donor must also obtain a qualified appraisal as well.

B. CHARITABLE LEAD TRUSTS

One of the most popular techniques, for mid-level to high ne-worth clients, is the utilization of Charitable Trusts. There are two general forms for Charitable Trust:

A. Charitable Lead Trusts; and
B. Charitable Remainder Trusts.
Since the Tax Reform Act of 1969, only certain kinds of bequests in Trusts qualify for the estate tax charitable deduction where there is one or more non-charitable beneficiaries in addition to the charitable beneficiary. Both Charitable Lead Trusts and Charitable Remainder Trusts are vehicles by which there are benefits both to donor and/or his or her family as well as charitable organizations.

A Charitable Lead Trust is a Trust, which is established by a donor, with the contribution in trust of investment property in which the income from the Trust is to be paid to one or more qualified charitable organizations at least annually for the term of the Trust. Typically, assets, which are used to fund this Trust, are those which are expected to appreciate over the life of the Trust. Upon the expiration of the term of the Trust, the remainder interest passes to a non-charitable remainderman, specifically the donor’s intended beneficiary.

The use of Charitable Lead Trusts, in general, meet two goals. First, it allows the donor to make significant lifetime donations to charitable organizations. Second, it also ensures that the family members, who will be the ultimate heirs of said Trust, will enjoy the ultimate prosperity of the asset. In establishing these Trusts, the donor, as well as his or her family, forego income for the tradeoff of realizing long-term capital appreciation and at a low gift or estate tax cost.

In order for a Charitable Lead Trust to qualify for the charitable deduction, the income interest, to be received by the qualified charitable organization, must be either in the form of a guaranteed annuity or a unitrust interest. The term of the Trust may be either for finite period of years or can be based upon the life or lives of individuals who are alive at the creation of the Trust.
A Charitable Lead Annuity Trust is one in which a charitable organization receives a fixed amount in the form of a guaranteed annuity for a certain number of years, with the remainder passing to a private individual or individuals. A Charitable Lead Unitrust is one in which a fixed percentage of trust corpus, determined annually, is paid to a charitable beneficiary or beneficiaries, with the remainder passing to one or more non-charitable beneficiaries at its termination.

To properly understand Charitable Lead Trusts, one must recognize that they are split interests where the charitable organization holds the first or lead interest and the non-charitable entity or individual receives the remainder interest. A guaranteed annuity interest is deductible regardless of whether or not it is in Trust. It must consist of the right of a charitable organization to receive a guaranteed annuity. If a Charitable Lead Trust is used, the Trust must be irrevocable. If the interest is not in a Trust, it must be paid by an insurance company or other company that issues annuity contracts.

See Sections 170(f)(2)(B), 2055(e)(2)(B) and 2522(c)(2)(B).

The Unitrust interest is deductible, whether utilized in a Trust or not, if it consists of the right of the charitable organization to receive payment of a fixed percentage of the fair market value of the property if funding the interest so long as the payment is made at least annually. Like the annuity interest, it must be paid by an insurance company or other company in the business of issuing such interests if the Unitrust interest is not in Trust. If it is in Trust, the Trust must be irrevocable. See Sections 170(f)(2)(B), 2055(e)(2)(B) and 2522(c)(2)(B).

Both forms of Lead Trusts can be established as Grantor Lead Trusts, Non-Grantor Lead Trusts and Testamentary Lead Trusts. A Grantor Lead Trust is one which is established by a donor and provides the donor a current income tax charitable deduction for the present value of the charitable distribution over the term of the Trust, but the Trust income is imputed as taxable income to the donor each year. In a Non-Grantor Lead Trust, a gift or estate tax deduction is allowed for the value of the charitable interest, established as the present value of the payments to charity over the term of the Trust. Unlike the Grantor Lead Trust, there is no income tax deduction for the Non-Grantor Lead Trust for the donor. Testamentary Lead Trusts are commonly used when there is no deferral through the use of the marital deduction and the estate can thereby obtain an estate tax charitable deduction for the present value of the charitable lead interest.

C. CHARITABLE REMAINDER TRUSTS

Charitable Remainder Trusts are practically the opposite of Charitable Lead Trusts. Both are split interest vehicles. However, the initial beneficiary of the Trust is the donor and/or his or her family in the Remainder Trust, whereas in the Lead Trust, it is the charity itself. As a result, in the Lead Trust, the family is the remainder beneficiary. In a Remainder Trust, one or more charitable organizations is the remainder beneficiary.

A remainder interest in a Trust is deductible if the Trust takes one of three forms:

Charitable Remainder Annuity Trust, Charitable Remainder Unitrust or a Pooled Income Fund. A Charitable Remainder Annuity Trust is authorized under Section 664(d)(1). It is an Irrevocable Trust in which a fixed amount is paid at least annually to one or more persons for a term of years or for life. The fixed amount must be a sum certain not less than 5% or more than 50% of the initial net fair market value of the Trust. The lead beneficiary (or if there is more than one, at least one of said beneficiaries) must not be a permissible donee of a charitable contribution listed in Section 170(c). If a term of years is utilized, it must not exceed 20.
Individuals, who will receive payments from a Charitable Remainder Annuity Trust must be living at the creation of said Trust. No other payments may be made other than to or for the use of an organization qualified under Section 170(c).

At the termination of the fixed amount payments, the remainder must be distributed to or for the use of a charitable organization or held for the benefit of such an organization. The Trust may have one or more remainder beneficiaries that are charities. All remainder beneficiaries must be charities.

In order to qualify for a charitable deduction, the present value of the remainder interest must be at least 10% of the initial fair market value of the property contributed to the Trust. This requirement applies to all Charitable Remainder Trusts established after July 28, 1997.

A Charitable Remainder Unitrust is an irrevocable Trust from which a fixed percentage is paid at least annually to one or more persons for a term of years or for life. The requirements as to percentage, lead beneficiaries and term are the same as with a Charitable Remainder Annuity Trust. As with a Charitable Remainder Annuity Trust, individuals receiving payments, from a Charitable Remainder Unitrust, must be living at the creation of the Trust. The 10% rule also applies.

The difference of a Charitable Remainder Unitrust is that this type of Trust may pay annually to the income beneficiary income if it is less than the fixed percentage amount rather than the fixed percentage mandated by the Charitable Remainder Annuity Trust. In addition, if income is greater than the fixed percentage amount, that income may also be paid to the income beneficiary to the extent that the aggregate Charitable Remainder Unitrust income in prior years was less than the aggregate fixed percentage amounts (A Charitable Remainder Unitrust with these net income and “makeup” provisions is often referred to as a NIMCRUT.)

An alternative to the Charitable Remainder Trust is a Pooled Income Fund. It is also referred to as a “Poor Man’s Trust” or a “No Trust Trust”. It is an irrevocable Trust in which multiple donors transfers property, retaining an income interest an contributing an irrevocable remainder interest to a charitable organization listed in Section 170(b)(1)(A). Private foundations and public charities, which support other public charities or which receive more than one-third of their support from memberships, admissions fees, grants and gifts and less than one-third from investment income are excepted. The income interest retained by the donors is for the life of one or more income beneficiaries living at the time of the transfer. The income interest is also paid at the rate of return actually earned by the Trust itself. Whereas the aforementioned Charitable Lead Trusts and Charitable Remainder Trusts may be maintained by an individual or financial institution as Trustee, a Pooled Income Fund is maintained by the charitable organization that will receive the remainder interest. See section 642(c)(5).

One interesting facet of a Charitable Remainder Trust is that a Grantor can also serve as Trustee. Typically, any Trust, in which a Grantor can also serve as Trustee will be referred to as a Grantor Trust and have no significant estate or gift tax benefit.

However, an important exception is made for the Charitable Remainder Trust. In doing so, a Trust can make investments consistent with the Grantor’s plans. However, in doing so, the Grantor, in his or her capacity as Trustee, must balance the goal of investment control with the fiduciary duty owed to the charitable remainderman. Morever, a Grantor, who serves as Trustee, must be certain that no powers are retained which would cause the Trust to be subject to the Grantor Trust rules of Sections 671-678. Otherwise, the Trust will be considered a Grantor Trust and will not qualify as a Charitable Remainder Trust. Typically, the type of assets, which can be contributed to Charitable Remainder Trusts, is unlimited. However, in the aforementioned event when the Grantor is also the Trustee, the Trust interest must hold clearly identifiable assets. Real estate, stock in closely held companies, and personal effects are often difficult to value, and could disqualify a Trust for the Grantor’s charitable deduction.

Upon the death of a Grantor, the estate tax deduction for the Charitable Remainder Annuity Trust will equal the actual or fair market value of the remainder interest of the Trust. It is determined by taking the fair market value of the property placed in the Trust and reducing it by the present value of the non-charitable annuity interest. These values are to be determined as of the Decedent’s date of death or by the alternate valuation date.

The ABCs of Wills

Any individual, who aspires to practice estate planning or elder law, must be proficient in the areas of will drafting, trusts, and basic taxation. One of the fastest growing areas of litigation throughout the country is will contests. The primary reasons for this growth are: (1) the increase in our elderly population and (2) inadequate preparation of estate planning documents. The latter reason stems from the fact that many attorneys utilize a boilerplate approach to estate planning, believing that “one will fits all.” This problem is also found in the utilization of trust mils and computer programs.

Competent attorneys recognize that individual and financial factors must be evaluated prior to preparing a will. An evaluation of these factors will determine what clauses should be utilized in drafting a will, whether a living trust should be utilized as an alternative to a will, and the extent to which federal and state death taxes must be addressed. The focus of this article is on the proper recognition of estate planning issues and competent drafting of wills.

WILLS
The will is the centerpiece of estate planning. It provides for the legal transfer of assets upon an individual’s death, names an individual or entity to settle the probate estate, names a trustee to administer any testamentary trust established therein, and appoints a guardian for any minor or disabled children. However, it is not the only estate planning document nor does it dispose of all assets.

There are three basic estate planning documents: (1) a will, (2) an advance directive, and (3) a power of attorney. Due to the continued increase in the elderly population, as well as the commensurate growth in medical costs (most notably, nursing home costs), it is imperative to prepare all three documents for clients. Simply put, a will may have little value if an individual’s estate is dissipated by such expenses. A properly prepared advance directive and power of attorney can minimize the severity of these costs.

Moreover, it is imperative to recognize that a will does not necessarily dispose of the entirety of an individual’s estate. It only disposes of the probate estate, which primarily consists of assets owned by an individual in his or her sole name. Assets which are owned with a right of survivorship or beneficiary designation pass outside of a will. Thus, an attorney must evaluate the manner in which assets are held to ensure that the testamentary intentions of the client are met.

Intestacy
An individual who dies without a will subjects his or her estate to the laws regarding intestacy. Intestacy is a state’s statutory scheme governing the disposition of any estate and the direction of its administration absent a valid will. In many states, intestacy laws demonstrate the need for individuals to execute wills. For example, some states divide probate property between children and surviving spouse although there are very few wills that would ever be prepared with such a division. Whether or not an individual has children from a prior marriage or relationship will effect this division.

Disposition of Assets
A prerequisite of will or trust drafting is an understanding of how assets pass from an individual to his or her heirs. In general, property may pass from an individual in four ways during lifetime or at death:

(1) Lifetime Gifts – An individual may transfer, by gift, part or all of his or her property during lifetime. Gifts can be made for a variety of reasons, ranging from simple benevolence to a desire to minimize death taxes. Gifts can be made outright or into a trust.

From a basic standpoint, there are three forms of gifts. One form of gift is that which qualifies for the federal annual exclusion (currently $13,000 per year per donee). Pursuant to the Taxpayer Relief Act of 1997, this amount increases from the long-standing amount of $10,000, in increments of $1,000, as indexed for inflation, commencing retroactively from January 1, 1998. The second form of gift involves gifts in excess of the annual exclusion amount. Such gifts require either the payment of a tax, or a reduction in the exemption amount which can pass free from federal estate tax at an individual’s death. The first two forms involve gifts of present interests. The third form is the gift of a future interest, which can range from the transfer of a remainder interest in real property by a deed to a sophisticated tax planning trust, such as a Qualified Personal Residence in Trust (QPRT) or a Grantor Retained Annuity Trust (GRAT).

When gifts are made, a donor should be aware of the concepts of basis. Gifts, made during lifetime, will be accepted by the donee with the same basis as received by the donor. This particularly impacts gifts of stock and real property which are subject to capital gains taxation upon sale. If held until death, these assets receive a “step up” in basis so that the donee’s basis will be the value of the asset on the donor’s date of death.

(2) Joint Ownership
There are three forms of joint ownership: tenancy by the entirety, joint tenancy with right of survivorship, and tenancy in common. An interest in property, held as a tenancy in common, will pass through an individual’s probate estate. However, a tenancy by the entirety automatically passes to an individual’s spouse upon death. Likewise, a joint tenancy with a right of survivorship passes to a surviving interest holder upon the passing of the first interest holder.

(3) Contract Assets
By contract, two sets of assets do not pass through probate. One set involves assets which have beneficiary designations. These assets include retirement plans, individual retirement accounts, life insurance, and annuities. The second set involves assets which have designations for transfer upon death. These include pay on death (POD) and transfer on death (TOD) accounts.

(4) Probate Assets
Property, held in an individual name, shall pass into an individual’s probate estate upon death. Such property shall pass either through a valid will or, in the absence thereof, the laws of intestacy.

Statutory Basics
In order to prepare a will, an attorney must review the statutory requirements of the state in which the testator resides. These requirements will vary from state to state. In general, they will set forth a minimum age requirement for a testator (typically, eighteen years of age) as well as the number of witnesses required to ensure the validity of a typewritten will or to make same self-proving.

In some states, a holographic will is recognized. A holographic will is one which is written entirely in the hand of the testator and typically does not require witnesses. Some of the state limit the use of holographic wills such as restricting their acceptance to members of the armed services serving overseas. In many states that do accept holographic wills, a formal court proceeding must be held in order to determine if it will be admitted to probate.

In all states, a testator must have legal capacity to execute a will. Capacity is contextual; as such, the standard to execute a will varies from that to execute a contract or to be determined as incapacitated in a guardianship proceeding. In general, testamentary capacity is a four-prong test. The testator must know: (1) the objects of his affection (i.e. his beneficiaries), (2) the nature of his bounty (i.e. the type and extent of his holdings), (3) the document that he is executing (i.e. a will), and (4) the interrelation of the first three factors. In most states, there is a strong presumption to uphold wills. As such, the threshold to maintain testamentary capacity in will contests is typically slight.

Intake Information
Many wills are deficient because they are boilerplate in nature. A will cannot be properly drafted unless an attorney understands the personal background of the testator. This background will reveal whether or not special needs and circumstances exist, such as children from a previous marriage, disabled or mentally ill beneficiaries, or spendthrifts. Moreover, it is imprudent to draft an estate plan without knowing a testator’s financial background. This background will allow an attorney to ascertain whether there are non-probate assets and the extent they will affect a testator’s overall estate plan. In addition, this information is necessary to determine the potential effect of the federal estate tax and state inheritance taxes upon an individual’s death.

When gathering intake information, an attorney should acquire the following information:
– the full name and address of the client(s), as well as their date of birth, medical condition, and whether or not they are a United States citizen;
– the names, addresses, and ages of children and any other estate beneficiary;
– the names and addresses of any individual or entity which the client may wish to act in the capacity of executor, trustee, guardian, health care representative, and agent under a general durable power of attorney; and
– a complete list of the client’s assets and liabilities.

Naming Fiduciaries
There are three primary fiduciaries that can be named in a will. In every will, an executor is named. In some states, this role is referred to as the personal representative. The executor can be an individual or a corporate entity, or a combination of both. The role of an executor is to marshal the decedent’s assets, pay any liabilities lawfully assessed to the individual or his estate, and to distribute the net estate to the estate beneficiaries.

When the beneficiary is a trust, rather than an individual, a trustee should be appointed. A trustee administers and makes payments from a trust to the trust beneficiaries, which may be either individuals or charities, subject to the directions set forth in the will. Like an executor, a trustee may be either an individual or a corporate entity, or a combination of both.

When an individual has minor children, or has a disabled adult child, a guardian may be named. In the case of a minor child, the role of the guardian is to make personal and medical decisions on behalf of a decedent’s minor child until that child attains the age of majority. Many individuals mistakenly believe that the guardian has a financial role as well. This assumption is flawed. Funds for a minor child are managed in trust by a trustee. The client may decide whether or not the guardian or trustee be the same or different.

In the case of a disabled individual, a guardian is typically named as persuasive evidence to name an alternate guardian when a testator dies. Basically, when an individual becomes an adult, he or she is generally recognized as emancipated even if he or she is mentally incapacitated. Parents can become legal guardians upon application to the court system. In order to name a successor guardian, in the event of the parents’ death, a preference may be stated in the will.

A prudent attorney should distinguish between the aforementioned roles to his or her clients. Moreover, the attorney should discuss the need for a client to make wise choices. Many executors are chosen because of their age, gender and proximity to the decedent. Such selections are inappropriate as none detail the qualifications needed to fill the fiduciary role. An attorney must emphasize the need to appoint a qualified representative rather than merely asking for a name.

Types of Bequests
There are four types of bequests which may be made in a will: (1) specific bequests, (2) demonstrative bequests, (3) general bequests, and (4) residuary bequests.

Specific Bequests – Specific bequests are those that allocate a particular asset to a particular beneficiary. This bequest can include personal effects, jewelry, collectibles, automobiles, and real property, among other items. In many estates, with the exception of real property and liquid assets, such bequests may be made by a handwritten note or memorandum rather than in the will itself. In the general will, a clause should be used to dispose of personal effects not mentioned in any such note or memorandum. This clause should either provide for the disposal or sale of such property. If such property is to be divided among estate beneficiaries, such as children, such shares should be approximately divided subject to the discretion of the executor in the event of a disagreement over who shall take a particular item. This particular direction is important as it is virtually impossible to divide property equally.

Demonstrative Bequests – These bequests include precise distributions from or of a particular asset. Examples would include “100 shares of General Electric stock” or “$10,000 to be paid from my mutual fund at Salomon Smith Barney”. An attorney must be very careful to ascertain the intent of his client in the event this particular asset is sold or is subject to a change in name. When distributing stocks or funds, it is advisable to state that the bequest of the stock in a company shall survive in the event the company is acquired by another entity.

General Bequests – A general bequest is a precise dollar amount not designated from any asset. In making such a bequest, as well as a specific or demonstrative bequest, an attorney should evaluate the need to adjust this bequest should the value of an estate increase or decrease. For example, if a client is concerned that his or her assets may dissipate, the attorney can draft language tying in the bequest to a percentage of the estate as a limit. As such, if the size of the estate decreases substantially, the bequest can be adjusted downward as well. This drafting philosophy is important in protecting the distribution to the residuary beneficiaries who are typically the most important to the client.

Residuary Bequests – This bequest includes all property not disposed in the other three forms of bequests and usually represents the bulk of the estate.

Contingent Beneficiaries
In the event a beneficiary predeceases the client, direction must be given as to the disposition of property. As such, an attorney should note whether contingent beneficiaries will inherit or whether the bequest shall lapse.

Tax Allocation
As indicated throughout this writing, taxes are imposed upon an individual’s estate upon death. It is imperative that a will contain a clause which allocates the responsibility of taxes. The estate taxes – both federal and state – are generally considered the obligation of the testator and paid by his or her estate. In determining whether such taxes are to be assessed, both probate and non-probate assets are to be considered. However, the Internal Revenue Service initially looks to probate assets for payment of this tax as do the states for their levies. Thus, an attorney must calculate estimated tax when undertaking estate planning for a client and set forth the manner in which assets will be distributed from contract assets, assets with right of survivorship, and probate assets.

Many states impose an inheritance tax. Like the estate tax, it is a levy based on the value of both probate and non-probate assets. Unlike the estate tax, it is a levy on the beneficiary. As such, the taxes do not necessarily have to be paid from probate funds. In addition, the tax may be imposed upon each beneficiary’s share of the probate estate rather than from just the residuary.
Common Drafting Considerations

Many attorneys frequently utilize boilerplate documents which do not adequately discuss routine situations which may occur. For example, many wills only name one executor. In the event the executor predeceases the client, it is preferable to have a successor executor named. In addition to a spouse, two successor executors should be named. Likewise, at least one successor trustee and one successor guardian should be named when such roles are used.

Perhaps, the biggest area of concern involves the treatment of minors. Many testamentary documents state that the share of a minor is to be held in trust upon attaining an age such as eighteen (18) or twenty-one (21). In addition, such wills shall neglect to appoint a trustee. As indicated previously, a trustee should be appointed in this situation. Moreover, a sober analysis should be undertaken to determine the appropriate age for distribution. A prudent attorney should note that the age of majority does not necessarily equate with an age of maturity. On the other hand, principal may need to be distributed for health, education, maintenance, support, and other objectives of the client. In light of the foregoing, the attorney should note that distributions for the needs of a minor should be made, but that outright distributions of principal will be stayed until a more mature age such as thirty (30) or thirty-five (35).

Special Needs and Circumstances
When drafting a will, an attorney must recognize that individuals have different backgrounds. In an initial client interview, an attorney must determine whether the special needs or circumstances exist. These needs and circumstances include, but are not limited to:

(1) Disabled beneficiaries – Outright bequests to disabled beneficiaries may disqualify them from government benefits which they are receiving and may be mismanaged in the event the disability is mental. However, a special needs trust can be established to protect a bequest for a disabled beneficiary while maintaining his or her government benefits. This trust may be testamentary or it can be established as a stand-alone document.
(2) Spendthrifts – Occasionally, families have a child who has significant financial problems. This definition can vary from a child who merely lives paycheck to paycheck to one who is beset with judgments or bankruptcy. Individuals with mild problems can have their distributions staggered, but more serious cases warrant the use of a spendthrift trust. A spendthrift trust can provide support for a spendthrift. However, the trust assets will not be subject either to the claim of creditors or the poor habits of the spendthrift child.
(3) Second marriages – This issue arises far too often. In the case of a second marriage, where both spouses have children from a prior marriage, simple wills are ill-advised. If one spouse leaves the entire estate to the survivor, then the surviving spouse frequently will distribute most, if not all of the combined estate to his or her own children, leaving little or no assets for the family of the spouse who died first. A distribution in a trust, such as a Q-Tip Trust, can ensure that a surviving spouse will have economic protection yet allow for any remaining principal and interest to be distributed among the decedent’s family.
(4) Non-citizen spouses – non-citizen spouses do not qualify for the unlimited marital deduction. In order to accommodate the competing needs of such a spouse, who would like access to the decedent’s assets, and the Internal Revenue Service, which would like to tax any assets of a decedent in excess of the applicable exemption amount, a Q-DOT trust may be established to provide for access to funds by a non-citizen spouse until their death so long as there is an independent trustee and location of trust assets within the United States.

The ABCs of Trusts

Any individual, who aspires to practice estate planning and elder law, must be proficient in the areas of will drafting and trusts, and basic taxation. Competent attorneys recognize that individual and financial factors must be evaluated prior to preparing a will or trust. An evaluation of these factors will determine what clauses should be utilized in drafting a will or trust, whether a living trust should be utilized as an alternative to a will, and the extent to which federal and state death taxes must be addressed.

This article shall focus on the basic elements of drafting for trusts in the context of estate and tax planning.

TRUSTS
Many types of trusts exist to assist an attorney in drafting an adequate estate plan for his or her clients. These trusts can be broken into three categories: (1) simple estate planning trusts, (2) tax planning trusts, and (3) public benefits planning trusts.

Simple Trusts
In general, there are two types of simple trusts. They are: (1) minors’ trusts and (2) revocable living trusts.

Minors’ Trusts – Many boilerplate wills provide that any minor have his or her distribution from an estate held in trust until attaining the age of eighteen (18) or twenty-one (21). This notion is unfortunate as many individuals are incapable of handling assets until a much more mature age. In addition, many of these boilerplate clauses do not provide for either a trustee or for maintaining the basic needs of a minor.

Any basic will should provide for an age requirement clause. This clause will state the requirement to hold any distribution in trust for a minor. It is frequently prudent to state that such distributions be held in trust until a particular age is reached, such as thirty (30) or thirty-five (35). Prior to attaining this age, the trustee can be given the power to make distributions of income and/or principal for a number of purposes, including: (1) the health, education, maintenance and support of a beneficiary, (2) assistance in making a down payment on a residence as well as closing costs for such a purchase, and (3) assistance with starting a business so long as the Trustee feels it is a worthwhile venture.

In the event a client has more than one minor or young adult child, the use of a sprinkle and share trust system should be implemented. A sprinkle trust directs that the entire estate be placed in one collective trust for all children, recognizing that the needs of young children should be addressed prior to unrestricted distributions. This trust will also recognize that different children have different activities and may require varying distributions from the estate. For example, parents typically will not adjust estate plans just because one child participated in soccer versus theater, or because one child went to an Ivy League school versus a state college.

When the youngest child attains a particular age, or completes college, the sprinkle trust is discontinued and the remaining principal and accrued income, if any, is separated into as many trusts as there are children. These trusts are known as share trusts. Subject to the exceptions set forth in the age requirement trusts, shares will be held in trust until an age at which the client feels his or her children will be financially responsible to receive an outright distribution.

Revocable Living Trusts
Revocable living trusts, for lack of a better term, are a substitute for a will. Their genesis was the response to the costs and delays of administering estates due to the probate laws of many states. Their primary purpose is to avoid probate. In essence, a living trust is established with similar dispositive provisions as a will and uses a trustee rather than an executor to administer the trust estate after the death or incapacity of the client. It is formally a contract between the client, who is known as the grantor (or in the alternative settler or trustor), and a trustee. In most instances, the client will be initial trustee so that he or she may manage their assets until death or incapacity. The client will name a series of successors to serve as trustee in response to either of those events.

In order for the trust to be effective, a client’s assets must be re-titled so that they are owned by the trust rather than by the client. Of course, this cannot occur with tax deferred investments such as 401ks and Individual Retirement Accounts (IRAs). Changing the ownership of these assets will precipitate an immediate tax obligation. As such, it is advisable to name individuals (or if necessary, the trust) as the beneficiary of such assets to maintain the avoidance of probate.

Tax Planning Trusts
A variety of trusts exist to minimize or eliminate federal estate tax. They include:
(1) Credit Shelter Trust – This trust is also known as an applicable exemption trust, a bypass trust, and a unified credit trust, among other titles. It is the most commonly used trust in representing married couples who possess estates in excess of the federal applicable exemption credit amount.

A federal tax is assessed upon an individual’s estate upon his or her death. This tax has varied over the years; however, it has ranged in progressive rates from 37% to 55%. In general, there are two exceptions to this tax. First, if the surviving spouse is aUnited   Statescitizen, no tax will be imposed due to the unlimited marital deduction. Second, distribution to any other class of individuals will be given a set monetary exemption, known as the applicable exemption amount.

Many estates are unnecessarily taxed when married couples, with significant net worth, utilize simple wills. These wills provide for outright distribution to a surviving spouse, then distribution to the children or other beneficiaries upon the survivor’s death. By utilizing this approach, one of the spouse’s applicable exemptions is wasted.

By using a credit shelter trust, the first spouse will leave his assets in trust for his spouse, allowing her to utilize same during her lifetime, but precluding such assets from being taxed when she dies. The trust must provide that the spouse have the right to the income generated off of the trust assets as well as any amount of principal to maintain the health, education, maintenance, and support of the surviving spouse. This latter right can be extended for the needs of the decedent’s children. In addition, the client can choose to include the right of the surviving spouse to invade 5% or $5,000 of the trust corpus, whichever amount is greater, on a non-cumulative annual basis without restriction as to how the funds are used. This right is commonly known as the “5 and 5 power”.

(2) Disclaimer Trust – An alternative to the credit shelter trust is the disclaimer trust. The disclaimer trust can provide the same tax benefits as the credit shelter trust, but it provides flexibility to the surviving spouse. Whereas the credit shelter trust is mandated upon the death of the first spouse, a disclaimer trust is an option for the surviving spouse who can decide whether to set up the trust or to take her spouse’s estate outright. In addition, if the disclaimer trust is elected, the spouse can decide to what extent it will be funded so as to allow for a combination of trust establishment and receipt of an outright bequest.

If a disclaimer trust is utilized, it provides for the right to income as well as health, education, maintenance, and support. However, it does not provide for the 5 and 5 power.

Traditionally, this trust was infrequently used as the benefits to a surviving spouse, under a credit shelter trust, were greater. However, in light of the increases in the exemption under the federal death tax structure, as well as new and/or increased death taxes from the states, this trust has become very attractive. It allows for greater flexibility in post-mortem planning which has become an important factor in light of the number of important changes to death tax laws over the past ten years.

(3) Irrevocable Life Insurance Trust. Life insurance can provide ready cash for estate taxes. However, life insurance is included in the policy owner’s estate. The majority of clients with life insurance policies designate the insured as the owner and the surviving spouse as beneficiary of the policy. Accordingly, the policy death benefit is included in the survivor’s estate. Some clients try to circumvent this problem by naming their children as both owners and beneficiaries of the policies. However, problems can arise if a child is beset with financial trouble or predeceases the parent. Furthermore, the surviving spouse would not have access to any of the life insurance proceeds.

In order to avoid these problems, yet still shield the life insurance proceeds from estate tax, an individual can transfer ownership of his or her policy or policies into an irrevocable trust. The trust becomes both the owner and the beneficiary of the policy. When the insured dies, the trustee collects the insurance proceeds on behalf of the trust and reinvests or distributes the money in accordance with the terms of the trust. The trust can remain in effect after death. Typically, the surviving spouse is given the right to income and principal during his or her lifetime. At the surviving spouse’s death, the remaining assets pass to the beneficiaries. Provisions can be made to continue the trust even after the surviving spouse’s death by establishing an age requirement for distribution. This maintains the assets beyond the reach of creditors and limits the beneficiaries’ ability to spend the proceeds immediately.

Although a life insurance trust saves estate taxes, it has certain drawbacks. For instance, the life insurance trust is irrevocable. The terms cannot be altered or amended once executed. Second, the previous owner of the policy must relinquish control over the insurance. That means that the insured cannot be the trustee.

(4) Qualified Personal Residence Trust. A qualified personal residence trust can be used to reduce estate taxes on a primary or secondary residence, or both. To establish a qualified personal residence trust, a homeowner must transfer title of a residence to a trust, the terms of which provide that the trust grantor retains the use of the residence for a specified period of years. Thereafter, the residence will pass to designated beneficiaries (usually the children). For a qualified personal residence trust to work, the person establishing the trust must outlive the term of the trust, or the residence will be included in that person’s estate.

During the trust term, so long as the trust is structured as a “grantor trust,” the grantor is entitled to the same income tax deductions as if he held the property individually. For instance, the grantor should be entitled to the income tax deduction for real estate taxes and mortgage interest, and he should be entitled to exempt up to $250,000 ($500,000 if married filing jointly) of gain upon the sale of the property.

If during the term of the trust the residence is sold and a new house is purchased for less, the sale proceeds must be otherwise invested in the new residence. If the entire proceeds from the sale of the old residence are not reinvested in the new residence within a certain period of time, the trust converts to an annuity trust for the benefit of the person establishing the trust for the remainder of the term of years specified. At the end of the trust term, the donor has to vacate the property or enter into a lease to pay rent at the market rate.

The trust establishes a means to leverage the applicable exemption amount and remove all future appreciation from the estate. Since the beneficiary of the trust does not receive the property immediately, the I.R.S. discounts the value and reduces the amount of the gift. The amount of the discount depends on the owner’s life expectancy, the terms of the trust, and the current interest rate. If the value of the property increases from the inception date of the trust, the appreciation is removed from the estate.

(5) Grantor Retained Annuity Trust – A Grantor Retained Annuity trust can be established to undertake with liquid assets the same function a Qualified Personal Residence Trust does for real property.

(6) Family Limited Partnership. A Family Limited Partnership can be an attractive method of shifting wealth to younger generation family members to reduce federal estate taxes. Transferring assets to a Family Limited Partnership permits older family members to retain management and control of assets while making tax-free gifts of equity in the asset to intended beneficiaries. Typically, assets that are placed into a Family Limited Partnership include stock in a family owned business, rental real estate, or liquid investments such as stocks and bonds. The partnership creates two classes of partners: general and limited. The general partner makes all decisions relating to the partnership, while the limited partner has no voice. In a typical Family Limited Partnership, the husband and wife are the general partners. In some partnerships, however, they are the limited partners. The children, grandchildren, or other family members can also be limited partners.

Each year, the parents may amend the partnership agreement to decrease the share of their limited partners’ interest and increase the share of the other family members. If the partnership is properly structured, the family can also obtain valuation discounts for having a minority interest and a lack of marketability. Since children are limited partners and the parent is the general partner, the children, initially, would not have any control over the partnership assets. In addition, a properly drafted partnership agreement would provide that the children could not dispose of their interest without first offering it to either the remaining partners or the partnership.

These restrictions placed upon the limited partners’ interest allow a discount to be taken for the value of the partnership interest transferred. Therefore, it may be possible to transfer an amount in excess of the annual exclusion gift amount to each of the beneficiary children without triggering any gift or estate tax consequences. Also, while maintaining control of the assets, the general partners are removing the partnership assets from their estates.

(7) Charitable Remainder Trust. Individuals with assets that have a low cost basis should consider gifting to charity. Due to its nonprofit status, the charity would then be able to sell the assets without paying any capital gains tax. Out of the proceeds, the charity would then pay the trust grantor an income stream based on a market rate of interest for the full value of assets which were initially transferred.

The charitable remainder trust setup routinely reduces income taxes for clients because they receive a substantial charitable gift income tax deduction which can be spread over five years. Furthermore, the value of the property that will pass to charity will be excluded from the trust client’s estate.

Because with this planning technique, the donated assets will not be distributed to children, it is recommended that a life insurance policy be used to replace the value of the investment. The insurance policy should be of an amount at least equal to the value of the transferred assets. Premiums may be paid out of the income stream from the charity. Moreover, the value of the life insurance policy can be excluded from the estate as well through an irrevocable life insurance trust.

Public Benefits Trusts
There are a range of trusts available to assist individuals who require Medicaid planning. The rules regarding these trusts have changed substantially over the past decade and many state Medicaid offices seek to challenge such trusts on a regular basis. At this time, the most significant Medicaid planning trusts are: (1) under 65 disability trusts, (2) pooled trusts,
(3) real estate preservation trusts and (4) “sole benefit of” trusts.

Without question, the discussion of these trusts is beyond the scope of this introductory article. However, the need for public benefits planning must be recognized by attorneys who represent elderly or disabled clients and their families.

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