Hawaii Estate Planning Blog

Asset Protection Planning Pitfalls

In the real world, asset protection planning is not a game of silver bullets or invincible armor. However, this doesn’t prevent asset protection hucksters from marketing their "services" that way, and it doesn't prevent an unsophisticated public from buying into it.

A tale of gullibility, faked complexity, and predictable endings can be found in a recent Forbes article titled “Bill 'Bulletproof A$$et Protection' Reed's Complex Plan Pierced By Nominee And Alter Ego Theories.”  The case of U.S. v. Cohen, C.D.Ill. Case No. 08-3282 (Mar. 8, 2013), chronicles an asset protection plan that blew up in the faces of its intended beneficiaries.  Just the name used to market the scheme, “Bulletproof A$$et Protection,” should give pause to the prudent.

Asset protection is all about understanding the legal nature of your assets and the potential risks that may threaten your future use and enjoyment of those assets.  State and federal laws offer varying degrees of protection, as do time-tested legal strategies.  Understanding the applicable rules and the relative advantages and limitations of different strategies is critical.  Asset protection planning involves art as well as science, but it’s not magic.

Is it wrong to plan for Medicaid qualification?

Our law allows qualified individuals to seek governmental assistance in paying for long-term care, and it provides opportunities for individuals to plan ahead and take appropriate steps to meet those qualifications.  Some people are understandably squeamish when it comes to planning for possible qualification for what is often regarded as a “welfare” benefit.  In fact, there was a time when the Medicaid laws prohibited people from planning for Medicaid qualification (the so-called “Granny Goes to Jail” law).  The Medicaid laws also prohibited people from advising others about how to qualify for Medicaid (the so-called “Granny’s Lawyer Goes to Jail” law).  It turns out that nobody went to jail under these laws. 

The U.S. Attorney General declined to prosecute forward-thinking Grannies, and the Federal courts moved quickly to determine that banning lawyers from advising their clients about Medicaid qualification violates the First Amendment to the U.S. Constitution, which guarantees freedom of speech.  These decisions make a great deal of sense, especially in light of how we, as taxpayers and citizens, interact with our government in other contexts. 

For example, everyone knows that it is immoral and illegal to cheat on your income taxes.  But does that mean that any of us has an obligation to pay more taxes than the law requires?  Of course not.  The Internal Revenue Code allows us to take various kinds of deductions when we file our annual income tax returns.  As long as we deduct no more than the law allows, we are engaging in the noble practice of tax avoidance.  However, if someone knowingly takes a tax deduction in an amount or of a kind that the person is not entitled to take, the terminology changes to tax evasion.  For tax avoidance, a person is praised, for tax evasion, a person can be imprisoned. 

In the 1916 U.S. Supreme Court case of Bullen v. Wisconsin, reported at 240 U.S. 625, Justice Oliver Wendell Holmes wrote that “when the law draws a line, a case is on one side of it or the other, and if on the safe side is none the worse legally that a party has availed himself to the full of what the law permits.  When an act is condemned as an evasion, what is meant is that it is on the wrong side of the line.”  Taking economic advantage of what our law allows—staying on the “safe” side of the line—is both legal and moral. 

Justice Louis Brandeis, whose tenure on the U.S. Supreme Court overlapped that of Justice Holmes, famously stated this same principle another way:

I live in Alexandria, Virginia.  Near the Supreme Court chambers is a toll bridge across the Potomac.  When in a rush, I pay the dollar toll and get home early.  However, I usually drive outside the downtown section of the city and cross the Potomac on a free bridge.  If I went over the toll bridge and through the barrier without paying the toll, I would be committing tax evasion.  If, however, I drive the extra mile and drive outside the city of Washington to the free bridge, I am using a legitimate, logical and suitable method of tax avoidance.  For my tax evasion, I should be punished.  For my tax avoidance, I should be commended.  The tragedy of life today is that so few people know that the free bridge even exists.

Knowing the alternatives that are available to you is the essence of wise planning.  You cannot make a choice that you do not know you have.

The rules that govern Medicaid qualification are fairly clear-cut, but they allow for planning opportunities that are not all that obvious.  For some of us, learning about what those opportunities are can make the difference between leaving a modest inheritance to your children and leaving them with nothing.  As long as you follow the Medicaid rules, you can ethically, morally, and legally make a significant difference in your children’s financial future by leaving them what the law allows.  So if paying for long-term care is an issue for your family, learn all you can about Medicaid qualification so you can plan your and family’s financial future wisely.

What is a Generation-Skipping Trust?

If you want to scare the you-know-what out of your grownup kids, casually let them know that you are talking with your lawyer about leaving your assets to your descendants in "generation-skipping trusts."  The name implies that somebody is going to be skipped when it comes time to distribute your stuff after you are gone, but "somebody" may only be the IRS, along with your descendants' creditors and ex-spouses.

Of course, if you want to, you can snub your kids and leave everything to their kids, but that is not usually how a generation-skipping trust ("GST") works.  More typically, the GST agreement will name your children as beneficiaries, but not include a requirement that everything be distributed to your children.  For tax and asset protection purposes, it can make a great deal of sense to have your trust agreement give your successor trustee the discretion to make (or not make) distributions to your children and their descendants, and have the trust last as long as the law of your State (or the State in which the trust is created) will allow.  As long as the trustee is not a beneficiary or close relative or employee of a beneficiary, your descendants' creditors and ex-spouses will generally not be able to get their hands on any trust assets.

If you like, you can split your estate into as many GSTs as you have children, and then give each of your children the power to remove and replace the trustee of his or her GST.  That way, each child controls his/her trust during his/her lifetime.  You can also give each child the power (called a "power of appointment") to say where any remaining trust assets go after the child's death.  The default in the trust agreement might be that the assets continue in a trust or several trusts for the child's children, but the power of appointment could give each child the power to change the percentages going to the grandkids and even add stipulations to how and under what circumstances distributions will be made to the grandkids.

If you do all of the above in the right way, you can be pretty sure that the IRS will not get its estate tax hooks into your assets for a very long time after you are gone.  As long as the trust produces income, there will probably be income tax to pay, but payment of estate tax can be entirely avoided.

One of the best estate planning rules is that you can, within certain limits, write your own rules when it comes to your estate plan.  Talk with your trusted advisors about the kind of rule book that will best carry out your wishes for your estate.

WHERE NOT TO DIE IN 2013

Now that 2013 is underway, there are finally some solid numbers from which to base your tax planning – at least from a federal tax standpoint. But what about those state taxes? If you reside in one of 22 jurisdictions that assess an independent inheritance or estate tax, it’s time to start paying attention to your state’s tax changes.

Forbes recently provided some helpful information in an article bluntly titled “Where Not To Die in 2013.”

There always are myriad state level taxes to consider. However, here’s the rub: several states may tax one estate.  For example, the family of the Seattle resident who spent summers in his Waikiki condo could have to face estate tax liability in both Washington and Hawaii, in addition to Federal level taxes. Twenty-two jurisdictions (including the District of Columbia) exact some form of taxation. The tax laws of many of those jurisdictions were not written with the current federal taxation limits in mind, because those have only been on the books since the beginning of the year.

The good news is that Hawaii tries to match the Federal Coupon amount (i.e., the amount that can be passed free of estate tax), and that amount is currently $5.25 million.  This means that estates of no more than $5.25 million ($10.5 million for couples who plan carefully to use both of their Coupons) can pass estate tax-free.  The bad news is that the Hawaii estate tax on the excess over $5.25 million is 16%--which is imposed on top of the 40% Federal estate tax.  Federal law does allow a deduction for State estate taxes paid (within limits), and this brings the overall tax bite down to about 50%.

So what states are the worst for 2013? It’s worth clicking over to the original article and map on Forbes.

Reference: Forbes (January 28, 2013) “Where Not To Die in 2013”

What to have on hand in case disaster strikes

On the night of October 27, 2012, the Hawaiian Islands were placed under a tsunami alert.  An earthquake measuring 7.7 on the Richter scale had struck near an island off of British Columbia, and had sent shock waves--and possibly a tsunami--racing across the Pacific Ocean.  The haunting memories of the March 11, 2011 tsunami that devastated Japan sent many of us scurrying to gather up essentials and head for higher ground.

To our relief, the tsunami that hit our islands was minimal and no substantial damage was reported.  However, the lessons of this "dry run" should not be lost on us.  If you were not completely prepared for several days without access to outside sources for food, water, medication and medical supplies, please take this opportunity to be ready in case disaster really does strike.  

You can find a helpful list of basic disaster supplies here.  One thing the list does not address is what you will need for the comfort and security of your pets.  You can find some helpful resources for your fine feathered, furred, or otherwise non-human friends here.  You can look here for a helpful resource for deciding what financial records and information you should include in your disaster preparedness kit.

Let's all benefit from what turned out to be a false alarm by being better prepared for the next time a disaster looms.

 

What about using trusts to avoid probate?

The most effective probate-avoidance vehicle is the living trust.

A trust is the legal relationship that is created when a person transfers "stuff" to a trustee with the understanding that the trustee will manage it for the benefit of one or more beneficiaries.  "Stuff" includes both real property—such as land and buildings—and personal property—such as bank accounts, stocks and bonds, and personal effects.  The person who transfers the stuff to the trustee is called a trustmaker.  This person is also known as a settlor, grantor, or trustor.  Usually, the trustmaker is also the trustee (or perhaps co-trustee) and the initial beneficiary of the trust. 

For a variety of reasons, a married couple will usually want to create two revocable living trusts instead of just one.  It is not uncommon for husbands and wives to be the co-trustees of both of their trusts during their joint lifetimes, and then, after the death of one spouse, to have the survivor serve either as sole trustee or co-trustee with one or more other individuals or a trust company.

A trust is controlled by a document called the trust agreement (sometimes called the trust instrument).  The trust agreement sets out the rules about how the trust will be run.  If the trust agreement says that the trustmaker can revoke it or change it, the trust is what we call a revocable trust.  If the trust agreement does not allow the trustmaker to change or revoke it, we have what is called an irrevocable trust.  

Irrevocable trusts can be powerful estate planning tools.  They allow trustmakers to make gifts but keep the recipients from having complete control over the gifted assets.  Irrevocable trusts play an important part in many estate plans.  They can help provide tax savings, creditor protection, and expert management of assets.

A living trust is one that you create and fund (transfer stuff into) during your lifetime.  It can be revocable or irrevocable, depending on how much control you want to maintain over the trust and its assets.  A revocable trust gives you complete control, whereas an irrevocable trust gives you limited or no control.  A testamentary trust is one that goes into effect and is funded following your death because it is governed by your last will and testament.  Testamentary trusts do not avoid probate, and they are rarely used in contemporary estate plans.

Joint Tenancy: out of the frying pan, into the fire

Probate is generally a very good thing to avoid.  Joint tenancy is sometimes touted as a cheap and easy way to do this.  However, it is not a "fix" that should be embraced without an appreciation for what could go wrong with it.  Consider the sad tale of Mom and Dad and their three sons.

One day Dad and Mom hear about this great idea called “joint tenancy” and put their sons Moe, Larry, and Curly on title to their house.  Joint tenancy appeals to Mom and Dad because it provides a way for title to the house to pass more or less automatically to the next generation without the headaches of probate.

All goes well for about 20 years, but then one day Moe announces, “My wife is leaving me and she says she is going to take me for everything I’ve got, including my 20% of your house.  She can’t touch that, can she?”  Not to be outdone, Larry chimes in with, “Remember that car crash I was in three years ago?  Well, the people in the other car got a judgment against me and their lawyer is asking questions about what I own.  I don’t have to tell them that I own a fifth of your house, do I?”

To make a long story short, if Dad and Mom are not able to buy off Moe’s ex-wife and Larry’s judgment creditors, then their house could get sold out from under them.  They would get 40% of the net proceeds, but that probably would not be enough to replace their home with a comparable place to live.  A “cheap” and “easy” estate planning strategy ends up being neither.

Even if Dad and Mom were to dodge the bullet with Moe’s ex-wife and Larry’s creditors, another way joint tenancy could bite them in the behind is by losing the opportunity to provide some adult supervision for Curly’s share of the inheritance.  If Curly is characterized by bad judgment, bad habits, and hanging out with bad influences, Dad and Mom would be foolish to give Curly anything.  What they might want to do instead is have Curly’s share of the house held in trust for Curly’s benefit.  Dad and Mom can place a range of restrictions on distributions to Curly, from proving to the trustee that he is gainfully employed, to passing a drug test.

While joint tenancy is not necessarily to be avoided at all times and at all costs, it is very important to understand its ramifications.  He (or she) who puts other people on title to assets for probate avoidance/estate planning purposes may be making a huge mistake.  Joint tenancy costs very little at the front end, but it exposes your back end to some very unpleasant possibilities.

There must be a way to avoid probate without exposing your assets to predators, creditors, and bumbling beneficiaries.

 

New Hawaii Law Gives Tenancy by the Entirety Protection to Trusts

This may be a good time to review your estate plan with your attorney.  Hawaii recently enacted a new law effective July 1, 2012, extending tenancy by the entirety protection to transfers of real property to trusts.  This new law is applicable to spouses, reciprocal beneficiaries, and civil union partners.

Do you know how you hold title to your real property?  Hopefully when you and your spouse/partner purchased your new home, you took title as tenants by the entirety.  For a long time, Hawaii law has afforded you special protections if you did.  It is possible as spouses/partners you hold title to your property other than as tenants by the entirety.  The only way to be certain is to review the deed, which indicates how title is held.   Tenancy by the entirety is the only kind of title-holding device that provides special protections.

Among the characteristics of property owned in tenancy by the entirety are:  one owner, acting alone, cannot convey any interest in the property (in other words, both spouses/partners have to sign a deed in order to transfer the property to someone else); the property automatically passes to the surviving spouse/partner upon the death of the first to die; and the creditors of one spouse/partner cannot reach tenancy by the entirety property. 

Prior to the enactment of the new law, if spouses held property as tenants by the entirety and then transferred their property to their respective revocable living trusts (which is a very common estate planning strategy), they may have lost the creditor protection afforded by the tenancy by the entirety.    If one spouse/partner were to have a car accident or a business setback or otherwise incurred substantial debt, the formerly tenancy by the entirety property in that person’s trust might have been subject to creditors’ claims.  This result can now be avoided by including special wording in your trust agreements and in the deeds transferring real property into your trusts.  If you transferred tenancy by the entirety  property into your trusts prior to July 1, 2012, or if that special wording was not included in your trust agreements and deeds, you might want to revisit the question of how to make sure your property is protected by tenancy by the entirety.

The new law is an important reminder that laws change from time to time, and that your estate plan must be reviewed and updated periodically in order for it to work as intended for the best interests of yourself and your loved ones.

NOTE: My Maui associate, Roya Deyhim, co-authored this with me.

The sad financial truth about many of our celebrity heroes

What do Lawrence Taylor, Mike Tyson, Wayne Newton, and MC Hammer have in common?  They all achieved the pinnacle of success in their chosen fields, but soon found themselves flat broke.  Follow this link for an article that talks about these falling stars.  There is a lesson here for all of us, though.  When we leave assets to our loved ones as part of our estate plans, we have abundant opportunities to provide guidance and safeguards so that our loved ones truly benefit in the long run from the legacies we leave behind.  For some ideas, check out www.est8planning.com.

 

 

"Be Giving While You're Living so You're Knowing Where it's Going"

Kingdom Advisors founder Ron Blue takes and interesting approach to estate planning.  He advocates lifetime giving as a way to assure that the objects of your bounty are worthy recipients of your wealth.  This could play out a couple of different ways.

As Blue points out, there are three places your "stuff" can go after you die.  To the government, attorneys, and other professional advisors by way of taxes and administration expenses; to your loved ones; or to charity.  A good estate plan will minimize the amount that is bled away in the first category.  A really good estate plan will help to make sure that your intentions regarding your loved ones and your favorite charities are carried out as well.

Giving assets outright to your loved ones is a way to give them full control over and responsibility for those assets.  However, one of your intended beneficiaries could easily lose his or her inheritance as a result of a divorce, car accident, or bad business deal.  And this could happen due to no personal fault of your beneficiary.  For this reason, many estate plans include ongoing trusts that allow the beneficiaries to have as much control as they are able to handle, while at the same time insulating the trust assets from creditors and predators who might try to take those assets away.

The thing about leaving assets to your loved ones after you are gone is that you will have no idea how each loved one will handle his or her inheritance.  Your best guess during your lifetime could turn out to be wrong.  So what about making gifts during your lifetime that will enable you to see how your intended beneficiaries handle their new-found wealth?  This could be a great way to "test drive" your estate plan and determine how well it works while you are still able to make adjustments to it.  If one beneficiary turns out to be a poor steward of your wealth, you can always redirect assets in your final estate plan to other beneficiaries, or provide greater restrictions on a spendthrift beneficiary's control over your wealth.

The same principles apply to charitable gifts.  Your favorite charity could turn out to be a poor manager of donated assets.  It would be far better to find that out during your lifetime than to leave your loved ones regretting your philanthropic choices.  If a charity does what you hope it will do with your gift, you can add to it upon your death.  Not only that, but your gift may have far greater impact the earlier you make it.  If, for example, you want to provide funding for scholarships so underprivileged children can go to college, the sooner you make your gift, the sooner a scholarship recipient will graduate from college, get launched in a career, and turn around and "pay it forward," as you have done.

As Ron Blue would say, you should consider "giving while you're living so you're knowing where it's going."  Sound advice for anyone who prefers to test the water before diving in head first.