California Trust, Estate & Probate Litigation

To be honest I have lost track of how we refer to different generations.  I know baby-boomers and generation X, I’ve heard tell of generation Y, but I’m lost after that.  So let’s just call everyone under age 21 as of now “generation X-Box.”  How do you deal with the transfer of wealth to generation X-Box?

The reason Trust and Will litigation lawyers are in business today is largely due to sibling rivalry—just like children fighting over an X-Box, they fight over a parent’s assets.  And parents have a hand in that as well, sometimes not planning the transfer of their assets or sometimes planning in a way that defies reality.  For example, parents like to put the oldest child in charge after they are gone, is that a good idea?  Maybe or maybe not depends on the personal traits of the oldest child.

Sometimes none of the children should be appointed to act as successor trustees because there’s just too much discord among the children.  That’s when parents need to be realistic.  There are other options, such as corporate trustees or private, professional trustees, that can do a great job administering the Trust while they remain above the fray created by sibling rivalry. 

In fact, some sibling rivalries are so explosive, that just having one child acting over another is enough to create an atmosphere of doubt and mistrust—which could be justified or just perceived.  Either way, tensions mount and Trust matters boil over into Court action.  That’s great for the lawyers, no so good for the Trust and its beneficiaries. 

Further, family dynamics are become more complicated with people being married multiple times and having children from different marriages.  Then the tension truly shoots through the roof when the children of one parent are fighting with the children of the other parent. 

What’s the answer?  Not every potential conflict can be resolved with planning, but there is much that can be done with a proper (and realistic) estate plan.  Here are some lessons we have learned from our year’s of litigating trust and will messes that can help in passing wealth to generation X-Box:

1. The Oldest Child doesn’t always know best.  It is common for parents to name a child as their successor trustee, and sometimes multiple children.  The problem is that (1) not every child is ready to handle that type of responsibility—especially where the law requires that the trustee treat all beneficiaries fairly—(2) sometimes the mere fact of having a child in charge causes problems with the other children.  The solution: be realistic with your choice of co-trustee.  If your going to name a child, pick the right one, make sure they can handle the job of trustee and that they understand their duties as trustee (few people really understand their duties).  Or consider using either a corporate trustee or a private, professional trustee.  Private, professional trustees are a great alternative because they charge less than corporate trustees (usually) and provide more hands-on attention to the Trust administration.
2. Co-Trustees can lead to Co-headaches.  Some people think the solution to sibling rivalry is to put all the kids in charge, that way no one can complain about being left out.  Bad idea.  Children who can’t get along should not be expected to work together in managing the Trust and its assets.  The better solution is to find a neutral third party. A trusted friend or advisor, a private professional trustee, or a corporate trustee—anyone other than the children.
3. Messy Amendments = Happy Lawyers.  Want to help keep lawyers employed?  When you go to amend your Trust or Will don’t do it with the help of a lawyer.  Instead, write on the document, in the margins without signing it, or write on the back of a napkin, or use a computer program without knowing how to complete the amendment.  All of these techniques will end up in a mess of a plan, and a messy plan means good business for lawyers because there’s more to argue over. 
4. Information is Key – don’t be shy about what you want.  And whoever is placed in charge needs to know the duties and obligations they are undertaking.  Share at least some basic information with your successor trustee.  You don’t need to show them your Trust or Will, but tell them you have it, where it is kept, and what you expect when the time comes.
5. Don’t be Afraid to Lay Down the Law – if you’re going to disinherit someone, tell them beforehand.  I know it is hard to do, but it can save those children who are not disinherited a heap of trouble after you are gone.
6. If you really want a personal memento to go to one child, give it to him or her while your still alive.  Small personal items can be easily lost, misplaced, overlooked or stolen.  And nothing ignites family discord like fighting over the smallest personal item.  It may have no economic value, but there’s tons of emotional value and that will keep the fire of litigation burning for years.
7. Make sure your assets are properly titled.  There’s nothing more frustrating than seeing a perfectly good Trust go to waste because the decedent’s assets were not titled in the name of the Trust.  Hopefully there is a pour-over Will that transfers the assets to the Trust, but that’s not always the case.  So some assets pass under the Trust, some pass under the Estate, and some may even pass under joint tenancy.

These are just a few of the biggest issues we see on a daily basis.  When it comes time to sit down and plan your estate, give these items some thought and be sure you are ready to hand your estate to generation X-box with as little fighting as possible.

I will admit that I am not the biggest proponent of asset protection devices.  Primarily because there seems to be a lot of schemes and scams sold under the guise of "asset protection."  But not every asset protection device is bad.  In fact, there are some very good, and legitimate (and, yes, legal), asset protection strategies.  Our friend and colleague, Michael Hackard, at Hackard Law in Sacramento, was kind enough to submit this guest post on the subject of domestic asset protection trusts, one of the legitimate forms of asset protection.  Hope you enjoy this informative post:

THE SUBTITLE: I struggled a bit for an appropriate subtitle regarding Domestic Asset Protection Trusts (DAPTs). I wanted the subtitle to be descriptive, to underscore the benefits of DAPTs and to neither overstate nor understate the trusts’ advantages. While such trusts have limitations, they can substantially improve “financial longevity” for individuals and families.

DEFINITION: Alaska has been the leader in updating its trust laws and has some of the most expansive asset protection laws in the United States. Alaska was the first state in the country to allow “self-settled” trusts. The advantages and a description of “self-settled” are delineated in the website of one of Alaska’s leading trust companies.

Alaska has the best trust spendthrift statutes for both the grantor and other trust beneficiaries. Alaska provides for "self-settled" spendthrift trusts which allows the grantor to set up an irrevocable trust, be a discretionary beneficiary and avoid having the assets be subject to creditor claims of either the grantor or any other beneficiary. Also, the assets in such a trust may be excluded from the grantor's taxable estate even though the grantor is a trust beneficiary. . . Alaska has no special "class" of creditors which, unlike the laws of other states, would permit those creditors to attach the assets of the trust. Alaska allows creditors to attach trust assets in a self-settled trust only upon proving by actual fraud (and not "constructive" fraud).[1]

ADVANTAGES: As the above definition reflects, “self-settled” spendthrift trusts allow the grantor to establish an irrevocable trust while still being a discretionary beneficiary of the trust. A grantor is the creator of a trust and is the person who initially places his or her assets into a trust. Thirteen states now have some statutory frameworks that allow for self-settled trusts. Not all statutes are the same, and the level of protection available to grantors varies widely. That said, the remaining states that do not allow “self-settled” trusts follow the common law rule that generally prohibits the establishment of a trust with your own assets to benefit yourself.

ASSET PROTECTION AND THE DANGERS OF LITIGATION: The New York Times recently addressed one of the realities facing American families: The United States is the most litigious society on earth.[2] I purposefully did not describe asset protection as “insuring financial longevity” because asset protection does not provide absolute insurance from the potential of runaway litigation. It does improve the probabilities of financial longevity and should address an orderly wealth transfer with effective tax planning. Self-settled spendthrift trusts are only part of asset protection. A number of other multiple entity structures are also important to effective planning.

SUCCESSES AND FAILURES: All states recognize the attorney-client privilege. The attorney-client privilege provides that what is said and written between a client and his or her lawyer is confidential and protected from disclosure to others. The “ethical duty of client-lawyer confidentiality is quite extensive in terms of what information is protected. It applies not only to matters communicated in confidence by the client but also to all information relating to the representation regardless of whether it came from the client herself, or from another source.”[3]

The attorney-client privilege precludes much storytelling in the domestic asset protection field. Suffice it to say that some circumstances will preclude the utility of DAPTs while other circumstances will present “golden opportunities” for domestic asset protection that substantially improves family and personal “financial longevity.”Asset protection successes are successes that rightly belong in the zone of confidentiality and constitutional rights of privacy. Asset protection failures are often the focus of news stories or the cautionary tales of creditors’ lawyers.

CAVEATS: Wealth preservation planning is an ongoing process. Attorneys competent in the field must be aware of the ethical and legal issues that are part and parcel of asset protection. On the one hand an attorney might be vulnerable for failing to counsel a client about asset protection; on the other hand the same attorney must be cautious in counseling clients who wish to protect their assets from creditors. The asset preservation available in Domestic Asset Protection Trusts is evolving. Not many years ago self-settled spendthrift trusts were not allowed in the United States. Now the trend, although not cascading, is for their allowance. The impact of this trend and the statutes that accompany it will be part of “the life of the law” and its evolution through “experience.”

The life of the law has not been logic; it has been experience . . . The law embodies the story of a nation’s development through many centuries, and it cannot be dealt with as if it contained only the axioms and corollaries of a book of mathematics. (Holmes, Selections from the Common Law, The Mind and Faith of Justice Holmes (Random House 1943), 51.)

It is likely that the role of Domestic Asset Protection Trusts will be tested, expanded, at times contracted, explored, updated and judicially articulated as time goes on. That said, their utility for estate planning should at the very least be considered and weighed for their applicability. Our observation in “Successes and Failures” is an appropriate close to this article: Some circumstances will preclude the utility of DAPTs while other circumstances will present “golden opportunities” for domestic asset protection that substantially improve family and personal “financial longevity.”

© Copyright Michael A. Hackard, 2012. All rights reserved. 

[1] Alaska Trust Company (August 10, 2012), available at http://alaskatrust.com/index.php?id=89 (last viewed August 10, 2012).

[2] Rubin, More Money Into Bad Suits, The New York Times, Nov. 16, 2010, available at http://www.nytimes.com/roomfordebate/2010/11/15/investing-in-someone-elses-lawsuit/more-money-into-bad-suits (last viewed August 10, 2012).

[3] Sue Michmerhuizen, Confidentiality, Privilege: A Basic Value in Two Different Applications, Center for Professional Responsibility (May 2007) available at http://www.americanbar.org/content/dam/aba/administrative/professional_responsibility/confidentiality_or_attorney.authcheckdam.pdf  (last viewed August 10, 2012).

I recently had the pleasure of speaking with Kate Ashford, a freelance journalist who occasionally writes “The Help Desk” column for CNNMoney online.  Her question was a common one: how are gifts taxed?  There is a lot of confusion on how gifts are taxed, and to whom they are taxed.  Here’s a few tips to sort out taxes relating to gifts:

What type of tax are you talking about?

There are different types of taxes that could potentially apply to gifts, namely, income tax and gift tax. 

Income Taxation of Gifts.

As a general rule, gifts you receive from others are not included in your income tax.  In other words, any amount received by you as a gift is completely tax-free (same rule applies to inheritances too).  Of course, this assumes that the amount received is actually a bona-fide gift.  You can’t try to fool the IRS by passing off a large bonus from your work as a gift.  But if you honestly receive a gift from a family member, for example, then there’s no income tax to you.  It doesn’t matter if its $1.00 or $1,000,000, it’s a tax-free gift to the recipient.

Don’t confuse gifts with things such as gambling winnings, lottery prizes, game-show loot, or receiving the HGTV Dream Home (if you are so lucky)—all of those cash and prizes are subject to income tax when, or rather if, you receive them.

Gift Tax.

Gifts are subject, however, to our Gift and Estate Tax rules, which obligates the grantor (that is the person GIVING the gift) to pay tax on all gifts made.  Read that again: the person making the gift is obligated to pay the tax—not the person receiving it.  Sounds ridiculous?  Maybe.  But that’s our gift tax system; if you’re going to be generous by giving a gift, then you may have to give an extra gift to Uncle Sam.

To begin with, you should also think that all gifts are taxable.  There are a few exceptions, but if you don’t fit within one of the exceptions, then prepare to be generous to the IRS.

The Exceptions to Gift Tax.

Annual Gift Tax Exclusion.  Every person has the right to gift up to $13,000, per person, per year.  These annual exclusion gifts do not have to be reported to the IRS.  The “per person, per year” requirement means that a single person can make multiple gifts to different people each year.  So a grandfather could gift up to $13,000 to each of his children, and each of his grandchildren and not have to report the gifts, provided that no one person received more than $13,000 in a given year.

Many people remember the annual exclusion gifts as being the annual $10,000 gifts.  That is the prior gift tax exclusion amount before they were indexed for inflation.  The annual gift amount is now $13,000.

Marital Deduction.  Spouses can gift each other an unlimited amount of gifts and pay no gift tax whatsoever.  The only requirement is that the couple must be legally married.  Sounds simple, but it can be tricky at times. 

For example, California does NOT recognize common-law marriage, unless such marriage is established in another State that does recognize common-law marriage (such as Texas).  Also, California does not recognize same-sex marriage (remember Proposition 8?).  California does allow same-sex partners to register and thereby receive many of the same benefits and obligations as married couples, but not the status of legal marriage. 

Gift Tax Exclusion.  Under our current Estate and Gift Tax laws, every individual is allowed an exclusion from gift and estate tax equal to $5,000,000.  This means that you can give up to $5,000,000 away and not have to pay a gift tax on that transfer.  However, any amount of exclusion you use during your lifetime by making gifts, reduces what you have left for your estate.  So if you gift $2,000,000 during your lifetime, you pay no gift tax, but your Estate Tax exclusion is reduced from $5,000,000 to $3,000,000 to account for the $2,000,000 of exclusion you used while alive.

Gifts in any single year to a single person that exceed $13,000 must be reported to the IRS using a Gift Tax Return (Form 709) even though no tax will be due on the return.  This reporting requirement allows the IRS to track gifts made over your lifetime to determine when, and if, you exceed you tax-free limit.

Charitable Gifts.  As you would expect, gifts made to charity, in any amount, are free of gift tax.  Luckily the IRS is not so callous as to require a generous donor to pay tax on gifts to charity. 

But beware, the charity must be recognized as a valid charity by the IRS under Internal Revenue Code Section 501(c)(3).  Always ask to see proof of a charity’s determination letter before making any large gifts to charity, and then confirm the charity’s status with the IRS because sometimes charitable status can be revoked by the IRS.

Tax Law Changes.

Tax laws these days are very fickle things.  The current set of laws for Estate and Gift Tax are set to expire at the end of 2012, meaning that a whole new set of rules will be put in place.  We have no way of knowing if the rules will be better or worse than what we have now.  So you have to keep an eye out for future developments.

The bottom line: no good dead goes unpunished.  Giving ‘till it hurts really can hurt if you don’t plan out your gifting ahead of time.

Trust and Will litigation tears families apart.  It may be that family relationships aren't too good to begin with if litigation arises, but taking matters to Court doesn't help.  And as lawyers we have little to no ability to repair family relationships.

In one case, out of the many hundreds I have handled over my career, a client of mine chose to make a bold statement after a family dispute arose.

Her name is Sofia.  Sofia—who didn't have a lot of money—worked as a registered nurse.  While her mother was alive, Sofia helped her with her care.  While Sofia’s father was alive, Sofia sold her home and gave the proceeds of the sale to her parents because they were in need of money at that time.  Her parents, in turn, put Sofia on the deed to their home so that she could be repaid after their deaths.  Over 15 years later, both parents passed away and the house passed to Sofia.

Sofia's brothers and sisters were not too happy about the arrangement and a nasty dispute arose over the property.  But in the end Sofia won out because she had given a large sum to her parents and in return, they gave her their home when they were done with it.

The whole ugly affair did not sit well with Sofia.  So she decided to make a bold statement with the house she received from her parents, she gave the entire thing-100%-to charity.  This was a substantial gift for anyone, as it was for Sofia.  The house was worth around $350,000 and had no mortgage.  That is a large amount of money for a single working woman, something to tuck away for retirement and future care. 

Instead, Sofia gifted the entire home to the Ronald McDonald House charities, which provides housing free of charge to parents who have very sick children in the hospital.  Ronald McDonald House was planning on building a new home in Long Beach, California, and Sofia’s gift kicked-off their fund raising for the new Ronald McDonald house with an entirely unexpected gift.  The home was sold by the charity and now is being used for their charitable purpose.

Sofia's one requirement in making the gift was that it be dedicated to the memory of her parents, David and Teodora Pacheco, and their grandchildren, because they loved their many grandchildren unconditionally.  The kitchen of the new Ronald McDonald house charity will be dedicated to Sofia’s parents, primarily because her mother loved cooking and it was a central part of any family gathering.  A plaque will read “David and Teodora Pacheco Kitchen in honor of their grandchildren.”

Sofia had no obligation to make this gift.  The house was hers and she should have used it to provide for her retirement.  But for the first time in my 11 year career as a California Trust lawyer, Sofia demonstrated the power of personal sacrifice.  She did not have money to spare and could not afford such a generous gift, but she made the gift anyway.  It was important to her to turn a family dispute, one that she alone could not repair, into a lasting tribute to her parents.

Joint tenants beware. Placing assets in joint tenancy presents a number of pitfalls in Califonria estate planning.  We discuss a few of those pitfalls in this video.  For those viewing this blog by email subscription, you can click on the title for a link to the video.

Non-profits, charities, 501(c)(3)’s, foundations, private foundations, family foundations—what do all these terms have in common?  They are typically used to refer to the same thing, an entity that is recognized as not-for-profit under Internal Revenue Code Section 501(c)(3).  But not all charities are created equal.  There are different types of charities based on the type of activity they engage in and the primary source of their charitable contributions.

The three basic types of 501(c)(3) charities are (1) private foundations, (2) private operating foundations, and (3) public charities.

• Private Foundations.  A private foundation is a charitable entity that does NOT receive a bulk of its charitable contributions from the general public.  Foundations are usually formed to provide grants to other public charities.  They can receive contributions from any source, but they typically are funded by a single family or a small group of corporate or individual donors.  Under Section 501(c)(3) of the Internal Revenue Code, all charities begin life as a private foundation unless and until they can establish that a bulk of their contributions come from the general public.

Because private foundation status is the easiest level of non-profit to obtain, it also has the least tax advantages.  When individuals make contributions to a private foundation, the income tax deduction may be limited.  For example, if you were to give a private foundation real property that you bought long ago for $50,000, but the real property now has a market value of $500,000, your charitable deduction would be limited to $50,000.  When giving that same real property to a public charity, your deduction would be $500,000—the full market value.  So the type of charity you’re giving to can make a difference.  These rules apply for any appreciated property (including business interests), but do not apply to cash gifts or “marketable” securities (i.e., stocks listed on a stock exchange). 

Furthermore, private foundations are required to contribute a minimum of 5% of their annual net worth to a qualified 501(c)(3) charity each year.  So if you are involved with a public charity, you want to seek out private foundations who desire to support your cause because every private foundation is required to make minimum grants to public charities each year.

Private foundations are often created by individuals or even businesses that wish to support charitable causes, but don’t necessarily want to engage in the actual charitable activity directly.  It can be a great way to build good-will in the community.  For example, the Ronald McDonald House charity, or the In-N-Out Foundation.  These are great examples of charities created by businesses.

• Private Operating Foundations.  Private foundations that choose to engage directly in charitable activities are referred to as private operating foundations.  They are somewhere between a private foundation (which is just a grant-making charity as discussed above) and a full-blown public charity.  Operating foundations do not qualify for public charity status because their contributions are not derived primarily from the general public.  But they do engage directly in a charitable activity.  For example, someone who begins operating a animal rescue/shelter charity may not have enough contributions from the general public to qualify as a public charity, but since they are actually engaging in their charitable purpose (i.e., rescuing and sheltering animals), they qualify as an operating foundation. 
• Public Charities.  This is the type of organization most people think of when talking about a charity.  A public charity is an organization that directly engages in their charitable purpose and receives a bulk of their support from the general public.  They are not funded by any one individual or business, but rather, a whole segment of the general public.  They can still receive large donations from individuals or businesses, but those contributions cannot exceed more than 50% of their overall income.

Public charities are the most beneficial entities from a tax perspective.  A large amount of their income is exempt from tax and the income tax deduction individuals receive for making gifts to public charities are very generous. 

• How can knowing your charities help business?  Knowing about the different types of charities can be helpful in a number of ways.  First, if you are going to make a gift to charity, the best tax benefits you will receive come from giving to a public charity.  If that is a concern to you, then you will want to find out what type of charity you are giving to.

You can also leave gifts to charities as part of your estate plan (under your Trust or Will), which is a great way to leave a legacy and provide a greater charitable contribution than you may be able to give during your lifetime.

If you do work for a public charity, or as a business you help support a public charity, you would want to seek out private foundations that share you charitable purpose.  Since you know that every private foundation must make minimum grants to public charities each year, finding a private foundation may lead to a great charitable contribution for your public charity.  How do you find charities?  Ask the IRS, by going to www.irs.gov and clicking on the “Charities & Non-Profits” tab at the top of the page.  You can search for approved charitable organizations.

Also, as an individual or business you may want to create a private foundation to help benefit charitable causes you care about.  It’s relatively easy to do and helps build good-will in the community.  For example, my firm created the Albertson & Davidson Children’s Foundation to help support children’s causes in our community.  It is a private foundation that is funded by contributions from my firm and contributions from clients, vendors and friends of the firm.  Each year our foundation will provide grants to public charities that support children’s causes. 

But a foundation does not need to be limited to a single cause.  It can be a general charitable purpose and provide grants to a wide range of public charities—the sky’s the limit when it comes to being charitable!

How does your trust help you while you’re alive?  Many people think of trusts as death planning instruments--the type of thing that only operates upon your death.

But trusts have a critically important role to play while you are alive in the event you lose capacity.  People are living longer and the likelihood of being physically able, but mentally unfit is growing.

Without a trust plan in place, a person and his money cannot be easily cared for. In fact, a court supervised conservatorship is required to manage the person and estate of people who lose mental capacity, but have no other safeguards in place for the management of their money and personal care. 

Unfortunately, conservatorships are costly, time consuming and expose everything (and I mean everything) to ongoing court supervision.  In other words, your life becomes an open book and the court decides who will make decisions for you and then tries to oversee those decisions as best it can....yikes!

Since a conservatorship takes place in court, it provides a ready forum for lawsuits.  It's not uncommon for a person's children to fight over who should be named as the conservator.  And those types of lawsuits can be nasty business.

But a well planned trust can avoid all of that because under the trust terms, you appoint a successor to manage your money if you ever become incapacitated.  You should also have a Health Care Directive in place so that you can name someone to make your medical decisions.  With these two documents properly prepared, your personal care and your assets can be quietly and easily managed until you return to full mental capacity.

So the next time someone tells you that a trust isn't necessary because it only takes effect after you're dead and gone, think again.  That trust may save you a lot of time, money and public scrutiny while you’re still alive.

There are times when a business owner wants to get out of business.  With the recent down economy many people have either left, or want to leave, their current businesses.  But getting out is not so easy, especially when there is a mountain of debt the business has accumulated over time.

A more positive aspect of business succession is when an owner simply wants to pass on the business to her children and grandchildren.  Deciding on the best way to exit a business can have important and long-lasting ramifications for the soon-to-be ex-business owner.

Here are a few options to consider when you reach quitting time:

Scenario Number 1:  Business owner has too much debt and wants to dissolve his business (and his debt). 

Dissolving a business in California is relatively easy, but dissolving debt is not.  For example, if your business is formed as a corporation, limited liability company, limited partnership, or any other type of entity, you can dissolve that entity with the Secretary of State’s office with a few simple forms.  But there’s a catch, and it’s a BIG catch: once a corporation is dissolved the debts and liabilities of the corporation must pass to someone else.  The dissolution forms require you to name a person who will personally take on the debt and liabilities of the corporation after it is dissolved.  This is a huge problem because you likely formed the corporation in the first place to limited yourself from the debts and liabilities of the corporation.  So why take those debts and liabilities on personally now? 

All too often I have clients come into my office and tell me that they dissolved their business and so the debt is no longer a concern.  Not so.  In fact, if a business is dissolved without resolving the debt issues, then you just made matters worse because debts that may have been limited just to the entity before are now on your own personal balance sheet after dissolution.

The correct approach is to resolve debt issues before dissolving the business entity.  Resolution could take many forms from negotiating the debt to a smaller amount so it can be paid, to filing for bankruptcy protection for the entity so the debt is discharged either in whole or in part prior to dissolution.  Either way, the debt must be dealt with first.  Never dissolve a business entity that has debts and liabilities.

What about debts that the business owner guaranteed personally?  That may require a personal bankruptcy to resolve.  The point is to look at your options before dissolving anything.

Scenario Number 2:  Business owner wants to transfer business to family member to avoid creditors.

Let’s be clear right up front, this never works.  Transferring the ownership and management of a business entity to a family member in order to avoid a creditor is fraud, plain and simple (called Fraudulent Transfers under the law).  And courts generally disfavor this type of tactic because it just causes a huge mess.

Plus, transferring a business means giving up control, so the business owner is no longer calling the shots from a legal view.  This means that once the business ownership and management is transferred to someone else, you are powerless from stopping them from taking actions you may not like. 

It is far better to simply deal with creditors head on.  It may seem painful, but it’s the only way to resolve the problem.  And the worst that can happen is a bankruptcy filing.  Bankruptcy is there for a reason, to help people who need help with creditors. 

Scenario Number 3:  Business owner wants to sell a business.

There are many ways in which to sell a business to a new owner.  A sale is a great way to pass a business on to the next generation without having to worry about gift tax implications (because it’s not a gift, it’s a sale).  My advice to every business buyer: pay as little up front and push as much of the purchase price into monthly payments as possible.  My advice to every business seller: receive as much of the purchase price as possible up front and don’t allow any payments on the purchase price, if possible (unless you want to spread payments over time for tax purposes). 

Simply put, sellers want their money (all their money) up front when selling, and buyers want to pay as little as possible up front.  And there are safeguards that can be built into sales contracts to ensure the business either continues as it has in the past or the purchase price must be adjusted to account for the change.

The one thing to remember in selling a business is to have all the terms agreed to clearly articulated in a written sales contract.  If there is a down payment with the remaining purchase price being paid over time, then determine how those payments will be made, when they will be made, and what will happen if they are not made.  You will want to have some mechanism built in so that if payments are not made, the business can be re-possessed without going to Court.  The best way to secure payment is with “security”.  Security is a legal term that generally refers to being able to take something of value from the buyer without having to go to court first. 

Scenario Number 4:  Business owner wants to gift business to a family member.

Gifting a business to a child or grandchild can be a bit tricky, but not impossible.  Many people gift an interest in their business to children when they add them to the ownership percentage.  If I add my son to my corporation as a 10% shareholder, I have just made a gift to him of 10% of my company value.  Unless my son actually pays me for that interest, the transfer of 10% to him is a gift.

When making a gift of a business interest, you are required to have that interest appraised for gift tax purposes.  Also, if the interest gifted is greater than $13,000, then you also have an obligation to report that gift to the IRS (using Form 709).  Fortunately, for 2011 and 2012, each person is allowed to gift up to $5,000,000 during their lifetime without having to pay gift tax.  So unless your business is highly valued, a gift of a business interest comes with a reporting requirement, but no real gift tax consequences.  For that reason, now is good time to consider making a gift of part or all of your business to the next generation.

Of course, when you make a gift, you must give up control of whatever is gifted.  That means you will give up control of the entire business if you choose to gift it to a child or grandchild.  But you can still be involved in the business, and even be an employee of the business.  You just won’t be an owner and you won’t call the shots any more.

Adding a child or grandchild could also change the income tax consequences of your business, depending on the type of entity you have.  Be sure to check with a tax professional before making any gift of a business interest.  And remember that the addition of anyone as a shareholder, member, partner, or owner of any type is a gift unless that person pays you full value for the interest.

These are just a few examples of the way in which you can exit your business when quitting time arrives.  Make sure you know your available options and never obligate yourself for your business’ debts and liabilities if you can avoid doing so.  If done correctly, exiting a business can be a pleasant experience.

One of my first litigation cases was against attorney Thomas W. Dominick in San Bernardino County Probate Court. Tom is one of the best estate and trust litigators in California. To say the least, I was scared. The issue in that case revolved around whether my client had a right to his girlfriend’s real property after her death. She promised my client the property during her lifetime and he had spent money on the property, but nothing was in writing and the two were never legally married. I remember being frustrated that I could not find a legal doctrine to support my client’s claim after his girlfriend died. I was shocked that there appeared to be no real protection for long-term nonmarital partners after the death of the other partner. I ended up alleging several causes of action that were weak at best (i.e. oral promise to enforce trust in real property, quiet title, specific performance, constructive trust, and unjust enrichment—known generally as Marvin claims based on a case of the same name). Unfortunately, these claims must be brought within one year of the decedent’s date of death or they are forever time barred under the statute of limitations applied to decedents' estates. And, the girlfriend’s family waited over eight years to file a petition for probate, knowing all the while that my client continued to live in what he believed was his house (the eight year time-frame made most of my client’s claims moot).

But I had equity on my side as my client had lived with his girlfriend for almost 30 years and he had invested his own money into the home over the years. Thankfully, the case settled after Thomas and I worked out a settlement, on behalf of our respective clients, which allowed my client to occupy the home for his lifetime.

A recent Court decision would have made my job much easier in the above-referenced case.  In McMackin v. Ehrheart (decided April 8, 2011) Presiding Justice Robert M. Mallano, writing for California’s Second Appellate District, Division One, discussed (as a matter of first impression) whether a Marvin claim based on a decedent’s promise to leave her nonmarital partner a life estate in real property requires the nonmarital partner to file a lawsuit within one year of her partners death, and if so, whether the doctrine of equitable estoppel can be applied to preclude assertion of the one year statute of limitations. The court concluded that the Marvin claim is governed by a one year statute of limitations, but that, depending on the circumstances of each case, the doctrine of equitable estoppel may be applied to preclude a party from asserting the one year statute of limitations. 

The pertinent facts of McMackin established that nonmarital partners—Hugh and Patricia—lived together in Patricia’s home from 1987 to 2004. Hugh was never on title to Patricia’s home, but continued to occupy her home after her death. More than three years after Patricia’s death, her children filed a petition for probate, which would effectively kick Hugh out of the home leaving him with no interest in Patricia’s estate. In reply, Hugh filed a lawsuit alleging that Patricia had promised him a life estate in the home upon her death in consideration for 17 years of his “love, affection, care and companionship.” Hugh argued that the one year statute of limitations did not apply. Of course Patricia’s daughters argued that the limitation statute applied (as three years had passed). In response, Hugh argued that even if the one year statute of limitations applies, the doctrine of equitable estoppel precluded Patricia’s daughters from using it against him. The court of appeal agreed, stating the one year statute of limitation applies, but that equitable estoppel may preclude the daughters from raising it as a defense. The court of appeal then sent the case back to the trial court for determination of these issues.

Overall, McMackin is a great case to review if you run into nonmarital partner estate issues. Justice Mallano did a great job in articulating the legal analysis pertaining to Code of Civil Procedure section 366.3 and the doctrine of equitable estoppel. I think this case will be used as more people choose to live together rather than get married. Of course all of the Marvin claim messes can be avoided by proper estate planning (i.e. creating California trusts and wills).

If you are one of those forward thinking people who incurred the time, effort, and expense of creating an estate plan that includes a California Trust (living Trust or revocable Trust--they're the same thing), have you ever looked at it since its creation?  Did you know that your estate plan can become less valuable and your Trust can become less Trust-worthy over time? 

Like anything else, life brings changes.  Changes in tax law, changes in California Trust law, changes in assets owned, changes in debts outstanding, and a whole host of family changes (birth, deaths, marriages, etc.).  Most of these changes can have a substantial, and often negative, effect on your estate plan.  While doing an estate plan is great, checking up on that plan to ensure everything is still going smoothly is key.

For example, whenever I create an estate plan that includes a Trust, my firm will assist the client in transferring assets to the Trust.  Such as preparing a Deed to transfer real property in the name of the Trust.  Yet, as life goes on, the client may sell the house that we transferred into the Trust and buy a new one, but forget to title the new property in the Trust's name--a huge mistake.  A Trust can only control assets titled in the name of the Trust.  A Trust with no assets is no longer a valid Trust (in the legal field we call Trust assets "res" (latin for thing) or Trust corpus and a Trust cannot exist without res or corpus).

Or worse yet, a client refinances his or her home and the finance company pulls the property out of the Trust (this is common practice because lenders are wary of lending to Trusts).  Once the refinance is complete, the house is never put back into the Trust--another big mistake.

Transferring real property back into a Trust is an easy thing to do--just requires a Deed--but failing to do it before the Trust creator (called the Settlor or Trustor) dies creates a huge problem that could result in substantial attorneys' fees and costs. 

This is just one example.  The same applies to family changes, tax law changes and Trust law changes.  So having your Trust and overall estate plan reviewed every two years or so is a very worthwhile activity.  It will keep your estate plan on course and ensure that your plan is implemented when the time arrives. 

Shaun Maritn, in his blog entitled California Appellate Report (which I read regularly and enjoy), posts a recent Ninth Circuit Appellate Court decision penned by District Judge Timothy M. Burgess, sitting by designation with the Ninth Circuit Court of Appeals.

The case, entitled Baccei vs. United States, revolves around a request for extension of time to file an Estate Tax return and pay the dreaded Estate Tax (Form 4768).  Apparently, in Baccei, the taxpayer’s CPA filed his request for an extension of time to file a return and pay the tax.  Both the return and tax payment are due nine (9) months after the decedent’s death.  An extension of time to file an Estate Tax return six (6) months is almost always granted as a matter of course upon filing a request on Form 4768—easy.  An extension of time to pay the estimated Estate Tax is not so easily obtained.  The Government will wait for the paperwork, but not the money.  A sufficient explanation must be made before the IRS grants an extension of time to pay Estate Tax.

Unfortunately for Mr. Baccei, his CPA filled out Part II of Form 4768 requesting an extension of time to file, but did not complete Part III requesting an extension of time to pay.  As a result, the IRS imposed penalties and interest for late payment.  And since the tax came to over $1 million, the penalty was $58,954 and the interest came to $69,801, for a total hit of $128,755—all for not checking a box on Form 4768.

The taxpayer argued that he had substantially complied with the form by filing the form in the first place and completing the entire form other than Part III.  The taxpayer also argued it would be unfair to impose a penalty and that the taxpayer had “reasonable cause” to ask that the penalty and interest be abated given his reliance on the CPA to file the form properly.

The IRS disagreed with the taxpayer, the Federal District Court disagreed with the taxpayer and the Ninth Circuit Court of Appeals did the same.  Taxpayer loses for failure of his CPA to check a box on a tax form.  Shaun Martin in his blog post stated “this couldn’t be more right.”  I have to strongly disagree.  This couldn’t be more disturbing.  You don’t have to be a tax expert to know that tax forms are confusing!  Even the so-called “simplified” forms leave one puzzled at times.  And I speak from experience, having filed a good number of Estate Tax Returns and requests for extensions of time to file and pay in my career.

Luckily, I have never forgotten to request an extension of time to pay when one was required, but I can see how it could be done.  Quit easily in fact.  Primarily because payment is typically made at nine months and only the time to file is extended.  It’s true that the CPA should have filed the form correctly, but we all make mistakes (even the IRS).  What purpose is served by forcing a taxpayer to pay a hefty penalty when his CPA missed that portion of the form? 

Judge Burgess states that the unchecked box was essential to request an extension of time to pay even though the CPA’s cover letter to the IRS specifically stated that they were asking for an extension of time to pay.  While IRS forms should not be disregarded, failing to fill in all of the particulars should not lead to such a harsh and draconian penalty in every case—especially where a tax professional was retained on behalf of Mr. Baccei to file the form in the first place.  The Court reasoned that Mr. Baccei should have made certain the form was prepared correctly, but who would look over a form their CPA prepared?

The end result is that this particular decedent paid his share of Estate Tax and then some.  I don’t think the decedent would think this “couldn’t be more right.”  Apparently tax form technicalities can cost a decedent’s estate a bundle.  The lesson being that we must all submit perfectly completed tax form every time, no exceptions.  But does this "perfection" requirement equally apply to the IRS?  Hard to imagine it does.

How does the estate tax affect you? Likely, it does not affect a majority of us in the last few days of 2010. But it may begin to impact more of us, beginning January 1, 2011, if Congress does not pass the current tax-cut extension package recently negotiated by President Obama and the Republicans.

Writing for the LA Times, Lisa Mascaro and Michael Muskal report that liberal Democrats in the House of Representatives are protesting the proposed estate tax provisions of President Obama’s negotiated package. Without any action by Congress, the estate tax will return to its 2001 rates beginning January 1, 2011. The 2001 rates have a flat tax up to 55% of any net estate value over $1 million. For example, under the 2001 estate tax rates, an individual’s net estate of $2 million would likely incur an estate tax of approximately $500,000.

Under President Obama’s negotiated plan, individuals would receive a $5 million exclusion amount that would pass tax-free to heirs and beneficiaries, or if married $10 million would pass tax-free. Any amount over $5 million per person would incur a flat tax of 35%. For example, under this plan an individual’s net estate of $6 million would likely incur an estate tax of approximately $350,000 (because the first $5 million is tax-free, and the remaining $1 million is taxed at a flat tax of 35%). Additionally, under the plan, if a married couple had a net estate of $12 million, then the first $10 million would pass tax-free, and the remaining $2 million would be subject to a flat tax of approximately $700,000 (assuming the married couple properly set up an estate plan to ensure both $5 million exclusion amounts could be used).

In contrast, under the House Democrats plan, individuals would receive a $3.5 million exclusion amount, and married couples a $7 million exclusion amount, and the any amount over those values would be subject to a flat tax of 45%. Using the same examples under the President’s and the Republican’s plan (referenced above) evidences the differing estate tax impact between the two plans: An individual with a net estate of $6 million would likely incur an estate tax of approximately $1.125 million under the House Democrats plan. A couple with a net estate of $12 million would likely incur an estate tax of approximately $2.250 million.

There is not much time to fix the estate tax before the Republicans take control of Congress on January 4, 2011. Hopefully a package will be passed before January 1, 2011 so individuals will know how they may be impacted by the estate tax.