Category Archives: Probate & Estate Administration

Grounds for a Will Contest

Alberts Law, Probate & Estate Administration, Topics of Interest, , , , ,

A will contest can be a difficult and costly legal process so the will contestant needs strong grounds before taking this step. Various issues can be used to attack a proposed will. This is a look at some of the most prominent ones and the types of evidence that are needed for proof.

Burden of Proof in a Will Contest

The contestant attempts to weaken the position of the proponent of the will by offering clear and convincing evidence to undermine important facts that would support the probate of the will. This was defined in La Rocca Trust, 411 Pa. 633, 192 A.2d 409 (1963), as testimony by witnesses about the precise facts at issue that is credible, distinctly remembered, clear, direct, and weighty.

This goes beyond the usual “preponderance of the evidence” standard for the usual civil lawsuit. Such heightened scrutiny makes a will contest hard to win without careful, detailed preparation. What must be proven to this extent depends on the grounds on which the will contest is based.

When a Will Contest Might Succeed

Dating back to the 19th century, there are numerous Pennsylvania cases, statutes, and rules that have defined what must be proven to successfully attack a will. The strength of the evidence and the elements of the law must come together to provide a compelling story against probating the proponent’s will. A look at some of the more likely arguments follows.

Testator’s Capacity and Will Execution

The major issue is what constitutes mental capacity in order for a will to be seen as valid. The Pennsylvania Supreme Court consistently has defined the test for testamentary capacity as “whether the testator, at the time he executed the will in question, had an intelligent knowledge regarding the natural objects of his bounty, of what his estate consists, and of what he desires done with his estate, even though his memory has been impaired by age or disease” (from Cohen Will, 445 Pa. 549, 284 A.2d 754 (1971)).

Basically, the person needs to understand her or his ownership of property and how it should be distributed after death, even if age has decreased the sharpness of an individual’s overall memory over the course of time. As for the natural objects of one’s bounty, this often is expressed as the closest living relatives – however, knowing their identities does not mean that the testator will leave any property to them.

A will contest also focuses on capacity at a particular point in time. As stressed in Wertheimer’s Estate, a 1926 decision that remains precedential, the evidence must cover “the period immediately before, at or after [the will’s] execution.” When an alcoholic executed her will at a time when no evidence of her being intoxicated existed, the court found her will to be valid. Furthermore, in Ryman’s Case, 139 Pa. Superior Ct. 212, 218, Judge Keller emphasized that “[o]ne’s mental capacity is best determined by his spoken words, his acts and conduct.” Unless the evidence undermines the presumption of mental capacity at the time in question, events that are not contemporaneous with the will’s execution will not undermine the document’s validity.

In our society with an increasingly elderly population, we have to remember that the law does not look at such matters as physical age when determining testamentary capacity. For example, in Lawrence’s Estate, 286 Pa. 58, 65, 132 A. 786, 789 (1926), Pennsylvania’s Supreme Court stated that “[o]ld age, sickness, distress or debility of body neither prove nor raise a presumption of incapacity.” Additionally, failure of memory does not prove incapacity as long as it is not total or extended to the degree that incapacity becomes practically certain.

A Poor Memory Does Not Necessarily Equal Incapacity

A testator’s memory is not irrelevant in a will contest but its role can be overemphasized depending on the facts and circumstances involved. The Pennsylvania Supreme Court decided in Brantlinger Will from 1965 that a testator with a faulty memory still has capacity to execute a will. Other cases have stated that a complete lack of memory renders a testator incapable of executing a will. This is a matter of degree and is a reason that a will contest sometimes is necessary.

Incapacity Is Not Always Incapacity

One might think that the proponent of a will of a legally incapacitated testator is guaranteed to lose a will contest. 1964’s Lanning Will summarizes the applicable law: an adjudication of mental incapacity made prior to the execution of a will does not require the conclusion that the will is invalid for lack of testamentary capacity. Instead, one must look for the date that the will was executed. If the testator has not been adjudicated as mentally incapacitated, then the contestant bears the burden of proving this by clear and convincing evidence. On the other hand, if incapacity was determined prior to the will’s execution, the will could be valid if the testator can be proven – by clear and convincing evidence – to have had testamentary capacity of the date of execution. The will’s proponent shoulders the burden of proof here.

Eccentricity Is Not Insanity or Even Incapacity

In Higbee Will, 365 Pa. 381, 75 A.2d 599 (1950), those who brought the will contest proved that the testator was forgetful and, at times, confused and subject to rages and tantrums; that she had plenty of money but lived in poverty and filth; she was; she locked herself in her house while alone; that she refused medical attention even when she needed it; and that she was very ungrateful to people who did her favors.

Meanwhile, in her will, she left her property to an agnostic society instead of relatives. While this upset those relatives, two attorneys and a secretary of a trust company testified that she had clear and full testamentary capacity when she executed a will and two codicils. As a result, the testamentary documents survived the will contest.

This case also demonstrates that what appears to be an “unnatural” disposition does not prove an incapacitated testator. This principle is found in Morgan’s Estate, 219 Pa. 355, 68 A. 953 (1908), which states that a will is unnatural only if contrary to what a testator’s known views and intentions would be expected to produce.

Are Insane Delusions Relevant in a Will Contest?

Maybe, yes; maybe, no. Two cases from the 1950s show how the facts must be developed in order to answer this question. Duross Will, 395 Pa. 492, 150 A.2d 710 (1959) involved a testator who had insane delusions but still could have capacity to make a valid will, as long as any delusion did not affect the will’s dispositive scheme. Meanwhile, 1952’s Johnson Will, also decided by the Pennsylvania Supreme Court, stated that, when it appears that the will was the direct result of the delusion and that the will would have been different if the delusion had not occurred, then the will is rendered invalid.

Undue Influence in a Will Contest

Undue influence is a broad term that includes fraud; threats; misrepresentation; and coercion. This was summarized in Hollinger Will from 1945. It noted that, if sufficiently proven, any of these can undermine a will’s validity by prejudicing the testator’s mind, destroying freedom to act as desired, or acting as a present restraint upon the testator making the will.

Direct versus Indirect Proof

Undue influence can be proven directly or indirectly. With direct proof, the will contestant needs to show, by clear and convincing evidence, that acts which prejudiced the testator’s mind or destroyed the testator’s free agency occurred, resulting in the invalidity of the will produced for probate. In these cases, the presumption is in favor of the absence of undue influence.

However, in other cases, there is a presumption that undue influence existed. This “indirect” proof of undue influence arises in situations in which the law shifts the burden of proof to the will’s proponent, who must show the absence of undue influence for the will to be considered valid.

When is Undue Influence Presumed in a Will Contest?

The Pennsylvania Supreme Court followed a three-part rule regarding indirect proof of undue influence, leaving the will’s proponent with the burden of proving that undue influence did not exist. In Estate of Clark, 461 Pa. 52, 334 A.2d 628 (1975), the Court held that where (1) a person who is in a confidential relationship with the testator, (2) receives a substantial benefit under the will, and (3) at or around the time the will was executed the testator had a weakened mental intellect, a presumption of undue influence arises. The result is that the burden of proof shifts to the proponent to prove the absence of undue influence.

Confidential Relationships

In a will contest, a confidential relationship is considered a potential indication that parties are not on equal footing. In Leedom v. Palmer from 1922, Pennsylvania’s Supreme Court discussed such relationships and looked for “an overmastering influence” on one side or “weakness, dependence or trust” as indicators of a possible unfair advantage that leads to the presumption that a void transaction. Importantly, confidential relationships are not sufficient to create the presumption. In the 1975 decision in Estate of Thomas, which involved the probate of a will in Allegheny County, there was a recognition that a testator in a weakened state dealing with someone in a confidential relationship would result in a presumed unfair advantage. When these circumstances appear, the law presumes undue influence when the bulk of the estate is left to the will’s scrivener. Proving influence is not required to shift the burden of proof.

Various relationships can indicate the existence of confidential relationships. Kinship and marriage can serve this function; however, Aggas v. Munnell, 302 Pa. 78, 152 A. 840 (1930), specify that these relationships do not automatically equal confidentiality. A financial agent in a power of attorney has been given unequal power – if the agent is a will’s proponent, court believe that this clearly indicates there is a confidential relationship.

 Meanwhile, a substantial benefit to will proponent is relevant. The previously mentioned Estate of Clark noted that a substantial benefit to a will’s proponent would establish a prima facie case in favor of the contestant. Cases have noted that no hard and fast rules exist to define a substantial benefit; instead, this is determined by facts and circumstances on a case-by-case basis. In this way, a will contest does not differ from other court actions – the situation must be investigated, with an understanding of what transpired being carefully explored before a rush to court.

Examples of Circumstances that Are Not Automatically Defined as Undue Influence

When a will’s contestant suggests that the will’s proponent being named as executor is a substantial benefit, the contestant likely will lose. Unless the will provides the power to dispose of an estate in a manner contrary to the will’s specific provisions, the proponent (and executor) reaps no substantial benefit. Attempts to persuade a testator do not pass the test. Any form of restraint of a testator must be contemporaneous with the creation of the will and, additionally, must directly affect the testamentary act. If a testator made statements that might have indicated undue influence, courts have found these to be admissible only when linked with more direct evidence for the purpose of corroboration.

For a will contest to succeed, contestants must understand what must be proven and how it can be proven in order to prevail. Unless they understand and can do this, they will fail in their objective and stand to learn an expensive lesson at the same time.

Undue Influence and Proving Fraud in a Will Contest

As previously noted, undue influence is broadly defined in the context of a will contest. As a result, it generally includes fraud as an element. However, fraud often plays an important role in a will contest so it merits being singled out.

A contestant who raises this issue must prove it directly. Pennsylvania’s Rosenthal’s Estate from 1940 established that the burden of proof does not shift so the contestant must produce clear and convincing evidence in order to prevail.

In re Paul’s Estate, 407 Pa. 30, 180 A.2d 254 (1962), dealt with fraud in the inducement regarding execution of a will. The case set forth two elements that the will contestant must prove. First, the testator had no knowledge of the concealed or misstated fact. Second, the testator would not have made the bequest had the truth been known.

A classic situation in which the Pennsylvania Supreme Court looked the possibility of fraud through nondisclosure occurred in Stirk’s Estate from 1911. This involved a testator who authorized the assistant trust officer of the Land Title & Trust Company to draft her will prior to an operation.

The will’s basic objective was to benefit charitable, educational and religious uses. However, there could be a question of the legality of these bequests if the testator died within 30 days after executing the will. As a result, the scrivener prepared a codicil to deal with the possibility that the bequests might fail and left blank spaces for who would receive the funds if she died during the 30-day period. The testator mentioned that the Land Title & Trust Company as the recipient of what were charitable bequests in the will, and the assistant trust officer from that company inserted this into the codicil for the testator.

She then executed the codicil but died within the 30 days after executing the will. The Court questioned why the codicil substituted a for-profit entity to receive the bequests that intended for charitable uses and also noted that the scrivener’s close connection to the land trust company. Additionally, the fact that the trust officer did not attempt to make sure that this drastic change was what the testator actually intended seen as very problematic. The Orphan’s Court judge called this situation “incomprehensible and almost incredible.” The high court agreed. It decided that the scrivener’s silence under this case’s facts amounted to constructive fraud and reversed the decree that awarded the fund to the Land Title & Trust Company is reversed and remitted the record for a distribution of bequest in accordance with its views as set forth in its opinion.

An Overview of Other Grounds for a Potential Will Contest

While lack of testamentary capacity and various forms of undue influence are grounds commonly raised by contestants, there are a number of additional issues that might be introduced in these cases in order to undermine a will’s validity. Among these are lack of testamentary intent; mistakes in execution; issues concerning lost wills; and forgery. These are summarized, below.

Did Testamentary Intent Exist?

The form and language of a writing are factors to be considered but are not determinative of whether a writing is a will. Instead, an informal instrument may be legally effective as a will if its language shows testamentary intent, which is indispensable to the finding that a document is a valid will. The language must be dispositive in character, and this disposition must be intended to occur after the testator’s death. Instructions and memoranda for use in drafting a will at a future time do not show the requisite intent.

Although form is not a determinative factor, it is an element which may be considered. For example, in In Re Estate of Ritchie in 1978, the Pennsylvania Supreme Court noted that the decedent previously executed a will which was not a sophisticated document but did show some knowledge of the customary form and style used for a will. When a later writing was submitted for probate, the Court gave weight to the writing lacking any elements of the customary form that the testator used previously.

The Court in Ritchie also set forth a long-standing principle that, if a further or additional act or writing is contemplated by an alleged testator in order to make a will or codicil, then the current writing is not testamentary in nature. The prior will as well as extrinsic evidence were considered in making this decision.

While extrinsic evidence is not permitted when the intent is unambiguous, the trial court believed that real ambiguity regarding testamentary intent existed so it heard testimony of individuals who were present when the second document was drafted. While it permitted the document to be probated, the Pennsylvania Supreme Court reviewed the testimony introduced by the will’s proponents indicated that the document was a list or memorandum contemplating a will that would be drafted in the future. It concluded that testamentary intent was not present and reversed the trial court’s decision.

Two years earlier, in In Re Estate of Sedmak, 467 Pa. 379, 357 A.2d 142 (1976), the Court stated that, if the instrument is in writing and signed by the decedent at the end, it must be given effect as a will or codicil when it contains a legal declaration of the writer’s intention regarding actions to be performed after the individual’s death. If there is no ambiguity of this intent, then extrinsic evidence is not admissible.

Mistakes in Execution

A classic example of this and how Pennsylvania courts approach the problem occurred in 1959’s Pavlinko Will. In 1949, Vasil and Hellen Pavlinko had their wills drafted by an attorney. The basic estate plan left the property of the first spouse to die to the other spouse. Hellen made the mistake of signing the will prepared for Vasil, who then signed the second will which was supposed to be executed by his wife. Hellen died in 1951, but no will was submitted for probate.

After Vasil Pavlinko’s death in 1957, the will that he signed was offered for probate at the Register of Wills in Allegheny County by the residuary legatee (Hellen’s brother who was identified in the will as “my brother”) named in the will executed by Vasil. Because the document stated that it was Hellen’s will while it was executed by her husband, the Register of Wills refused to accept this to be probated.

Eventually, the case went to the Pennsylvania Supreme Court. It cited Section 2 of the Wills Act of 1947, which stated that every will shall be in writing and shall be signed by the testator at the end thereof. This provision now is found at Section 2502 of the Probate, Estates and Fiduciaries (PEF) Code. The document that was to be submitted as Vasil’s will intended and purported to give Hellen’s estate to Vasil; as a result, it could not be his will but, instead, was a nullity.

The Court noted that the will would need to be rewritten in order to be probated as Vasil’s will, and it was not willing to take this action. The decision emphasized “[h]ow firmly and without exception the courts have carried out the provisions of the Wills Act, when the language thereof is clear and unmistakable” and cited other cases in which the execution of a will did not meet the essential requirements of the statute. The Court did acknowledge the seeming harshness of the result but stated that strictly following the Act was necessary in order to prevent “countless fraudulent claims” from succeeding. When someone submits a will in which mistakes in execution were made, a will contest – if the will would be accepted for probate – has a very good chance of success.

A Will Contest and a “Lost Will”

A “lost” will can be the basis for a will contest. Before doing so, an individual must understand what must be proven in order to proceed. The Pennsylvania Supreme Court’s decision in 1961’s In Re Murray’s Estate involving an unsigned copy of the will of Beatrice J. Murray provided the test for establishing the lost will’s legitimacy as the testamentary document to be probated. The necessary proof includes (1) the testator duly and properly executed the original will; (2) the contents of the executed will were substantially the same as those included in the copy of the will presented for probate; and (3) the testator did not destroy or revoke the will prior to death.

Burns v. Kabboul is a decision from Superior Court that has precedential value when a will contest centers on the status of a lost will. While the case has an interesting fact pattern, it also discusses a number of fundamental legal principles dealing with probate. It begins by noting that estate law in Pennsylvania favors testamentary dispositions of assets over intestate distribution. The policy in Pennsylvania stresses that a will should be interpreted in a way that avoids intestacy if this is feasible. To further this policy, if a later will is contested and determined to be the result of undue influence, a revoked prior will effectively is reinstated.

Burns v. Kabboul reviewed a will contest in which a lost will proved pivotal. Mae Kabboul was named the decedent’s agent in a power of attorney when he executed his final will in 1985. Kabboul was the scrivener and also was named the estate’s executor (who would receive the bulk of the residuary estate). The will was found to be a product of her undue influence and was determined to be invalid. At that point, the law of intestacy apparently would be applied to the estate, and Kabboul would inherit nothing from the decedent.

Then, Ms. Kabboul produced an unsigned copy of a will from 1982. As Pennsylvania strongly favors testamentary dispositions, there are exceptions that permit copies of lost wills to be probated. The test that shows what must be proven to overcome the presumption that a testator destroyed or revoked the lost will is set forth, above.

Kabboul was able to navigate two prongs of the 3-step test with relative ease. There was testimony from witnesses that showed proper execution of the will from 1982. The third prong regarding lack of revocation has met when the 1985 will (which was found to be the product of Ms. Kabboul’s undue influence) was invalidated. The second prong involving proof that the 1982 will’s actual contents were substantially the same as the document purported to be a copy of that will.

The problem with the copy was that the fourth page was missing. The result was that the size of the residuary estate to be received by Ms. Kabboul, again, was uncertain without knowing the provisions on page four. This was why the trial court would not accept this lost will for probate. However, the appellate court chose to attempt to follow the policy that favors testamentary dispositions and ruled that the lower court erred in not examining the document to see if any portion could be salvaged in order to prevent a total intestacy in this case.

To do this, the appellate court looked for the portions of the 1982 will that were not dependent on what may have been stated in the missing page. If possible, it would give effect to those portions so that total intestacy could be avoided. This review revealed that the bequests on the first three pages as well as clause twenty-nine on page five were for determinate sums and merited treatment as valid testamentary dispositions. Meanwhile, the missing clauses only impacted two clauses which concerned the distribution of the residuary estate; since testamentary intent regarding the residuary estate could not be determined, those two clauses were declared void. The court decided that what was apparent from the will’s terms would be subject to probate while the remainder of the estate was distributed according to the intestacy laws of Pennsylvania.

Most will contests that involve lost wills are not as convoluted as Burns v. Kabboul, but the case does demonstrate the problems that can result when old wills are not revoked and destroyed. In this case, a partial copy was at issue. Ms. Kabboul was fortunate that she was able to produce it after a later will was invalidated based on her use of undue influence. If someone else had possession, the PEF Code states what to do. In Section 3137, a party in interest can compel a person having possession or control of a testator’s will to show cause why it should not be deposited with the Register of Wills.

Forgery

While forgery is related to fraud, it is more narrowly defined so it will be discussed briefly here. In 1961’s Kadilak Will, the Pennsylvania Supreme Court stated that the will contestant must directly prove forgery with evidence that is “clear, direct, precise and convincing.” What might be considered as forgery in a will contest?

While an unauthorized signature by someone other than the testator in violation of PEF Code Section 2502 probably would be the typical answer, there are other situations in which courts have invalidated wills and codicils on the basis of document forgery. The latter variation also may be referred to as fraudulent substitution.

The previously mentioned Kadilak Will dealt with allegations of forged signatures. However, there are numerous cases in which contestants have charged others with removing pages of testamentary documents and then replacing them with more favorable pages. For example, Kane’s Estate from 1933 concerned a document bearing the decedent’s signature in which it was alleged that one page had been substituted for the original page and that another page was subjected to alteration. As this occurred nearly 100 years ago, the courts that had to decide on the will’s validity had to scrutinize what was produced by a portable typewriting machine. In the end, the Pennsylvania Supreme Court’s examination of the machine’s output was the same as that of the trial court. The document submitted for probate was riddled with evidence of forgery.

Wide latitude is permitted regarding what can be offered to prove forgery. Over the course of time, the following are among the factors used as proof: comparisons to examples of  the decedent’s handwriting which are positively identified as such and were made as close in time as possible to the date of the disputed document; differences in typing; the presence of extra staple marks; differences in paper used within the document as well as differences in ink; the validity of signatures of witnesses; and the amount of time that elapsed prior to presenting documents for probate as well as explanations for the delays if concerns were raised.

 

A will contest is a difficult and expensive undertaking. However, if there are reasonable grounds for disputing the validity of a document offered for probate, one can succeed in such an action. The grounds alleged and the evidence in support have to be weighed carefully before proceeding to court because the party with the burden of proof must meet this burden by producing clear and convincing evidence to support each element of the cause of action.

The S Corporation & Estate Planning

Alberts Law, Estate Planning, Probate & Estate Administration, Topics of Interest, , , , ,

When an estate plan includes an S corporation, a shareholder seeking to protect the Subchapter S election under the Internal Revenue Code (IRC) must be aware how the stock can be passed to others without jeopardizing this status. Restrictions limit the ways that the stock can be transferred, but – within these restrictions – one can find opportunities in the estate-planning context to protect the S corporation election while achieving objectives for the estate plan. Various possibilities will be introduced after a look at why a business owner would make this election in the first place and why its continued existence would be a focus of an estate plan.

WHY PROTECTING THE CORPORATE TAX STATUS MATTERS

In Subchapter S of Chapter 1 in the Internal Revenue Code, the statutes explaining the S corporation election, the purposes for deciding on this status, and limitations and restrictions that must be followed in protect this status are set forth. Small businesses may choose to incorporate, typically becoming C corporations. A hallmark of such entities is “double taxation.” This means that the average corporation is taxed on its profits (if any); then, after the corporate income tax is assessed, the profits that remain can be distributed as dividends, for example, to the entity’s stockholders. They must account for their shares of the corporate profits when they pay their personal income taxes. Since the corporate profits are taxed at these two levels, this is labeled as double taxation.

On the other hand, when a C corporation makes a successful election to become an S corporation, the problem of double taxation no longer exists because S corporations are taxed as if they were partnerships, which are treated as pass-through entities under the IRS’s income-tax laws. In partnerships, the individual partners receive their shares of the profits, and these are taxed only once – i.e., as shares of each partner individually.

While partnerships are not taxed at two levels, there are other problems, including the possibility of partners being personally liable for a portion of the partnership’s liabilities and debts. A major benefit of incorporation is the basic rule that individual shareholders are not legally responsible for the corporation’s debts and damages beyond their investment in the corporation. This look at partnerships and C corporations leads to the reason that the S corporation appeals to many business owners.

Meanwhile, another potential consideration regarding estate planning with an S corporation that has more than one owner of its stock is that a shareholder agreement often will exist. Due to the closely-held nature of the company, this agreement may contain restrictions on transfers of stock because these transfers can disrupt the continued operation of the business. It may require consent from any other shareholders, who want new members who are likely to act in the best interests of the corporation and the current shareholders. Any plan for the future must fit into the parameters of the shareholder agreement, in addition to the legal considerations.

Despite the various limitations and restrictions that S corporations face which result in making estate planning a precarious undertaking for a layperson, an S corporation is an entity that also has distinct advantage over the C corporation and over the partnership that lead many business owners accept these limitations and restrictions to achieve a tax advantageous position. The IRS treats S corporations as pass-through entities, despite their corporate status. This provides the benefit experienced by partnerships – there is no double taxation, and any profits only are taxed at the shareholder level. A shareholder of S corporation stock also does not pay self-employment tax.

Furthermore, as a corporation, this entity’s owners have the same protections that stockholders in any C corporation have regarding personal responsibility for corporate debts and damages. Of course, there is a price to be paid for receiving this favorable treatment. As noted earlier, estate planning with an S corporation presents difficulties that must be navigated in order to protect the corporate designation permitted by the Internal Revenue Code. Methods that can allow the transfer of S corporate shares while not causing the revocation of the S election exist and must be considered when an estate plan is being constructed.

LEGAL LIMITATIONS AND RESTRICTIONS TO WORK AROUND

The fact that business owners who successfully elect to benefit from the advantages of being an S corporation also must accept certain limitations and restrictions that are tied to this election has been noted. As these elements are a major concern when an individual prepares an estate plan, an introduction to the limitations and restrictions that exist is necessary. One needs to understand why the transfer of S corporation shares is not straightforward in the way that it is with an ordinary C corporation and then have some knowledge of what options are available as a result.

The Internal Revenue Code places restrictions on the number and types of shareholders that S corporations can have. For example, an S corporation faces a limitation on the maximum number of stockholders who can own its stock. Currently, this number is one hundred – exceeding 100 owners violates the law and results in a forfeiture of the S election. While a family-owned business might not be large enough for this to prove troublesome, any plans for succession and stock transfers must be set up in order to avoid allowing ownership to expand beyond this total.

In terms of the shares themselves, an S corporation can have only one class of stock according to IRC Section 1361(b)(1)(D). However, within this class, shares may be classified as voting or nonvoting. The use of nonvoting shares allows transfers of significant value to be made without also transferring control.

The estate plan also must be drafted with a clear idea of the types of individuals and entities that are permitted to own S corporation stock; without such careful consideration, an estate plan can undermine the objective of protecting the S election. Non-resident aliens cannot have an ownership interest; the owner’s estate should be set up so that all shares will pass to U.S. citizens, resident aliens, certain tax-exempt organizations, and certain types of trusts.

The restrictions on ownership ensure that profits, which pass through the S corporation to its shareholders, will not escape annual taxation by the IRS. The limited group of potential owners eliminates most corporations, partnerships, and LLCs, for example, from owning any stock in an S corporation if it is to retain its tax status under the Internal Revenue Code.

INCLUDE QUALIFIED OWNERS TO PERPETUATE THE BUSINESS

When developing an estate plan, a current owner of stock must focus on choosing “qualified” owners – these are individuals and entities who meet the requirements to own shares in an S corporation, which are set out in the Internal Revenue Code. Otherwise, the business could lose this status, meaning that any current shareholders are likely to suffer financially. While a large number of entities and individuals are eliminated from consideration by tax laws, there are specific categories of entities and individuals qualified under the tax code to be owners. When estate planning, an owner needs to understand this so that she or he can determine the choice that is appropriate based on the owner’s vision of the corporation’s future and the best course of action to turn the vision into reality.

Of course, for a business to survive as an ongoing concern, an individual owning shares in an S corporation not only must choose a new owner who falls within the group of qualified owners but also must choose a successor who can perpetuate the business. Beyond looking at individuals, the person could name a trust or a tax-exempt organization to receive the available shares from the estate. This becomes a difficult decision that involves considering multiple options.

 THE CATEGORIES OF POTENTIAL SHAREHOLDERS UNDER THE IRC

While looking at these options, an individual must be sure that the any succession plan accounts for two major decisions that are vital to preserving S corporation status. First, the plan must avoid transferring any shares of the corporate stock to ineligible shareholders, the categories of which already have been reviewed. Second, the individual must detail necessary elections (e.g., the Qualified Subchapter S Trust or Electing Small Business Trust election) that protects against termination of the S corporate status when the grantor dies as well as post-mortem elections that may be required to prevent termination.

With these concerns in mind, the planner generally can look at only a limited number of possibilities. The choices for the transfer of stock ownership include the following: family members, “key persons” who are involved with the S corporation, the decedent’s estate (for a limited period of time), various types of trusts, and certain tax-exempt organizations.

TRANSFERS TO HEIRS OR BENEFICIARIES

With a family business that involves an S corporation, a number of options for ownership transfer can be available. If not specified in the estate plan, a decedent’s shares would pass to the individual’s heirs. This probably is not the optimal choice. For example, the heirs who receive shares based on laws of intestacy may not have the skills or interest to be involved in running a business. A will could be set up to transfer shares to beneficiaries chosen by the testator who had the will drafted to distribute her or his stock.

AN ESTATE CAN BE A QUALIFIED OWNER … FOR A LIMITED TIME

If stock is passed according to a decedent’s will or via a state’s intestacy laws, the ownership of the shares does not transfer to beneficiaries or heirs immediately. In addition, stock does not pass to a trust or a tax-exempt organization, both of which will be reviewed in more detail later, at the time of death. When going through the estate planning process, the shareholder needs to understand that her or his estate can own stock of an S corporation.

However, the length of time that this situation can exist is not open ended. Eventually, these shares will be owned by individuals (as noted above) or entities (as will be noted below). The estate’s personal representative can maintain ownership in the estate for a “reasonable” time. This is not defined in terms of days but is defined by the diligence of the personal representative, who cannot permit an unreasonable delay in transferring ownership from the estate to the new owner as chosen by the decedent or, if the decedent as not set up a comprehensive estate plan, by the defaults established under the law.

If the time frame is determined to be unreasonably long, then the S election may be terminated. What is “unreasonable” is not defined with precision. Instead, it depends on the facts of the case because, the more complicated the estate, the longer the period in which it can reasonably be the owner of the S corporation stock. In the end, though, no estate can last forever so, at some point, the stock must move out of the estate and go to a qualified owner pursuant to the Internal Revenue Code.

GIFTING SHARES COULD BE A USEFUL ESTATE-PLANNING OPTION

Of course, not every estate or succession plan calls for transfers to be made after death. There are ways that the current owner can look to transfer shares prior to death. One possibility is the use of gift giving during one’s lifetime. Often, a parent wants to pass interests in a business to the parent’s issue when they might be considered appropriate successors to the parent. These transfers could be made to individuals or, if distribution is to occur to those individuals in the future, to a trust for this purpose.

Using gifts to make the transition necessitates looking at gift-tax implications. The plan may avoid gift taxation by making gifts each year to each individual that are valued at no more than the annual exclusion for gifts, which is $16,000 per individual for 2022. Other possibilities exist, but the ones mentioned are used commonly to pass business interests from one generation of a family to the next.

BUY-SELL AGREEMENT: CURRENT OWNERS MAY PURCHASE STOCK

There may be reasons why a plan to bring new family members into the business might not be feasible. A shareholder may plan for the S corporation to have an agreement in place that permits a “key person” within the business to purchase a decedent’s shares. In conjunction with the buy-sell agreement, the current shareholder could facilitate this transition by arranging for a life-insurance policy to fund the purchase.

When setting up such a plan, the shareholder should have a qualified appraiser determine the fair market value of the stock since the shares are not publicly traded – valuation always is a concern when an S corporation is involved. Also, this plan only works when there are at least two shareholders in the corporation since the person buying the shares must be an owner at the time.

ESTATE PLANNING AND ELIGIBLE ENTITIES AS SUCCESSOR OWNERS

The current owner may determine that passing shares to individuals does not fulfill the intent behind the estate plan. As long as the shareholder is not bound by an agreement to offer the stock to particular individuals, she or he is in a position to consider specific entities as the new owner of S corporation stock via the estate plan. Some of these options exist prior to death while the others occur post mortem.

Trusts Are the Most Common Entities to Consider

Commonly, an owner in this situation will look at the various types of trust are allowed to own S corporation shares. This requires a thorough understanding of the different purposes that trusts can serve so that an informed decision regarding which is best suited to carry out the intent of the estate plan can be implemented. A brief review of the various possibilities follows.

There are numerous variations among the universe of trusts. However, while purposes may differ, they share common elements. For example, a trust is a legally distinct entity in which assets are managed for the benefit of a select group of beneficiaries. It is created when the grantor (sometimes known as of the settlor) provides trust property that generally should grow in value; this corpus (or principal) is intended to increase in value so that the beneficiaries, under specified conditions, will share in thus benefit. Finally, the trust property is under the control of a trustee – the legal owner of this property – who must manage and invest the trust’s principal on behalf of the beneficiaries.

There are a variety of reasons for using a trust, as opposed to an outright gift to beneficiaries, which is why different types of trusts exist – they have their own characteristics that establish their character and their usefulness in certain situations. The estate planner must be aware of this and select the type of trust(s) that fits with the grantor’s intent in setting up the trust.

Only a Few Trust Types Can Own Subchapter S Stock

Meanwhile, with an S corporation, only a handful of trust types can be used. The grantor has to understand the purpose of creating a trust as well as creating the type of trust that not only fulfills this purpose but also fits into one of the permissible categories.

In estate planning, an individual is limited in the types of trusts that can be established, and various options will depend on elections made after the individual’s death. The Internal Revenue Code includes the following among the trusts that can be eligible S corporation shareholders: grantor trusts; trusts established by the shareholder who also is the deemed owner of the trust at death can continue for two years after the date of death; testamentary trusts created within two years of receipt; Qualified Subchapter S Trusts (QSSTs); Electing Small Business Trusts (ESBTs); and voting trusts. The Internal Revenue Code spells out these choices within Section 1361, in which the IRS also defines what an S corporation is. Considerations regarding each of these are set forth below.

Grantor Trusts

The grantor trust can be relatively easy to establish, but there are certain requirements if it is to hold S corporation stock without jeopardizing the S election. The grantor who sets up the trust must be a U.S. citizen or resident. Additionally, the stock and other assets of the trust must be treated as owned by the grantor. This means that person who puts the assets into this type of trust maintains control over the trust, including the ability to determine distributions from the trust. As a result, the grantor is responsible for any income taxes incurred due to the operation of the trust, as opposed to the trust having any obligation for their payment.

As long as the trust meets these requirements when the grantor dies, it does not have to terminate at that time. Instead, the IRC permits the trust to continue its existence for up to two years after the death of the deemed owner. During this period, it remains eligible to hold S corporation stock, with the estate of the deemed owner becoming the new shareholder.

A grantor also can create a trust that is irrevocable, with control over the assets placed in the trust being surrendered by the grantor. By surrendering this control, the grantor generally is not responsible for paying taxes on the trust’s income. This would eliminate the use of this type of trust for the transfer of S corporation stock.

Intentionally Defective Grantor Trusts: A Twist on the Grantor Trust

However, trusts and the laws and regulations that pertain to them can be quite complex. There are trusts in which the grantor surrenders control over assets placed in the trust – which usually would lead to taxation of the trust for income that is generated and prevent it from holding S corporation stock – receiving some treatment by the IRS as a revocable trust. This is known as the “intentionally defective grantor trust” (IDGT).

This is one of the more complicated trusts among those that can be used with S corporation stock – it must be drafted very precisely to succeed here. An IDGT relies on specific rules in which the IRS permits an irrevocable trust to employ certain conditions that will allow an irrevocable trust to be treated as a revocable trust to a sufficient extent when a S corporation in involved. Usually, this starts with a grantor trust that is drafted with an intentional flaw that will require the individual to remain responsible for paying taxes on income produced by the trust.

The assets in the IDGT will not be part of the estate of the former S corporation shareholder – this is in contrast to a revocable trust in which the grantor remains the actual owner of the property held in the trust. These assets are transferred to an IDGT by either gift or sale. The typical beneficiaries will be the grantor’s children or grandchildren, who benefit by eventually receiving the trust’s assets without a reduction in value due to income taxation because the grantor already paid these. The intentionally defective grantor trust can be a useful tool when an S corporation is involved but only when enough care has been taken to structure it so that it does not run afoul of the applicable rules.

Time-Limited Usefulness of a Testamentary Trust

While an intentionally defective grantor trust can be rather complicated to include in an estate plan, a testamentary trust is simpler to establish. After the shareholder’s death, the estate’s personal representative must work to establish a functional trust. The trust must be funded, with steps taken to permit it to hold the S corporation stock without jeopardizing the corporation’s election. The problem with this option is that it is time limited by definition.

A testamentary trust can retain the stock for no more than two years after the shares are received. If this trust is intended to be an irrevocable trust, the language establishing it must be examined and modified, if necessary, so that the testamentary trust ceases to hold the S corporation stock beyond the time limitation.

Before this period has expired, the trust must qualify as a type of trust that the Internal Revenue Code permits to own S corporation stock. If the terms will not allow the steps required to turn this into an eligible trust to be taken, then the stock should not be placed in the trust in order to protect the S election.

Two Statutory Elections that Can Replace a Testamentary Trust

Assuming that an eligible trust can be created, there are numerous variations of trusts that meet the requirements set out in IRC Section 1361. Since grantor trusts are eligible, an estate planner could use the previously described intentionally defective grantor trust. There are two trusts set forth within Section 1361 that a testamentary trust could become with a timely election.  These are the Qualified Subchapter S Trust (QSST) and the Electing Small Business Trusts (ESBT). A brief review of each follows.

A Qualified Subchapter S Trust Election and Its Effect on the Estate Plan

Section 1361(d) of the Internal Revenue Code introduces the Qualified Subchapter S Trust as a trust that can own stock of an S corporation. However, a trust that elects to have this subsection apply to it has to meet specific criteria. One of the requirements is that the trust can have only one current income beneficiary who can receive benefits from the S corporation stock.

Additionally, any distributions of the QSST’s assets can be made only to that beneficiary, who must be a U.S. citizen or resident. The current beneficiary’s interest ends with this individual’s death. However, if the trust terminates prior to this beneficiary’s death, then the beneficiary will receive all of the trust assets

The timing of a QSST election is important. For example, a testamentary trust that becomes the owner of S corporation stock must elect to be treated under this subsection within two months and 15 days after it becomes a shareholder. If this deadline is missed, then the opportunity to make this election is lost unless late-election relief under Revenue Procedure 2013-30 is obtained.

Electing Small Business Trust and the Impact of its Election

A second option that can be considered before the period that a testamentary trust can hold S corporation stock expires is found in Section 1361(e) of the IRC. Like the QSST, the Electing Small Business Trust (ESBT) must be a domestic trust; this means that a U.S. court exercises primary supervision over its administration and at least one U.S. person controls all of its substantial decisions (26 CFR Section 301.7701-7). It also has a period of two months, 15 days after the trust becomes an S corporation shareholder or the business becomes an S corporation to elect to be an ESBT.

QSST v. ESBT: Advantages and Disadvantages under the IRC

An area in which the Electing Small Business Trust differs from the Qualified Subchapter S Trust involves beneficiaries. A QSST is limited to one income beneficiary while the ESBT is more flexible, allowing there to be more than one “potential current beneficiary” (as defined in Section 1361(e)(2)).

The EBST also permits the multiple beneficiaries to receive income from the trust, but each is required to be eligible to be owners of S corporation stock. The list of possibilities includes U.S. citizens and residents, estates and qualifying tax-exempt organizations (see below).

While the ability to have more current beneficiaries than a QSST can have may be advantageous in terms of the estate plan, the income distributions to the trust’s beneficiaries are likely to face higher tax rates since the ESBT is taxed on this income and generally will pay at a higher marginal tax rate than individual beneficiaries. Meanwhile, the QSST’s income is taxed as income to its current beneficiary. The respective limitations of these two trusts have to be considered before choosing one in the context of an estate plan.

What are Potential Purposes of a Voting Trust?

There is another trust that can hold S corporation stock which is mentioned in Section 1361 that can hold S corporation to be considered here: the voting trust. It is not really an estate planning option because it involves owners of stock creating a trust via a written agreement that delegates their voting rights to one or more trustees. The individual owners of the shares are taxed on any income generated, and the trust is subject to termination on a specific date or upon the occurrence of a specific event. Such trusts can be important when an S corporation is facing a hostile takeover, loss of control, and potential conflicts of interest. The voting trust is mentioned in the interest of completeness since its purpose of pooling voting rights of shareholders would arise after the estate plan’s purpose of transferring ownership to the shareholders is fulfilled.

Viewing Tax-Exempt Organizations Alone or Within a Trust

Another estate-planning option for an S corporation shareholder centers on certain tax-exempt organizations (see Section 1361(c)(6)) that are permitted to be shareholders under the Internal Revenue Code. These include Section 401(a) organizations (pension, profit-sharing and stock-bonus plans) as well as Section 501(c)(3) charitable organizations that are tax exempt under Section 501(a) of the IRC.

Some Section 501(c)(3) organizations merit further scrutiny because they are private foundations instead of public charities. Private foundations usually receive most of their contributions from a primary donor and are controlled by a small group of individuals. As a result, they lack public accountability, and this has led to them facing additional restrictions and excise taxes that can reduce the impact of contributions. This is worth considering if you would look at a private foundation to become an S corporation shareholder in an estate plan.

SOME CONCLUDING CONSIDERATIONS

When there is no shareholder agreement that specifies to whom or what an owner’s shares can be transferred, then an S corporation shareholder’s options fall into the above categories. The person looking at estate planning must work within the limited structure provided by the Internal Revenue Code. Gifting of shares those eligible under the Internal Revenue Code, passing ownership via will to eligible individuals and entities, and placing stock into certain types of trusts are the basic choices available for the estate planner here. Of course, there is no perfect solution, but one must start with well-defined objectives regarding an estate plan to be developed. Then, each of the possibilities can be reviewed to find the best way to meet the objectives. Often, the assistance of experienced professionals is crucial in order to navigate this complicated process to lead to the development of the desired estate plan.

Digital Assets in Estate Planning & Administration

Alberts Law, Estate Planning, Probate & Estate Administration, , , ,

Digital assets are a relatively recent part of everyday life but become important piece in estate planning and administration. Their role is bound to become a larger issue in Pennsylvania in 2021 with the passage of the Revised Uniform Fiduciary Access to Digital Assets Act (“RUFADAA”) during July of this year. The new law will be found in Chapter 39 of Title 20 of the Pennsylvania Consolidated Statutes in January.

Even without the statute, digital assets could not be ignored due to their increasing presence. The first step in dealing with them is to understand what they are and then to take an inventory of the ones that you have. The number and the pervasiveness of these property rights may not be realized from day to day, but a thorough inventory will demonstrate that they need to be an important part of your estate plan.

Pennsylvania’s 2021 Law Regarding Digital Assets & Fiduciaries

As have most states, Pennsylvania has passed the uniform law defining a digital asset as an electronic record in which an individual has a right or interest while not including an underlying asset or liability that is not an electronic record. As an example, an online banking account would be a digital asset, but the money in the account is a physical asset not covered by this law. However, as technology continues to advance, the possibility that the underlying asset also is a digital asset has grown. If the currency in the account is a virtual currency, such as bitcoins, then all of the relevant assets in this situation are digital in nature. In addition, these types of assets generally have associated “metadata,” which is additional information about the specific assets that are intended to make finding and using them easier.

Start with a Comprehensive Digital Asset Inventory

Generating a comprehensive list of digital assets to include in an inventory probably is the best way to begin estate planning for this category of property. The problem with this approach is that the list of possible assets continues to expand so, while comprehensive today, any list soon could become outdated. If you have an idea of the types of digital assets that exist, this will aid you in recognizing other possibilities when you creating or updating your estate plan.

Since the universe of digital assets seems to expand exponentially, you should look at information and data that are stored in electronic form on numerous devices (such as personal computers, external hard drives, and flash drives) as well as online and, increasingly, in the cloud. The following are among the common categories that you might have: emails; text messages; photos; videos; audio recordings; social media; records and other documents; websites, blogs, and domain names that belong to you; and digital wallets.

Your estate plan should deal with the different types of digital assets in an appropriate manner. You may want some to be saved and others deleted. Various accounts may need to be transferred so that they can continue to be used. If the property has a monetary value or generates revenue, then you have to look at who should possess it when you can no longer use it. Of course, digital assets may be subject to contracts or terms of service that must be reviewed when planning because they can control what can be transferred and this would be accomplished.

Importance of a Uniform Fiduciary Access to Digital Assets Act

While digital assets continue to grow in importance, people may not always have a plan in place for a time when they might require someone to step into a fiduciary role and handle these assets when are not able to do so. In the past, this has caused some difficulties with digital assets. The enactment of RUFADAA will set various default rules when these scenarios arise in Pennsylvania in the future. A look at these defaults will take place a little later in this review.

States have control over laws that establish duties of fiduciaries, who must act make decisions for the benefit of individuals for whom they are acting. States often will set the rules to follow when other provisions have not been made. Legislation, such as Pennsylvania’s RUFADAA, can play an important role by “providing consistent rules and procedures from state to state,” according to the Uniform Law Commission that drafted the Uniform Fiduciary Access to Digital Assets Act in order to achieve this objective.

While there can be, and are, some differences among states in the laws that have been passed after the uniform law for fiduciaries was drafted, they do accomplish uniformity from state to state to a great extent. One must remember that, when reading the following overview of Pennsylvania’s new law, the law in any given state with a uniform law may be similar but cannot be assumed to be identical.

The Revised Uniform Fiduciary Access to Digital Assets Act in Pennsylvania applies to a fiduciary acting under a Will or Power of Attorney; a personal representative acting on behalf of a decedent; a proceeding for the appointment of a guardian of the estate for an allegedly incapacitated individual as well as someone named as the guardian; and a trustee acting under a trust (20 Pa.C.S. Section 3903). The basic idea behind this law is that default rules are needed if you have not stated your preferences.

Limitations of the New Law’s Scope

However, these rules are limited in their scope because they cannot trump federal privacy laws, for example. This can lead to the situation involving emails in which so-called “envelope” information – which can include the identities of senders and recipients as well as time of transmission – generally is not within privacy protections while the actual content of the email is granted such protection under the uniform law. It should be noted that even the envelope is shielded from the government and law enforcement agencies.

While the default rules serve a purpose when an individual does not create a plan regarding access during incapacity or after death, the individual can deal with digital assets similarly to the way that control over tangible assets can be directed. The same legal tools may be employed, although important differences can exist.

Some New Definitions to Learn

When a “custodian” (as defined in Section 3902 of Pennsylvania’s Title 20 of its Consolidated Statutes) stores a digital asset of a “user” (i.e., a person having an account with a custodian), the custodian might offer an “online tool” that permits the user to choose a “designated recipient” to control decisions about the digital asset involved.

The definition of an “online tool” also is found in Section 3902. However, what it means probably is less obvious than other terms that have been mentioned, but it likely is the most important one to understand. Section 3902 defines it as “an electronic service provided by a custodian” allowing a “user, in an agreement distinct from the terms-of-service agreement between the custodian and user, to provide directions” regarding disclosing digital assets to third parties. Under RUFADAA, the online tool will control access, but not every custodian provides this tool and not every user takes advantage of its existence when one is offered by the custodian. Therefore, the uniform law establishes a hierarchy of other possibilities that can apply.

RUFADAA’s Hierarchy for Access After Online Tools

For example, when there is no online tool to provide direction, Section 3904(b) of Pennsylvania’s version of RUFADAA provides for the rung in the hierarchy just below online tools. At this point, the appropriate person who is named in a Will, a Trust, or a Power of Attorney as the fiduciary regarding any or all digital assets will be able to obtain the information that the user has permitted pursuant to the relevant legal document. Of course, being higher in the hierarchy, an online tool can override the terms of these legal documents.

The law also defines a third level of the hierarchy, which is the terms-of-service agreement. When the agreement does not require the user to act “affirmatively and distinctly from the user’s assent to the terms of service,” the user can provide for either of the first two instruments to “override a contrary provision” in the agreement (as noted in Section 3904(c)). Otherwise, the terms-of-service agreement can be followed to determine the rights to access and to use digital assets.

The Role & Authority of a Fiduciary under RUFADAA

The role of a fiduciary has been mentioned throughout this article. Unless the law provides authority for tools or orders, for example, that would override the powers given to a fiduciary, anyone who is named to fill this position can have considerable authority and corresponding responsibility. However, RUFADAA does provide limits. For instance, relevant terms of service cannot be ignored; additionally, a fiduciary is subject to other applicable laws, such as copyright laws.

Other limitations come from the duties of a fiduciary that include the duty of care, the duty of loyalty, and the duty of confidentiality. Also, due to potential obstacles that can delay the fiduciary’s efforts, there may be a temptation to take a short cut that, essentially, involves the impersonation of the user, which may be possible if the username and password of the user are known to the fiduciary. While it may be the easier to proceed this way, the law does not permit this tactic. Fiduciaries can use authority provided by the user in accordance with Section 3904 but can be held accountable if they go beyond this scope.

Section 3915 specifically deals with what fiduciaries can and cannot do regarding digital assets. Unless the right to a digital asset is held by a custodian or is controlled by a terms-of-service agreement, the fiduciary will have the right to access digital assets that belonged to the user as long as the fiduciary has been given authority over the assets of this individual. The fiduciary will be viewed as an authorized user of the property of a decedent (estate), settlor (trust), principal (power of attorney), or protected person (guardianship) under such circumstances. The new law also sets out what a fiduciary will need to do in order to request that an account be terminated when the time is deemed appropriate.

When a Fiduciary Seeks Content of Electronic Communications

When fiduciaries have authority that goes beyond “envelope” information, they will be faced some specific challenges. This would be a situation in which a deceased user extends the fiduciary’s power to dealing with digital assets to the actual content of electronic communications after the user’s death. This can be a very touchy area due to information that those communications may contain. If there is a custodian involved, the decedent’s personal representative, acting in a fiduciary capacity, may find that obtaining the content can be time consuming and, sometimes, extremely difficult. The decedent may have made this task easier by consenting to the release of the content of communications sent or received. Otherwise, the personal representative will have to explore asking the court that is involved to issue an Order that the information can be disclosed.

In both scenarios, the fiduciary for the estate then can request that the custodian provide the electronic communication’s content. However, the request may seem simple to make but can be much harder to implement; Section 3907 explains the steps. First, the personal representative needs to send a written request for disclosure in physical or electronic form, along with a certified copies of the death certificate and the grant of letters (either testamentary or of administration), plus a copy of the Will or other record that shows that the user consented to disclosure of the content.

Finally, the law can permit the custodian to request information that identifies the account as that of the decedent, with evidence linking the account to the user or a finding by a court specifying that the user had the account in question, that the information sought is “reasonably necessary” for the estate’s administration, and that federal privacy laws or other applicable laws would not be violated by the disclosure. As digital assets continue to proliferate, fiduciaries need to be prepared to overcome hurdles such as these in order to fulfill their duties and meet their responsibilities.

This brief look at digital assets and laws that are supposed to deal with them provides an idea that how the world’s increasing complexities since the internet age began in the mid-1980s. As technology advances, we must be ready to keep pace in life and in death. New laws have to understood, and we must attempt to keep up with additional laws that will be on the horizon. Then, the changing technological – and legal – environment must be part of the estate planning process. The last link involves fiduciaries who must be willing and able to understand what they can do and how they can do it as they are tasked with administrating estates, running trusts, implementing power of attorney, and carrying out guardianships. The future may not get any easier, but we have to be ready to face its inevitable challenges.

Risk Distribution by the Personal Representative of an Estate

Alberts Law, Probate & Estate Administration, , ,

A risk distribution involves the personal representative of an estate distributing real or personal property without confirmation of the account by Orphans’ Court. 20 Pa.C.S. § 3532(a). The risk involves potential claims that may remain against the estate and property within it. The personal representative distributes estate property when estate debts may remain. She may have to pay the outstanding debt in this situation.

The Main Role of a Personal Representative

The personal representative gathers estate assets and then should pay off any debts that remain. If assets are transferred from the estate before debts are paid, the personal representative takes a risk that the debts and expenses of the estate may not be paid. The  personal representative faces possible liability and may have to pay these personally. In particular, the person who is serves in this fiduciary capacity cannot ignore 20 Pa.C.S. 3392, which classifies payments that the estate may have to pay. It also provides the order in which charges and claims must be paid.

The personal representative must understand these classifications and make payments on claims with the highest priority before moving to the next highest class. However, he cannot decide to distribute property and ignore the duty to pay debts and expenses of the estate.

Personal Representative & Protection from Claimants

Focusing on estates of individuals who died on or after December 16, 1992, the personal representative could be making a risk distribution despite statutory notice of the claim not being timely provided if the personal representative knows of the claim. There are ways to protect oneself from personal liability. The personal representative must make a written demand on the claimant for written notice of the claim.

The claimant must respond by the later of 60 days after the demand or one year after the first complete advertisement of the grant of letters. When the later of the dates passes, the personal representative can make a distribution without being held liable for repayment of the claimant. See 20 Pa.C.S. § 3532 (b.1).

This can seem complex, which is why the personal representative should not rush through the administration of the estate. After all, if a risk distribution is made and someone brings a legitimate claim, then the personal representative will be responsible for taking care of the debt that the estate would have paid.

Specific Protections To Use With Risk Distributions

Personal representatives must be careful and look to protect themselves from liability whenever a risk distribution is being made. This can be done through acting prudently.

There are various steps that can be taken whenever a risk distribution is being contemplated. The following paragraphs review some of the possibilities that the personal representative can use for protection from liability when avoiding the time and cost of account confirmation at an audit is an objective of the personal representative.

The Estate Settlement Agreement

Parties in interest, who would receive property from the estate either through a Will or via intestacy law, may be required to execute an “estate settlement agreement” for the personal representative. This agreement contains the pertinent facts about the decedent’s death as well as information about the grant of letters. A copy of the Will, if any, would be attached. Generally, it should have a statement that the signing parties agree with the distributions made and any yet to be made.

Additionally, the personal representative should provide with a copy of an informal account, which does not have to be filed, with the agreement. There would be language in the agreement that the parties approve of the account. The personal representative needs to include all of these statements and obtain the necessary signatures before making any risk distribution.

Other Tools: Receipt & Release ; Refunding Agreement

The personal representative also would be wise to obtain a receipt, release, and refunding agreement from anyone who is receiving a risk distribution. Basically, these are used to acknowledge the receipt of any assets while releasing the personal representative of liability for any acts or omissions during the estate’s administration and asset distribution. An important and vital clause for the personal representative to include involves the recipients agreeing to return any funds or property if legitimate claims are found to exist after these distributions.

When the personal representative seeks receipts, releases, and refunding agreements as a form of insurance before making any risk distribution, she or he can look to incorporate them into the estate settlement agreement or may have them executed as separate (although related) documents. Also, receipts, releases, and refunding agreements can be filed with the clerk at Orphans’ Court, although this does not indicate approval of these documents by the Court. 20 Pa.C.S. § 3532(c). Also, copies of these filings and the estate settlement agreement should be retained by the personal representative, the estate’s attorney, and each recipient.

“Satisfaction of Award” Should Not Be Overlooked

In addition to getting a release for each risk distribution that is made, the personal representative should obtain a “satisfaction of award” from anyone who is to receive a risk distribution. This directs the clerk of the Orphans’ Court to mark as “satisfied” any award subsequent to the distribution.

An Example of Why These Documents Really Do Matter

All of these documents are important for the personal representative. For example, a receipt and release amounts to an indemnity contract between the personal representative and the individual receiving the risk distribution. This permits the personal representative to file a petition against anyone who refuses to provide indemnification, since 20 Pa.C.S. § 3532(c) provides the Orphans’ Court with continuing jurisdiction regarding these documents.

In this situation, if no payment is forthcoming within 20 days from notice of the initial petition, then the personal representative is permitted to file a Petition for Enforcement of the Order to Pay with the Court. A personal representative may not want to have to take what may seem to be a heavy-handed approach. However, being that a risk distribution is involved, a person acting in this capacity who ignores these precautions can lose his or her own funds while others, who should be responsible for the debt after accepting the distributions, are untouched by the risk that became reality.

 

The personal representative must remember that any protection that is available must be used when dealing with potential risk distributions. Handling an estate is difficult, and anyone who is willing to take this responsibility should look to be shielded from liability not tied to intentional wrongdoing.

The Annuity: A Flexible Financial Tool

Alberts Law, Estate Planning, Probate & Estate Administration, Topics of Interest, , , , , ,

An annuity is a flexible financial tool that can be tailored to meet your needs and, possibly, have a role in your estate plan. The ability to deliver a stream of income makes annuities popular retirement planning tools. However, due to the variety of types and the multiple structures that can be used, the right match for a person’s needs can be created for other reasons as well.

What is an Annuity?

A basic definition of this financial tool is a good place to start when considering its use in financial planning. In the Internal Revenue Service’s Publication 575 (“Pension and Annuity Income”), an annuity is defined as a contract for a series of payments to be made at regular intervals over a period of more than one full year. You can choose to have the payments be either fixed so that you receive a definite amount each time or they can be variable, fluctuating based on investment performance or other factors. These payments could be immediate (the income payments are not delayed after the annuity is created) or deferred (payments are subject to an “accumulation” phase before the “payout” phase provides the income stream).

Also, you can buy the contract on your own, but these often are offered through a person’s em­ployer. The latter are considered “qualified annuities” because they are components of tax-advantaged retirement plans. The first type of contract creates a “nonqualified” annuity as it is privately obtained from insurance companies or financial institutions, in general. There are differences in tax treatment between these two types, and the reasons for obtaining one that is nonqualified is not necessarily related to concerns regarding retirement income. The focus here will be on the nonqualified annuity purchased by an individual.

Who Are the Key “Players” in its Creation?

Some basic definitions of the main “players” when an annuity is created is a good starting point because they are important in determining the way that this tool will be set up. The annuity owner, the annuitant, and the beneficiary are the three categories essential to consider when planning.

The annuity owner purchases the contract that creates this investment. She creates the terms for the annuity with the insurance company or financial institution that issues it. Key decisions include choice of the definition of the “annuitant,” the designation of beneficiaries, and the determination of who would have the right to sell the contract.

While the annuity owner is the purchaser of the annuity, this person may not be the annuitant, who is the individual over whose life expectancy income is paid. Owners commonly name themselves as the annuitants, but there are considerations that can lead to different choices. For example, the annuity owner might want someone younger as the annuitant since the longer life expectancy leads to smaller payments that are paid over a longer period, which extends the tax liability and reduces the taxable income on a yearly basis.

Many annuities are set up with only one annuitant (a “single life” annuity), but others may have a second annuitant, who is to receive payments at regular intervals after the first annuitant’s death. These “joint and survivor” annuities often involve spouses, but this is not always true. Since the second annuitant can be considered a beneficiary, the joint and survivor annuity will considered in more detail later.

Although the periodic payments are calculated based on the annuitant’s life expectancy, the annuity owner must remember that actuarial tables do not dictate an individual’s lifespan. If the annuitant dies sooner than would be predicted, this would leave some of the assets remaining to be distributed. The annuity contract needs to include provisions for who receives what would remain in this circumstance. Beneficiaries are important for this reason.

The beneficiary is the third key “player” when the annuity is being created. Two points to bear in mind are that there can be multiple beneficiaries and that organizations can be beneficiaries. In addition, although an owner can name himself as the annuitant, he cannot be a beneficiary of his own annuity.

Unless the contract requires the naming of an irrevocable beneficiary, the owner usually can change beneficiaries. Furthermore, the owner may be wise to have multiple beneficiaries because, if there are remaining investments after an annuitant’s death, the owner probably would want to be sure that someone is alive to receive these assets.

Some Considerations regarding Beneficiaries

With no beneficiary, an annuity can go through probate or estate administration, but the assets that it still holds may be surrendered to the insurance company or financial institution that issued the contract. Therefore, even without multiple primary beneficiaries, the annuity owner should consider possible contingent beneficiaries, who receive the primary beneficiaries’ payments when the annuitant outlives these beneficiaries.

When multiple beneficiaries are included, the annuity contract can provide for the death benefits to be divided into equal shares or by specified percentages among the beneficiaries. The owner could decide to go in a different direction when choosing a beneficiary, as well. Beneficiaries do not have to be individuals, but the contract owner should consider the legal implications here.

Entities are subject to different requirements as the beneficiaries of annuities. A possible choice for the annuity owner is to assign any remaining payments to a trust. However, after the trust receives this amount, it has five years to pay out these funds. This means that spreading out the taxation based on life expectancy is not possible, while this option does exist when payments are transferred to an individual as the beneficiary.

Choices that Depend on Why You Want an Annuity

While the “players” now have been defined, this does not answer what an annuity is good for. With its flexibility as a contract between the owner and an insurance company or financial institution, there could be a number of reasons that annuities may be appealing. However, we will look at common categories (and choices) that are considered when it is being set up.

One choice is between an immediate annuity and a deferred annuity. A person could decide on a deferred annuity in which taxation is deferred. This is a benefit when retirement planning and may be a good choice if you have made the maximum contribution to a 401(K) plan or an IRA. It would not be subject to any IRS contribution limits and can create a guaranteed stream of income payments during retirement. There would be taxation at ordinary income rates at that time, and there could be annual charges from the financial institution or insurer that issued the contract. They also are likely to be subject to a 10-percent penalty from the IRS for withdrawals prior to the age of 59½.

The choice of deferred payments can be paired with either variable or fixed income payments. A deferred variable annuity is one in which the issuer of the policy places your assets in riskier investments. People with longer time horizons are better candidates for this type of annuity because they have the ability to weather market fluctuations that tend to occur during shorter investment periods. Payments from this annuity type depend on the success of the investments made with the assets that were traded to establish it.

A more conservative investor who is looking to set up guaranteed payments for a number of years after she retires probably would lean toward a deferred fixed annuity. Typical of all fixed annuities, this is not subject to market risk but instead makes regular periodic payments of specified amounts to the annuitant. It could produce earnings that compound on a tax-deferred basis, although withdrawals prior to 59½ years of age might incur the IRS’s 10-percent penalty.

Choosing an immediate annuity results is smaller periodic payments. It may appeal to someone who is or soon will be retired because the wait for the payment stream to begin is not an issue here. The tradeoff involves the acceptance of a smaller amount of guaranteed income for life or, at least, a set period of time (if a “fixed-period” annuity is chosen). Generally speaking, the owner should have a large lump sum of money to trade for a cash flow that extends into the future when creating an immediate annuity. However, there is an example below in which this asset “rule” does not hold.

This often is paired with a fixed income stream. However, the owner may be able to set up cost-of-living adjustments for the income stream over the annuity’s timeframe by paying an extra cost for this benefit.

Annuities May Help Even People of Modest Means

While an annuity can provide a stable source of financial support during retirement for many individuals, it is flexible enough to be adapted to individual circumstances. This can involve tailoring the annuity based on such variables as age, income, and net worth. Also, the amount available to invest will dictate the options that are realistic – even a modest investment might be used to create a workable annuity. Remember that reasons beyond increasing retirement income can be met through this financial instrument, and they should be examined to determine if such an investment might be desirable depending on a given situation.

For instance, one possibility that may be overlooked concerns Medical Assistance. The individual on Medical Assistance would have a relatively low income. This person might look at a single-premium immediate annuity since one often can be obtained even when there are rather limited assets available. To be used to supplement income in this situation, the annuity has to be irrevocable, actuarially sound, and – importantly – payable to the Medical Assistance agency that would be designated in Pennsylvania as the beneficiary after the recipient’s death.

Single-premium immediate annuities also could be useful for retirees who are over the age of 59½ but not yet 70½. If an individual wants to delay the payment of Social Security benefits as well as any tax-deferred distributions for as long as possible, then he or she might consider this type of annuity to provide a stream of income to realize this goal.

Increasing Usefulness by Purchasing Riders and Other Options

As has been noted previously, an annuity is a flexible tool. This flexibility can be increased when the owner purchases various riders or other options. For instance, a person might want to have a rider that provides for accelerated payouts in the event of a diagnosis of a terminal illness.

Riders and options often are added on behalf of beneficiaries. The decision to create a deferred or immediate annuity can influence this choice. With deferred annuities, beneficiaries receive the total amount contributed to the account if the annuitant dies during the accumulation phase and receive the amount remaining in this account after payments that were made to the deceased annuitant have been subtracted during the payout phase.

However, with many immediate annuities, such as a lifetime immediate income annuity, the issuing company keeps any money that remains at the annuitant’s death. The owner might purchase a refund option or a rider for a term certain regarding the annuitant’s life so that beneficiaries can get whatever remains if the annuitant dies when the option or rider would be effective.

A standard death benefit rider may be desirable when it is needed to designate beneficiaries for the annuity if the remaining funds after an annuitant’s death would be forfeited to the issuing company. This is the most basic rider of this type. Other death benefit riders can be used to affect the amount received by beneficiaries, as well. Examples include “return of premium” riders (this equals greater of the market value of the contract and the sum of all contributions minus fees and withdrawals) and “stepped-up” death benefit riders (beneficiaries receive the highest amount using the values of the contract on the anniversaries of the purchase date, with fees and withdrawals subtracted). The basic rule to remember is that a rider which increases the amount going to beneficiaries also will increase the annuity owner’s cost to add it.

A Look at Death Benefit Payout Options

Death benefit payout options involve how the benefit will be paid to beneficiaries instead of how much can be paid. Three options commonly exist for beneficiaries who are not spouses of the annuity owner. The lump-sum distribution transfers the designated funds in a single payment. A “non-qualified stretch” payout provides beneficiaries with minimum payments stretched out over their life expectancies. Finally, the five-year rule payout option allows beneficiaries to make withdrawals during a five-year period or receive the entire amount in the fifth year.

A surviving spouse who is a named beneficiary has an additional option here. The spouse could continue the annuity contract as the new owner and – if the deceased spouse was the annuitant – step into that role, taking over the stream of payments, which delays immediate tax consequences that other beneficiaries face. This is known as “spousal continuation.”

The Joint and Survivor Annuity

This leads again to consideration of “joint and survivor” annuities. It is important to remember that the beneficiary does not have to be a spouse. However, non-spouse beneficiaries again have less flexibility than a surviving spouse would have.

With a joint and survivor annuity not involving a spouse, the beneficiary has the right to receive a payment stream instead of a lump sum of what assets remain upon the death of the annuity owner. This beneficiary lacks the ability to change any terms of the annuity contract, though. As a result, any access to the annuity’s funds continue to be controlled by deceased owner’s contract.

When the surviving spouse is named as beneficiary of a joint and survivor annuity, she can transfer the contract into her name and assume all rights from the initial agreement. Based on the terms of the original contract, the spouse may have the ability to accept all remaining payments and any death benefits, as well as the right to choose beneficiaries (if the predeceasing spouse could have done so).

An Overview of the Topic of Taxation

Taxation of nonqualified annuities is complicated so what follows merely provides information to raise awareness of things to review. While employer-sponsored programs and commonly recognized retirement programs make payments that are not taxed, nonqualified annuities provide payments that are taxable income in Pennsylvania, as well as for federal income tax purposes. To the extent that the distributions that are taxable for federal income tax purposes, they also are taxable as interest income in Pennsylvania.

Nonqualified annuities must use what is termed the “general rule” for federal taxation. Under this rule, payments can consist of a tax-free part of an annuity payment that is based on the ratio of the cost of the annuity contract to the total expected return, which is the total amount that the annuitant expects to receive. The expected return is calculated from IRS life expectancy (actuarial) tables. You can look at IRS Publication 939 for more details regarding this rule.

Beneficiaries also face income taxation. They owe income tax on the difference between the principal paid into the annuity and its value at the annuitant’s death (minus the principal that was paid to fund the annuity initially). If a beneficiary receives this amount as a lump sum, then income tax is due immediately on this amount. If the payments are arranged to be spread out over time, then the taxation will be spread out as well.

When a single premium was paid for an annuity with named beneficiaries, then the annuity represents a return on an investment, which is subject to inheritance tax in Pennsylvania. It would be listed on Schedule G (Inter-Vivos Transfers and Miscellaneous Non-Probate Property) of an inheritance tax return. Notably, the $3,000 exclusion for transfers within one year of death that is mentioned in the instructions to this schedule would not apply in this situation.

When an annuity fund creates the future interests that are reported on Schedule K of the inheritance tax return, the value of the fund creating these interests is reported as part of the estate assets on whichever schedule from Schedule A through G of the tax return is appropriate. As always, you probably want to consult a tax expert about up-to-date information on the various ways that annuities can face taxation, of course.

*             *             *             *             *

With the extensive varieties of annuities that are available and the ability to customize these contracts by working with annuity experts who have a solid understanding of how to tailor this financial tool to meet a client’s needs, an annuity can be fashioned for someone who possesses only modest assets to apply for this purpose. If the size of any death benefits also is a concern, the contract owner also needs a well-crafted annuity that provides for a better future for a beneficiary for whom financial protection after the owner’s death is a goal. Remember that there are numerous possibilities that can be discussed in order to make the right choice for your specific circumstances.

Estate Inventory: Why It Matters and Tips on Its Preparation

Alberts Law, Probate & Estate Administration, ,

Preparing and filing an estate inventory is an essential duty for the estate’s personal representative (the executor if there is a Will or the administrator if there is no Will). This is set forth in Section 3301 of the Probate, Estates and Fiduciaries Code in the Pennsylvania Consolidated Statutes. How this is done and why it is important need to be understood.

Estate Inventory Collects & Values the Decedent’s Property

Basically, the personal representative, who is in charge of the estate, must file a list of all real and personal property in the estate that is located in Pennsylvania. The property that is included is any property that the decedent owned solely or as a tenant in common. Property owned jointly with survivorship rights as well as property with named beneficiaries and “payable-on-death” accounts do not have to be listed in the estate inventory, although they could be included in a memorandum section in the interest of completeness.

Valuation of these assets is an important task of the personal representative. If you have this responsibility, you need to remember that all property in the estate inventory is valued as of the date of death. How this can be done for different types of assets will be reviewed in more detail, later. The date by which this document must be filed with the Register of Wills can differ based on circumstances, but it usually would be filed no later than the date that the estate’s inheritance tax return is due.

Why is the Estate Inventory Important?

Before looking at approaches to the preparation of the estate inventory, we should address why it is important. Of course, as mentioned earlier, Pennsylvania law names this task as a duty that a personal representative must fulfill so you have to do this because Pennsylvania tells you that you must. However, there are reasons that this duty exists.

One reason is that the estate inventory tells everyone with an interest in the estate all of the assets under the personal representative’s control. You have assumed personal responsibility for the listed assets and can be held liable for mishandling them. Their valuation also is used to determine the filing fee for the opening of the estate, which matters to the Commonwealth. This is why you can underestimate the estate’s value at the beginning when you do not know everything in the estate. When the estate inventory is filed, all assets will be included at their date-of-death values so the filing fee that was unpaid originally can be calculated at this point.

There are other reasons that make the estate inventory important for the personal representative. It can be useful when preparing the inheritance tax return because it includes assets and related information about those assets that will appear on various schedules of the return.

In addition, property listed in the estate inventory gives you the starting point for the estate accounting. This accounting should be provided at least on an informal basis if the estate is closed with a family settlement agreement. However, for an estate that closes after an estate audit at court, the accounting must be formally submitted to the court and interested parties for review. By having an accurate starting point, you are more likely to survive an audit unscathed.

Have a Plan to Locate & List Assets for the Estate Inventory

When you have a duty to complete, you need a good plan for handling this responsibility. As noted above, the estate inventory lists all real and personal property of the decedent at date-of-death values. There are numerous steps involved as you prepare the finished document.

The personal representative needs to find all the personal items, money and similar assets (such as bank accounts, stocks, and money-market funds), and real estate owned without any survivorship rights by the decedent. After identifying this property, you then have to value it. Generally, you can value the items without an appraisal. However, expensive personal property (which could include jewelry and art collections) and real estate (when located in Pennsylvania) will require a professional appraisal.

Detailed descriptions are important, especially with more valuable property. Real estate should be described well enough to be identified by someone looking at the estate inventory. Therefore, you should include its full address.

The type of property may lead to some less-than-obvious considerations. For example, financial accounts may involve a right to interest or dividends that are owed but not yet paid. These rights – if they exist at death – are estate property and must be listed in the estate inventory. A personal representative can work with the financial institutions to obtain theses values. Also, you could find previously unknown assets being held by Pennsylvania’s Bureau of Unclaimed Property.

When you begin to prepare the estate inventory, you probably would be wise to start with a more comprehensive list of property that then is grouped into categories, such as “household furnishings” or “wearing apparel,” before you file the document. Although it may not be filed, the more comprehensive list is useful for the personal representative tracking what becomes of the estate’s property.

Listings in an Estate Inventory: Categories v. Items

Household items and furnishings often are the most common estate items. Because they tend to have relatively small values, you could consider grouping them into categories. As an example, you probably would not produce a list of furniture that includes “sofa, $100; chair, $5”; and so forth. Instead, you would list “household furnishings,” encompassing items similar enough to be placed in a group. This is even more appropriate with small goods of minimal values falling within specific groups, such as “100 hardcover books,” “150 paperback books,” and “kitchen appliances.”

Remember that the items placed in a category with a blanket value are common items with nominal individual values. When the value of personal property is higher (e.g., something worth $3000), you would itemize it in the estate inventory. This would be true of jewelry. You might have a single category for costume jewelry, but you would itemize more expensive jewelry with their individual values and descriptions (stone type, carat weight, etc.).

Financial assets were mentioned earlier when looking at estate property that might be overlooked, such as accrued interest or dividends. All of the decedent’s financial assets are part of the estate inventory, though. You would include cash in the deceased person’s possession and bank accounts (with date-of-death balances). Also look for uncashed checks, balances of loans made to others, Certificates of Deposit, and similar financial assets. With financial accounts, you should include individual account types and numbers in the estate inventory.

Investments must be documented and valued. Among these are 401(k) accounts, IRAs, pensions and retirement savings, stocks, bonds, mutual funds, and annuities. Additionally, a personal representative must identify and list impending court awards that the estate will receive. Life insurance without a beneficiary also is in the estate, although it is not subject to inheritance tax.

Some Valuation Sources for the Estate Inventory

If the decedent owned motor vehicles, boats, or any other vehicles, the personal representative generally can use sources such as the Kelley Blue Book (https://www.kbb.com/) for a reasonable valuation. When listing these, you should include the make, model, and year for these vehicles.

The personal representative is responsible for locating any safe deposit boxes. Once located, they can be accessed by following the process detailed in Pennsylvania. Once you have permission, you need to include the number for the safe deposit box, where it is located, and the contents within the box.

Finding assets and then valuing them can be difficult at times. Financial assets may be difficult to identify at times, but the personal representative should review any personal income tax returns for the last 3 to 5 years for clues. Financial assets are not as difficult to value as they might be to find because there are public sources for such property as stocks and bonds. You would have to do some research to obtain the date-of-death values, but the information is not difficult to access. For other financial assets, you might have financial statements to use, or you could requests valuations from the financial institutions when necessary.

Valuation of Common Personal Items in an Estate Inventory

Personal property for which the title does not have to be transferred to the estate can seem to be difficult to value. Furniture, appliances, and clothing are notable examples. However, a personal representative seeking assistance with valuation for the estate inventory can find guides.

Establishing how much silverware, clothing, and small kitchen appliances are worth can be accomplished by using sources that provide estimates. For instance, you could use the Valuation Guide for Goodwill Donors, a similar source, for a starting point.

When an item is more valuable, you might want to turn to other sources that can establish a fair market value to include in the estate inventory. If the property is routinely sold in the marketplace, you could look at several ways to determine the value of single items or collections in this “middle” tier of possessions. One place to start often is eBay ( http://www.ebay.com ). If you are a registered user, you can type in the item that you are researching, and eBay searches for it. The search results are displayed for completed auctions, and you would look at the prices listed in green, which show sales. If the details of the estate item are similar to the details of the sold item, then you have a reference point when completing the estate inventory.

The Estate Inventory – The Effort Will Pay Off in the End

When you have uncovered all real and personal property that can be found and have chosen a reasonable method to obtain the date-of-death valuations, you then can prepare the official estate inventory to be filed with the local Register of Wills. Because it has various uses, the personal representative of an estate must take this task seriously. It is not easy, but it will make other aspects of handling an estate easier and more successful.

Estate Property Transfers Without an Estate

Alberts Law, Probate & Estate Administration, , ,

Pennsylvania provides a number of ways that estate property of a deceased individual can be distributed. Usually, this involves opening an estate. When this step is taken, the personal representative for the decedent receives Letters Testamentary as the executor named in a Will or gets Letters of Administration as the administrator when no Will naming an available executor is found. Pennsylvania law dictates who can be chosen as the administrator. Meanwhile, assets with a named beneficiary or a co-owner with a right of survivorship are transferred outside the estate.

There are other ways to distribute estate property without going through the usual steps to transfer estate property. When an estate has a total value of less than $50,000 in real and personal property, the personal representative can settle it by petition. This is possible one year after an estate is opened and the first complete advertisement of the grant of letters.

On the other hand, small estates consisting of no more than a gross value of $50,000 in personal property can be settled by a petition to the court. This does not require an estate to be opened. In this situation, you would not deal with any real estate owned by the deceased in this petition. The procedure also does not count payments to family and funeral directors under Section 3101 of the Probate, Estates and Fiduciaries (PEF) Code, which is the focus of the remainder of this article.

Payments to Family & Funeral Directors under Section 3101

Distributions under Section 3101 deal with the transfer of ownership of estate property without requiring any action involving an estate or the court. This property generally is monetary and can come from a variety of sources. As set out in the PEF Code, there are a number of ways for specific persons to obtain payments. The total value must be below a maximum amount, as well. The distribution would not involve the court system since you would not need to get a short certificate to transfer ownership. In addition, there is no need to present a petition when this provision applies. A brief review of what can be obtained without opening an estate follows.

The employer of a person who resided in Pennsylvania at the time of death can pay wages, salary, or employee benefits up to $5,000 to the person’s spouse, any of her children, her mother or father, or any brother or sister of the individual. The distribution preference in this and the other categories follows the order in which they are listed. Therefore, a surviving spouse is preferred over anyone else listed here. The person receiving payment of this estate property can be held accountable if the distribution was improper, although the employer is released from liability.

Banks, savings and loan associations, credit unions, and other savings organizations also are permitted to release funds of an estate after the death of a depositor, a member, or a certificate holder. The amount cannot exceed $10,000. Also, a receipt for the funeral bill or an affidavit of a licensed funeral director acknowledging satisfactory payment plans have been made has to be presented. The order of preference is the same as in the prior paragraph: a spouse, any child, the mother or father, or any sibling of the decedent.

A patient’s care account also can be accessed when the deceased was a qualified recipient of Medical Assistance and a patient in a facility that held such an account for the individual. The payment first would be released to a licensed funeral director for burial expenses of $10,000 or less. The facility can pay what remains, again, to a spouse, any child, a parent, or any sibling. The total amount paid from the account cannot be more than $10,000, though.

A life insurance policy that does not name a living beneficiary (primary or contingent), for example, results in property payable to the estate. Unlike most estate property, these life insurance proceeds are not subject to inheritance tax. They can be paid to the same list of relatives, in the same order, as listed in previous paragraphs. The insurer’s payment cannot exceed $11,000. There is a 60-day period following the death before the payment can be made. In addition, payment cannot be made if there has been written contact from an estate’s personal representative before the funds are released. The adult requesting the payment must submit an affidavit specifying the relationship to the decedent.

Finally, under Section 3101, estate property of a Pennsylvania resident held by the Bureau of Unclaimed Property can be released by Pennsylvania’s Treasurer. Certain conditions have to be met. One condition is that the person making the claim must be one of the following: the surviving spouse, a child of the deceased, one of the individual’s parent, or a sibling. In addition, the unclaimed funds or abandoned property must be no more than $11,000 in value. Finally, there cannot be a personal representative for the decedent or – if there is one – this person must have been appointed at least five years ago. The claimant submits the required documentation to the Treasurer, who determines if the claimant is entitled under the statute to claim the property.

Transfer of Title to a Vehicle

One additional category for transferring estate property without opening an estate or petitioning the court merits mention. Transfers of title to motor vehicles from a decedent can be accomplished without having opening an estate. The Vehicle Code permits title to be transferred from a deceased owner to certain relatives.

For example, when there is no Will, a surviving spouse could assign the title to another person. As long as this person submits the proper documents to the Department of Transportation, she becomes the new owner. In addition to an acceptable proof of death (usually, a death certificate), you need Form MV-39 (“Notification of Assignment/Correction of Vehicle Title upon Death of Owner”) and Form MV-4ST (“Vehicle Sales and Use Tax/Application for Registration”). Although you must submit a sales tax form, no sales tax is assessed. However, you may have to pay inheritance tax.

Other relatives may be involved in this assignment of title, as well. For instance, if the decedent had children over 18 years old and a surviving spouse, all would have to sign the MV-39 form transferring title to whomever they choose. Rather than review all possible fact patterns in which relatives can assign title, the Department of Transportation has a fact sheet on its website that detailing possible transfers after the owner’s death.

The categories of estate property that have been reviewed are examples of transfers of property without letters testamentary or letters of administration being issued. Other possibilities meeting this criterion, such as a small estate petition, involve the entire estate or, at least, all of the personal property of the decedent. They also action through the court. The categories of estate property discussed here do not require action involving the court. I will leave you with one word of caution to keep in mind, though. Since property was transferred from an estate, you still must check on the possibility that you have to pay inheritance tax.

Life Insurance with No Beneficiary

Alberts Law, Estate Planning, Probate & Estate Administration, , , ,

There are a number of reasons why a person might purchase a life insurance policy on herself. Often, the death benefit is to be used to pay for funeral expenses and other bills that the person still owed when she died. Another person should be named as the beneficiary if the policy purchased for this purpose. This person would be given responsibility for making these payments. However, life does not always go as planned.

When there is a named beneficiary, a life insurance policy is payable without having to go through the administration of an estate. When the company that issued it receives the necessary documentation, the money would be paid to this beneficiary, and, if used as planned, everything goes smoothly. Of course, the best laid plans of a deceased individual may go astray if events prior to her death do not follow the expected plan.

Often, the policy’s beneficiary is a child of the owner of the policy. This generally would mean the odds that the intended person will receive the proceeds. As long as the beneficiary uses the proceeds as the deceased parent requested, the plan will be a success. Then again, the odds may be in favor of this happening, but life does not promise, let alone guarantee, that something won’t go against the odds.

An elderly parent generally will outlive an adult child. When the adult child is the named beneficiary of the older parent’s life insurance policy, there could be a major problem if the child ends up dying first. Other variables of life may wreak havoc on what was expected. This example is based on a situation that occurred and is not all that rare. The other parent already had died. There were two adult sons, although only one was a beneficiary on the policy. He also had three children. When he died before his mother, her straightforward idea began to get complex and unworkable.

The Importance of Contingent Beneficiaries

After the son died, the policy’s contingent beneficiaries would be the crucial parties if the plan is to be implemented. A contingent beneficiary replaces a beneficiary who is unable to perform in this capacity. Sometimes, there is no contingent beneficiary, which will lead to potentially unintended consequences. The first problem is that the benefits remain to be paid. If no one was named to receive them under the new circumstances, the death benefits are paid by default to the decedent’s estate.

Since no Will existed, after the estate was opened and the policy was found by the estate’s personal representative who did then does what the insurer requires to prove that the named beneficiary could receive the death benefits while he (the other son) had the right to collect the asset on the estate’s behalf, the money ultimately would be paid to the parent’s estate. Being that she lived and died in Pennsylvania, the death benefits now must pass according to the intestacy laws of Pennsylvania – this result diverged considerably from what was intended.

Because the proceeds passed through the estate, any distribution and use would be delayed and may not follow the original plan that had seemed so carefully constructed. This could have been avoided, in part, by naming a contingent beneficiary in case the first beneficiary could not receive the death benefits. This was not done when the policy was purchased, and the mother did not update her beneficiaries after the son chosen to get them had died. Either way would have avoided payment to the estate. Also, if either path was taken, the likelihood that the policy’s benefits would be used as planned would have been better than the intestate distribution could promise since the parent had not discussed how the proceeds were to be used with anyone other than the original beneficiary.

Taxation always is concern and often is a reason that people pursue so-called nonprobate methods to distribute property. Life insurance proceeds that are paid to the beneficiary named in the policy have not been subject to Pennsylvania inheritance tax. However, after December 13, 1982, even when a policy’s proceeds are paid to the estate instead of a beneficiary, no inheritance tax is assessed. 72 P.S. § 9111(d). With this not being an issue, the question of what happens to the insurance proceeds that now were part of the estate is the main one in need of an answer.

The life insurance benefits now are another asset of the mother’s estate. The beneficiary designation is of no consequence because the one brother who was named already is dead. Since the mother had no Will at her death, Pennsylvania’s intestacy laws will determine what happens to the benefits after the insurance company has paid them to her estate.

Who Inherits if There is No Beneficiary?

The law is found in Title 20 of the Pennsylvania Consolidated Statutes in Chapter 21, “Intestate Succession.” Sections 2103 and 2104 provide the answers. The first section applies to an estate, such as this one, in which there is no surviving spouse. It provides the order in which property will pass based on the relationship to the person who has died. The mother’s issue are at the top of the list in intestacy so all the insurance proceeds will be distributed to those who meet the definition of issue. The surviving son qualifies here, but you have to look at the next section (“Rules of succession”) to determine his son as well as the shares for anyone else.

“Issue” includes siblings and, when applicable, their descendants. This is applicable in the current case. The brothers would have been in the same degree of consanguinity because they directly descended from the same ancestor – their mother. However, with only one son surviving, the number of equal shares is defined at this level of survivorship since he is the closest surviving relative. Since there were two sons, this means that there will be two equal shares. The surviving son will receive half of the benefits from the life insurance policy now. It is worth noting that this section contains a survivorship clause – anyone who would inherit under Pennsylvania’s laws of intestate succession must outlive the decedent by five days. He did, so this becomes a meaningless footnote here.

There still is the second one-half share of the insurance proceeds to be distributed. The statute dictates that this share passes by representation to the three children of the deceased brother, which gives each an equal share of one third of what their father would have received under the laws of intestacy. In the end, by not naming a contingent beneficiary in the life insurance policy, the mother altered her intended plan to a considerable extent. Instead of one person receiving all of the proceeds from the policy, her estate will distribute half of the benefits to her surviving son and a one-sixth share to each of the surviving children of the deceased son, who was supposed to receive all of the proceeds when the life insurance policy was purchased by the mother.

This situation provides a good lesson regarding any estate planning. When circumstances change, your plan may not represent your intentions. If the resulting change to your estate plan is significant, then you need to revise that plan as soon as you can because you’ll never know when it had to be implemented.

INSOLVENT ESTATE AND ITS CREDITORS

Alberts Law, Probate & Estate Administration, ,

An insolvent estate has debts in excess of decedent’s assets. This means that not every debt can be paid in full. Pennsylvania law determines the order that debts are paid and, ultimately, the amount. Surviving spouses and children often worry about their responsibilities for debts that the estate cannot pay. Generally, this is not a problem. This is a brief overview of what usually happens and why.

Usually, a decedent’s creditors only can reach assets in the decedent’s estate. A number of assets are exempt from claims of creditors or are not part of the estate. Therefore, creditors cannot pursue these. Examples include a life-insurance policy owned by the decedent naming a beneficiary other than the decedent or the estate. In addition, property owned with someone else having the right of survivorship is not part of the estate. These usually are removed from the estate when determining its solvency.

Responsibilities of the Personal Representative

The estate’s personal representative – the executor when a Will is being probated or the administrator when there was no Will – determines if an insolvent estate is involved. This is done before paying debts or making distributions. An insolvent estate adds difficulty to the personal representative’s job. Since one of the first responsibilities being the payment of the deceased individual’s debts, the personal representative review all claims against the estate. Next, the order in which the creditors will be paid is determined. Gathering the estate’s assets to use  to make the payments is another crucial task.

The personal representative quickly learns if the estate is insolvent. If it is insolvent, this individual should not make distributions to heirs or beneficiaries. Doing so can lead to liability for debts that otherwise could have been paid.

Section 3392 – Classification of Debts & Priority of Payment

With an insolvent estate in Pennsylvania, you have to look to the law for guidance regarding payment of debts. Section 3392 of Title 20 of Pennsylvania’s Consolidated Statutes sets out classifications of various types of debts and the order in which these are paid.

While there are 7 categories listed in Section 3392 (“Classification and order of payment”), there is an additional one given preference over these. These are claims that the federal government may have for taxes owed to it. Generally, the phrase, “subject to any preference given by law,” gives top priority to federal tax debts subject to liens. As the personal representative of an estate, you must look for these before paying other debts. Otherwise, you could be responsible for paying the debts that have priority due to the mistake of paying debts of lower priority instead.

Section 3392 is important when there is an insolvent estate, but it applies to all estates. This is especially important since an estate that looks solvent may be viewed differently after all claims against the estate have surfaced. You cannot pay claims of a lower classification before all claims of higher classifications are paid in full. Also, with an insolvent estate, when you reach the classification at which there are not sufficient assets to pay all claims, you would make partial payment for each claim using the same proportion throughout that class. Any classes below this would have to go unpaid.

As for the classes themselves, the first category to be paid involves the costs of administration of the estate. This includes filing and related fees (such as advertising the estate). Other administrative costs that Pennsylvania gives top priority include legal fees and the personal representative’s compensation. Second in the list is the family exemption, which is cash or property with a value of up to $3,500 that can be claimed by a surviving spouse or children and parents of the decedent who resided in the decedent’s household.

After this, priority is given to funeral and burial costs as well as the cost of medicine used by the deceased person during the final 6 months of life. Medical, nursing, and hospital services during this period also are in this category, along with money for services provided by any employees of the decedent during these 6 months. The final part of this category are services provided by Medical Assistance in the last 6 months of life.

The fourth priority for payment is the cost of a grave marker. Then, priority is given to any rent owed for the decedent’s residence during the 6 months immediately prior to death.

Listing 5.1 (actually the sixth priority) involves claims made by Pennsylvania and its political subdivisions. Finally, there is a catchall category of all other debts and claims, which would include such items as credit-card debts solely in the decedent’s name. If there are sufficient assets in the estate, the personal representative should work to pay all of the above debts as soon as possible. Then, the assets that remain can be distributed to heirs or beneficiaries (depending on whether there is a valid Will).

Possible Liability of Third Parties for the Estate’s Debts

However, when an insolvent estate may exist, not all claims and debts can be paid from its assets. This can raise a question that is important to various parties interested in the estate: can someone other than the decedent be held responsible for debts that cannot be paid by the estate? The answer is a qualified “yes.”

Again, remember that executors and administrators can be responsible for debts in some circumstances. To avoid this, they cannot distribute assets from an insolvent estate since they face personal liability for the debts that cannot be paid as a result. A distribution from an apparently solvent estate is an “at-risk” distribution because there can be claims that become known after the distribution. An executor runs the risk of being responsible for paying any amount of a claim that the money received by the beneficiary could have paid. With “at-risk” distributions, a personal representative generally wants to be protected by an “indemnification agreement.” This means the recipient agrees to reimburse the estate if this is needed to pay its debts.

When faced with an insolvent estate, the personal representative often seeks the court’s protection before acting. In this situation, you should not consider paying debts of the insolvent estate unless you obtain court approval of a petition under Section 3392. This will prevent you from being held responsible for paying the debts personally.

There also are some situations when others can be held accountable for debts in the name of the deceased person. While creditors may have more incentive to pursue third parties in an insolvent estate, the debts may be enforceable under any circumstance. You always will be liable for a debt on which your name appears as a co-signer or guarantor. Charges that you made on a decedent’s credit card can leave you with responsibility for that debt.

As for spouses or children, liability usually follows a similar course. In other words, surviving spouses and children generally are not responsible for debts solely of the deceased spouse or parent. However, when both spouses sign a note for a loan, for example, the estate and the surviving spouse are liable for the debt, even if only one spouse received its benefits. Also, if a surviving spouse or child signed a contract as a guarantor when the decedent needed medical care, liability for any unpaid debt likely remains. An important point that runs throughout all of this is that creditors want to be paid and potentially will look at all possible sources when a decedent leaves an insolvent estate.

Medicaid Estate Recovery – Questions

Alberts Law, Estate Planning, Probate & Estate Administration, , ,

I looked at the basics of Medicaid Estate Recovery in Pennsylvania previously in the first part of this series, but there are other matters that may come into play and should be kept in mind whenever the possibility of estate recovery exists. One involves an objective of estate planning (namely, to transfer wealth to those of one’s own choosing), which estate recovery can hinder. Another issue concerns the need to protect a claim subject to estate recovery, including who can be held responsible for not doing so. A third topic of potential interest is the ability of the Department of Public Welfare (DPW) to postpone or waive its claim and the implications of these paths.

When someone may become subject to Medicaid Estate Recovery, how does this impact estate planning?

For anyone who was at least 55 years old and was on Medical Assistance (as Medicaid is called in Pennsylvania) after August 15, 1994, estate recovery is possible if the individual received nursing facility services, home and community based services, and related hospital and prescription drug services, as was noted in the previous post. This means that any estate planning must be handled prior to that point in time in order to avoid possible Medicaid Estate Recovery.

You need to focus on assets that DPW targets – in general, these are assets that are part of the “probate estate.” If something does not have to go through the process of estate administration in order for a beneficiary to become the new owner, then it should be free from estate recovery. A life insurance policy that names a beneficiary is an example. For a house to avoid estate administration and also to avoid estate recovery, you must plan carefully. If you are over 55 and receiving Medical Assistance (MA), you have options as long as you do not receive it for the three types of services mentioned above. You would need a deed that makes the property jointly owned by you and your beneficiary with rights of survivorship or that transfers the property entirely to the other individual.

(As an aside, if you would die within one year of this transfer, the entire value of the house would be subject to inheritance tax. In fact, if you transfer things that you own to an individual that have a total value exceeding $3000 during the year of your death, then Pennsylvania’s inheritance tax will apply.)

If probate property that is subject to Medicaid Estate Recovery is transferred, can anyone be held liable and forced to pay DPW’s claim?

The decedent’s personal representative – the estate’s executor or administrator (when there is no Will) — has a duty to make sure that DPW’s claim is paid after creditors whose claims have higher priority have been paid. Therefore, the personal representative will be personally liable for DPW’s claim when property subject to that claim is transferred without valuable and adequate consideration to an heir or anyone else with a claim of lower priority if DPW has not been paid when the transfer occurs. “Valuable and adequate consideration” is defined by DPW as a sale of property at fair market value by the estate’s personal representative to a party who is unrelated to the decedent or the personal representative. If this amount is obtained, then the personal representative would not be liable for payment of DPW’s claim.

As will be discussed briefly, DPW may postpone its claim under certain circumstances. However, the personal representative remains liable for transfers during this period. The personal representative must take steps to protect DPW’s claim. This may require a mortgage or other recorded encumbrance to be placed against real property in the decedent’s 威而鋼
estate on behalf of DPW. There also are provisions for perfected security interests to be placed against items of personal property worth more than $10,000 as well as cash (or cash equivalents such as securities) to have a total value exceeding $50,000 to be placed in trust, with DPW receiving the remainder at the trust’s termination up to the amount of its claim.

In addition, a person who receives property subject to a Medicaid Estate Recovery claim by DPW will be liable if the property’s fair market value was not paid for it. The transferee’s liability is the difference between the property’s fair market value and the amount of money received by the estate for the property. This person also must protect DPW’s claim during a period of postponement so that it is paid when the period ends.

When will a claim under the Medicaid Estate Recovery Program be postponed or waived?

Postponements can be requested under certain circumstances. For example, DPW will wait to collect its claim against a decedent’s home when any of the following reside there: a surviving spouse; a child who is “totally and permanently disabled” (as defined by the Supplemental Security Income (SSI) program); a surviving child is under the age of 21; or a sibling who has lived in the home at least one year before the death of the MA recipient and who also owns an equity interest in the property. When the last of these individuals has died, transferred the property, or left it, the postponement period ends, and the Medicaid Estate Recovery claim must be paid.

Undue hardship waivers are more complex so what follows is not an all-encompassing review. However, the most important difference between these and postponements is that a waiver means that DPW has relinquished its right to collect its claim against the estate forever.

The most common type of waiver probably involves a person who meets certain criteria relating to the primary residence of the decedent. First, the person must have continuously resided in the home for at least 2 years immediately before the decedent started to receive nursing facility services or for at least 2 years during which MA-funded home and community based services were received. Also, the person cannot have an alternative permanent residence. The third requirement is that the person provided care or support to the decedent for at least 2 years while MA-funded home and community based services were received by the decedent or for at least 2 years before the decedent received nursing home services and while the decedent needed care or support to remain at home for those two years.

Other sources of waivers involve income-producing assets that were the primary source of household income, without which gross family income would be less than 250% of the Federal poverty guideline — family farms and businesses are examples; payment of necessary and reasonable expenses to maintain the home while the decedent was receiving home and community based services or while the home was vacant when the decedent was in a nursing facility; and the administered estate of the decedent had a gross value not greater than $2,400 and  there is an heir.

 

Medicaid Estate Recovery is a complex area of law, and answers to these questions only touch its surface. For all of the needed details, you should contact an attorney familiar with this subject to protect the interests of all concerned.