Wills, Trusts, Estates & Taxation
An estate is all that a person owns, both real and personal property, and is essentially a person's net worth. Within the context of estate planning, two other types of "estates" are also relevant. The taxable estate is that portion of the estate that will be subject to federal estate taxes and possibly state taxes. The probate estate is that portion of the estate that must be probated before it can be distributed. This article reviews wills and trusts, and other common components of most estate plans, in light of the two most relevant concerns: taxes and probate.
Keywords Estate; Estate Tax; Joint Tenancy; Probate; Trust; Will
Law: Wills, Trusts, Estates
An estate is all that a person owns, both real and personal property, and is essentially a person's net worth. Within the context of estate planning, two other types of "estates" are also relevant. The taxable estate is that portion of the estate that will be subject to federal estate taxes and possibly state taxes. The probate estate is that portion of the estate that must be probated before it can be distributed. The interplay and content of these three values of estate will drive most estate planning. The general principle is to eliminate the probate and taxable estates to the greatest extent possible. This is done through estate planning arrangements that include wills, trusts, certain property ownership arrangements and other devices.
The area of wills and estates is loaded with jargon. In this essay, three main ways that property can pass from one to another are discussed. This discussion requires the use of traditional technical language that should be addressed up front to avoid confusion and to attach modern simplified equivalent language where possible. A property can be passed along according to a will, under state law, and according to a trust.
Sometimes a will is called "last will and testament," but for all purposes, including legal uses, just the word "will" suffices. Traditionally, wills used the phrase "I give, devise, and bequeath." The modern approach is to use only word "give." A modern document titled "Will" that states "I give…" means exactly the same thing as document titled "Last Will and Testament" that states "I give, devise, and bequeath." The will has two basic parties: the person creating the will and the parties taking under the will. The person making the will is called the testator. As a technical matter, property distributed under a will is a legacy, devise or bequest. A legacy is a gift of money, a devise is a gift of personal property and a bequest is a gift of personal property other than money. The person taking then becomes a devisee or legatee. The deliniations regarding the different types of gifts are sometimes used and not always used exactly as defined. For our purposes, and for most purposes, they need not be mentioned again but if seen, they should be understood to relate to the passing of property under a will.
If a person did not make plans for their estate, or made plans that failed to address all property, state law dictates how their estate is to be distributed. A person who dies without making plans for their estate is termed an intestate or is said to have died intestate. The people who receive the property under state law are called distributes or heirs. The word heir, in this highly technical sense, refers only to people that receive property under state law, however the word is more loosely used to refer to people that also receive property under a will.
Trusts are arrangements used to transfer property from one person to another. The person that establishes a trust can be called a settlor, trustor or creator. The person who receives property under a trust arrangement is called a beneficiary. The word beneficiary is also generally used to mean any person who is designated to benefit from legal arrangement, as in a will, life insurance policy, etc.
In keeping with the modern approach, we will try to streamline our vocabulary. For our purposes, any person making a will is a testator. Any person receiving under a will or under state law is referred to as an heir. Although in discussion it may seem otherwise, heirs are only heirs after the testator or intestate dies. Legally, no living person has heirs, only "heirs apparent." Anything that an heir receives is simply a gift or property. A person starting a trust will be called a settlor and a person receiving property under the trust will called a beneficiary.
A will is a document that directs how a person's estate is to be distributed after their death. A will is a highly formal document that requires the testator to have capacity and must almost always be written, signed and witnessed according to state law. A will can direct almost any distribution of property that a testator has an interest in at death to almost any heirs (except laws that prevent a spouse from being left out of a will). A will only creates an interest in property after the testator has died — until that time, the testator is free to change or revoke the will. Upon the testator's death, interested parties must present the will for probate in the appropriate court. Probate is a court supervised process by which the validity of the will may be tested and the debts and assets of the estate are collected. The executor is the person who actually collects the debts and assets of the estate to make the final distribution. Executors are usually appointed in the will and can be a relative, friend, lawyer, bank or trust company. If the person named as executor declines the appointment or the will does not name an executor, the court will appoint the equivalent, called an administrator. The probate process is usually lengthy, taking an average of a year or more. The probate process is also expensive; it involves lawyers, accountants, appraisers and filing fees for the court. For these reasons, it is wise to try to avoid probate.
Even though it is preferable to avoid probate to the greatest extent possible, everyone should have a will. First, if a person dies without a will, they are said to die intestate. In that case, their property is distributed according the relevant state intestacy law. Intestacy laws represent a legislative judgment about how most people would want their property divided. Typically, the property would first go to a spouse and then be divided among children and grandchildren, then to parents and siblings and so on. In a case where virtually no family can be located, after a period of time, the property will ultimately go the state or escheat. To avoid the intestacy law and to distribute property exactly according to personal desires, a will or other estate plan is required. Wills also act as backups to other estate planning tools. Property may have been overlooked or newly acquired and not covered by some other arrangement. Wills are also important in that they allow a person to appoint personal and financial guardians for minor children.
There are several options to limit the property that passes under a will and through probate. Trusts, joint tenancies, certain bank account trusts and life insurance are common options. A trust is a legal arrangement whereby a settlor splits ownership of their property into two parts, the legal title and the beneficial interest. The legal title to the property is conveyed to a fiduciary, called a trustee. The trustee holds and manages the property for the exclusive use of the beneficiary or beneficiaries, including pets in many states. A fiduciary is one who owes another the duties of good faith, trust, confidence and candor and must exercise a high standard of care in managing another's money or property. In order to discharge those fiduciary duties, a trustee is generally required to apply, at least, the skill and prudence that a capable and careful person would exercise in conduct of their personal business. Trustees also have a duty of loyalty which means that a trustee must administer the trust solely in the interests of the beneficiaries without regard to the interests of any third party. Among other obligations, the trustee also has the duty to preserve and protect the trust property, keep the trust property separate from all other property, and to invest and make the trust property productive. The burden of trustee can be heavy and many trustees are professionals. As a practical matter, a person should only accept an appointment as trustee with full knowledge of the scope of the commitment (Goldberg, 2007).
Once a settlor creates a trust, the settlor can still use trust property, in fact, the settlor can usually be the trustee and beneficiary under the trust so long as there is at least one other beneficiary. Trust arrangements, in this context, are sometimes referred to as inter-vivos trusts, living trust or revocable trusts. All three terms refer to the same general arrangement where the settlor retains the right to use the property and can change the terms, or revoke the trust at anytime before death. This is opposed to an irrevocable trust, which does not allow the settlor to change it or revoke it after the trust has been established. At the...
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