Estate Planning Tips

DO create an estate plan for your family.
    You probably have a will. But do you have an estate plan?
    With proper planning you can reduce estate taxes, bypass probate, provide for management of your assets when incapacitated, protect your property when living in a nursing home, and guide your doctor should you become severely ill.
    Your estate -- which includes real estate, securities, life insurance, retirement plans, and everything else you own -- may be larger than you realize. But regardless of your assets, you and your family are sure to benefit from a well-formulated estate plan.

DON'T subject your assets to unnecessary estate taxes.
    If your estate exceeds $3,500,000, it may be subject to a federal estate tax of 45% (pretty hefty, huh?). For example, a $5 million estate left to your children can incur a federal tax of $675,000.
    Although the add-on Massachusetts estate tax was "phased out" in 1997, it was reinstated in January 2003 and now has an exemption of $1,000,000. (Actually, that number is a filing threshold, not an exemption; if you are a Massachusetts resident and your taxable estate exceeds that amount, in most cases the tax is paid on nearly the entire estate.) The Massachusetts tax rate effectively starts at 2% but quickly rises for larger estates and goes as high as 16%. If you're married and you established an estate plan before the current rule took effect, your lawyer should review the plan to ascertain that it still works to minimize your taxes. Be aware that if your plan calls for your estate to tax-shelter the federal exemption amount of $3.5 million, and if your plan also shelters that amount for Massachusetts estate tax purposes, your estate could end up paying a Massachusetts estate tax of over $275,000 instead of having the tax deferred until you and your spouse both are gone.
    If you are a Massachusetts non-resident, your estate will pay Massachusetts tax on property physically located in the Commonwealth, such as real estate or antiques. This is true even in cases where the value of your Massachusetts property is less than $1 million.
    There are numerous techniques for minimizing or avoiding estate taxes, and a good estate plan will utilize them to maximize the assets you're able to pass on to your children and others.

DON'T leave everything to your spouse -- especially if you have children.
    It's easy to leave everything you own to your spouse -- simply hold title as joint tenants with right of survivorship. By operation of law the survivor automatically becomes the sole owner. Or you can name your spouse as the beneficiary in your will, life insurance policy, or retirement plan.
    Although there is no estate tax on property passing to your spouse, a tax-saving opportunity is lost when the surviving spouse takes all. A married person can reduce the federal taxable estate of the surviving spouse by as much as $3.5 million by leaving assets to a tax-shelter trust, which will hold the property while the surviving spouse is alive and then pass it to your children tax-free. If you and your spouse each own assets worth $2.5 million, for example, leaving your estate to a trust could eliminate a federal tax on your surviving spouse's estate of nearly $700,000.
    As discussed above, Massachusetts law differs from federal law with respect to the amount required to be placed in a tax-shelter trust to minimize taxes. Having the trust qualify as a "QTIP" trust is one way to resolve this conflict. Another way is to set up two tax-shelter trusts, one of which will contain Massachusetts property worth the "exemption" amount of $1 million but not a penny more.
    Caveats: (1) Property held as joint tenants passes automatically to the survivor; there is a special procedure for getting this property into a trust. (2) Make sure your family estate is sufficiently balanced between you and your spouse so that if the spouse with the lesser estate is the first to die, the surviving spouse will not be left holding an unduly large estate. (3) Property passing to a spouse who is not a U.S. citizen will result in an estate tax unless special measures are taken to defer the tax.

DO consider the advantages of setting up a trust.
    A trust is a contract between you and the person responsible for managing the trust, your "trustee." You give property to the trustee, who invests it and makes payments to your spouse or children according to your instructions in the trust agreement.
    A typical tax-shelter trust might provide that the surviving spouse gets all income earned by the trust plus principal as necessary for his or her support; when he or she is gone, the remaining trust assets are divided among the children -- or held until the youngest child reaches age 25 (or 30 or whatever).
    Trust administration generally is not expensive when the surviving spouse or an adult child serves as trustee. Some people feel more secure, however, in appointing a trustee who is not a trust beneficiary, such as an attorney or a bank. But keep in mind that professional trustees do charge a fee.
    The most common trusts are revocable, which means you can amend or terminate your trust at will. You need not transfer your estate to a revocable trust while you're alive -- but if you do, the trust offers two additional advantages: it provides for the management of your property if you become incapable, and it allows trust assets to bypass probate.
    Your will can leave property directly to the trust, or it can leave property to your spouse with the proviso that if he or she "disclaims" the property it will go into the trust. (A disclaimer is simply a legal statement in which one refuses to accept property upon another's death.) The disclaimer approach provides the flexibility of allowing your spouse to wait until you're gone before deciding what to put into trust. It has the disadvantage of allowing your spouse to receive your property outright, which could result in your children being disinherited if your spouse remarries and then dies leaving everything to his or her new spouse.

DO consider an annual gifting program.
    Any property in your estate exceeding your $3,500,000 exemption will be subject to federal estate tax. Unfortunately, you can't simply give away your assets to reduce your estate to this amount, because lifetime gifts count toward the exemption the same as property that passes under your will.
    There's an exception to this rule, however. You can give $13,000 per person per year -- a married couple can give $26,000 -- to as many donees as you like. Such gifts, no matter how much they total, will not count toward the exemption amount. However, you cannot receive income from the property you give away nor continue to use it.
    If you have a choice, give property that has not greatly appreciated since you acquired it (such as cash). The recipient of a gift will pay the same capital gains tax upon selling it that you would have paid upon selling, but assets that remain in your taxable estate will not be subject to a capital gains tax if they are sold when you die.
    One way to make annual gifts without depleting your liquid assets is to give each donee a fractional interest in Nantucket real estate (perhaps a vacation home or vacant land). If you occupy the property, however, you must pay rent on the fraction given away. Putting the property into a "nominee trust" will facilitate future annual gifts, because subsequent deeds will not have to be recorded with the land records.
    Massachusetts has no gift tax, so lifetime gifts are not taxed or otherwise penalized by the Commonwealth no matter what the amount.

DO consider a "qualified personal residence trust" for your Nantucket home.
    At the federal gift tax limit of $13,000 per donee per year, it might take forever to bring your estate down to the federal exemption amount. Here's a much faster way to cut federal estate taxes.
    By making a one-time transfer into a qualified personal residence trust, or "QPRT," you can give away your Nantucket home at an estate tax "discount" yet continue to use the property. The trust gives you the right to occupy the house for the time period you choose (the "term"), during which you retain all income tax benefits of home ownership. After the term expires, you must pay fair market rent to the trust whenever you use the house -- but this is money that comes out of your estate tax-free. And the trust, not you, pays for taxes, insurance, and repairs.
    The estate tax "discount" is proportional to the length of your term. A 10-year term, for example, can reduce tax on the house by more than 50%. (Tax savings of hundreds of thousands of dollars are not uncommon for larger estates.) Moreover, all future appreciation of the property will escape taxation in your estate. The longer your term, the greater your estate tax savings -- but there's a "catch." You must outlive the term for the QPRT to be effective as a tax shelter.
    The house can be sold during the term, and the estate tax benefits of the trust will be maintained if the sale proceeds are used to purchase a replacement residence within two years. If the house is sold after the term expires, there is no tax requirement that it be replaced.
    Either a principal residence or a vacation home can go into a QPRT.
    The trust is irrevocable, which means it can't be changed once the property goes into it. But if you don't mind giving up legal control over your property, the QPRT can be a superb planning tool.

For more information on Qualified Personal Residence Trusts, go to:

DON'T subject your Nantucket house to probate if you are a non-resident.
    When a Massachusetts non-resident dies owning Massachusetts real estate in his or her name alone or as a tenant in common, separate ("ancillary") probate proceedings must be initiated in Massachusetts to pass title. Having the property in trust entirely eliminates this procedure.
    A "nominee trust" is the simplest form of trust for avoiding probate. You can be your own trustee, but the trust should have a co-trustee or name a successor trustee who will serve if you die. It also should contain an explicit direction from you that your property is to pass as directed in your will, which most likely will be probated in your home state. The nominee trust allows you to maintain complete control over your property, and it has no effect on taxes of any kind.
    You will not need a nominee trust if your property is in a "QPRT" (discussed above) unless you wish to avoid making the QPRT a public record, in which case you can file a nominee trust to hold title on behalf of the QPRT. A nominee trust likewise can be used to avoid making a revocable trust a public record; this approach generally should be used when Massachusetts real estate is owned by a living trust executed under the laws of another state.

DO execute a durable power of attorney.
    If you should become mentally incapable, your assets could get "locked up" so that no one can sell or reinvest them. That's because your property, whether held in your name alone or with others, requires your signature to transfer title. If you lack the mental capacity, your relatives will have to ask the probate court to appoint a guardian or conservator to act on your behalf.
    A better solution is to execute a durable power of attorney while you're mentally capable. This document gives your agent the authority to transfer your property and manage your business affairs -- without going to court. It can also authorize your agent to make gifts and to put your property into a trust to be managed by a trustee.

DON'T lose your assets should you need long-term health care.
    A nursing home is expensive -- a year at Nantucket's "Our Island Home," for example, will cost you more than $140,000. Medicaid will pay the bills . . . but only after you have depleted almost all of your own assets.
    If you try to qualify for Medicaid by giving away your assets, you will have to wait for as many as five years before becoming eligible for benefits. After the waiting period, however, you need not account for the assets disposed of -- that is, if you don't apply for benefits prematurely. Under the Medicaid law, timing is critical.
    Under the present Medicaid rules there are other ways to reduce your assets without giving them away. The rules also specify the amount of assets that a married person may keep when his or her spouse goes into a nursing home. Knowledge of these rules is imperative for smart Medicaid planning.
    The Medicaid program was established to provide health care for the poor -- so don't be surprised if the rules get tighter as government budgets continue to get crunched.

DON'T overlook the advantages of a life insurance trust.
    An irrevocable life insurance trust allows you to make annual contributions of $5,000 (and in some cases as much as $13,000) per trust beneficiary to pay the premiums on a life insurance policy owned by the trust. The premium money goes into the trust tax-free, and after your death the insurance proceeds are paid to your children or other beneficiaries tax-free.
    An insurance trust is a way to control the investment of money you give away as annual tax-free gifts. Or you can use an insurance trust to cover the taxes on an estate that is not sufficiently liquid to pay them.
    If you're married, you can get more coverage per dollar of annual contribution by having the trust buy a "survivor" or "second-to-die" policy. This type of policy is less expensive and generally easier to obtain than a policy on your life alone, yet it pays when it may be most needed: at the time taxes are due on the estate.

DO consider granting a conservation or preservation restriction on your Nantucket property.
    Perhaps your home is situated on a large tract of land with gorgeous views of abutting conservation land or the ocean. You would like the land to remain undeveloped, but you're sure your children will have to sell to pay estate taxes. What can you do?
    Instead of losing the property, create a conservation restriction that will forever restrict your land from being subdivided. Once restricted, it will drop substantially in value -- and your estate taxes likewise will drop. You'll also get an immediate income tax deduction for making a charitable gift, and you may even get a lower assessed value for property taxes.
    If you have a historic house which you wish to protect against "gutting" by a future owner, or if you wish to protect your beautiful garden or other open space adjacent to the house, consider a preservation restriction to permanently protect the property. You'll get the same federal tax benefits as you would from a conservation restriction (although generally to a lesser degree).
    Not all property will qualify for a tax-deductible restriction. But if your land has qualities that make it especially desirable to remain undeveloped, or if you want your antique house to remain an antique, it's worth checking out.
    For more information on preservation restrictions, go to:

DO consider a living will or a health care proxy to guide your doctor.
    If you should become severely ill with no reasonable chance of recovery and mentally incapable of making your own health-care decisions, your living will requests that you not be kept alive by artificial or heroic means and that your pain and suffering be alleviated. It's called a living will because it asks that action be taken (or not taken) while you're still alive. Even if you don't live in one of the forty or so states in which a living will is legally binding, this document can be effective to guide your doctor under extreme circumstances.
    Some states, including Massachusetts, recognize a health care proxy, which authorizes your agent to make medical decisions on your behalf. These decisions can include actions other than "pulling the plug," such as undertaking an aggressive medical procedure to improve your chances of surviving a life-threatening situation, or moving you from a hospital to your home.

DON'T assume there will be a repeal of the estate tax.
    Although a repeal of the federal estate tax was legislated to take effect until in 2010, the repeal lasts only for one year.
    If you're a Massachusetts resident or you own real estate in Massachusetts, you also have the Massachusetts estate tax to contend with. The Commonwealth of Massachusetts now levies an estate tax whenever an estate exceeds $1,000,000, and this tax is payable even if there is no federal tax. For out-of-state persons, only property physically located in the Commonwealth is taxed, but the tax is payable if the value of their total taxable estate (not just the Massachusetts property) exceeds the threshold amount. The good news for married couples is that any Massachusetts estate tax that might be payable at the first death can be deferred, through proper planning, until the surviving spouse dies.
    Back to the federal estate tax. Although the tax is to be abolished in 2010, a "quirk" in the law reinstates the estate tax in 2011 -- and the exemption amount drops all the way down to $1 million (from the current $3.5 million) and the maximum tax rate returns to 55%! This "quirk," however, surely was deliberate. The old tax law provided a gift-tax exemption that rose in sync with the estate tax exemption, while the new law limits the gift-tax exemption to $1 million even though the estate tax exemption rises well above that amount. Some believe this anomaly was designed to keep wealthy people from giving away their estates tax-free ahead of the return of the estate tax in 2011. Others think the new law was designed to prevent wealthy parents from shifting income to their less-wealthy (and less-taxed) children. Of course, it is possible the legislation was crafted in this way strictly for political reasons: to reduce the projected cost of lost revenues under the new law.
    It is hard to imagine that the estate tax law will remain as it currently exists. With the Democrats having taken control of Congress and the White House and with an ailing economy in need of a stimulus that will require significant increases in the federal budget deficit, it's doubtful there will be a serious movement toward a total repeal of the estate tax. The Obama administration proposes an estate tax with a $3.5 million exemption. A straw poll of U.S. senators sitting on the Senate Finance Committee in late 2007 indicated sentiment for a $4 million exemption. Republican legislators may try to negotiate for $5 million. Given these numbers, it's predictable that our lawmakers will reach a compromise on an exemption amount in the range of $3 to 4 million.
    (An interesting side note: The number of federal estate tax returns for estates over $5 million is only 11% of the total number of returns, yet those big-ticket returns yield approximately 60% of the total estate tax revenue.)
    It's safe to say the federal estate tax law will change before 2010 arrives. Without the benefit of a crystal ball, the smart money is on the estate plan designed to minimize taxes regardless of whatever federal estate tax law is in effect at the time.
    If the value of your estate exceeds $1 million, you should assume that sooner or later your estate will pay an estate tax. You would be wise to plan accordingly to minimize the burden.

DON'T wait to protect your estate.
    The longer you delay planning your estate, the fewer opportunities you have to preserve it. Don't take the chance.
    Much of what you own is at stake. Taking action now to establish your estate plan or update an existing plan will undoubtedly provide peace of mind. Even better, you could be making your best financial investment ever!

BIOGRAPHY OF C. RICHARD LOFTIN

Richard Loftin has been practicing law on Nantucket for 21 years and specializes in estate and tax planning, wills and trusts, probate administration, preservation restrictions, and real estate transactions. Before moving to Nantucket he was a partner in a Washington, D.C., law firm. He is a graduate of Georgetown Law School, Harvard Business School, and Georgia Tech.