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PERSONAL FINANCE LEAVING IT BEHIND

Where there’s a will, there are several ways.
By John Sansing |

THE SUBJECT for this month is passing on and passing it on: how to best leave your earthly fortune once you conclude you can’t take it with you.

Wills, the probate process, and estate planning are areas of discussion that people avoid as if they somehow hasten the day of departure, although someone – probably in the estate-planning business -has rightly observed that the purchase of fire insurance does not increase the chances of a blaze.

The fastidious and orderly among us – those who leave their desk tops clean at the end of the day-have the right idea; they no doubt wrote their first wills as a rite of adulthood and rewrite them with each significant milestone in life. Those without a will should ask themselves the following questions:

– Do I want a bureaucrat to determinewho gets my property?

– Do I want a bureaucrat to decide whocares for my minor children?

– Do I want the tax collector to extractthe most he can from my estate before myfamily gets its share?

If the answers to these questions are yes, you need not finish reading this. If the answers are no, you had better have a will.

Now a confession. Until last month I didn’t have a will. And I’m a lawyer. I suppose I was the typical lawyer in that regard, supremely confident of immortality or trusting that the laws would suffice. I was like the stockbroker without a portfolio, the doctor who smokes, the dentist who doesn’t floss. My reasoning: My wife will get it anyway, so why bother? I was dead wrong. Under the laws of intestate succession (dying without a will), my wife would inherit a third of my separate estate, not including community property jointly owned, and my five-year-old daughter would inherit two thirds. My wife would have to pay the mortgage and buy the food, and my daughter could open an unlimited charge account at Toys R Us. (Actually, a judge would appoint someone – most likely my wife -to be guardian and trustee of my daughter’s inheritance, but that involves complex annual accounting procedures and a limitation upon the discretion of my wife to spend money.)

Even worse, should my wife and I co-expire, the Texas Probate Court would determine in whose care my daughter and her inheritance should be placed, a choice about which I would certainly like to have a say.

With today’s more open and complicated family and extra-family relationships, the traditional laws of intestacy might dictate some strange results.

Will-making advocates are forever dreaming up sample horror stories to convince people that the laws of intestacy can wreak havoc.

– You and your wife celebrate your fiftieth wedding anniversary with a sense ofsatisfaction that you have outlasted allyour dratted relatives, save one obnoxiousnephew whom you haven’t seen since hissex-change operation. If you die without awill, your Texas real estate may be equallydivided between your wife and your niece.

– You and your boyfriend never did getmarried, believing the ceremony to be anoutmoded ritual; nevertheless, you hadfive children. If he dies, his estate mightwell go to his mother-who never approvedof you or your children -and you mightbe stuck with five little bastards to feed.

– You and your boyfriend do get married, believing the ceremony to be sacred,and you live together contentedly andprofitably for many years. Unfortunately,you are a he, and at his death you are outof luck.

– You and your spouse have a darling child and wonderful next-door neighbors. You have a 90-year-old mother and a brother who makes J.R. Ewing look like Mister Rogers. You and your spouse die together. Logic might dictate that the next-door neighbors take charge of your child and her inheritance. The courts, however, might dictate that your brother be appointed guardian.

Sufficiently scared? Lawyers are good at frightening people-it often helps business-but from a financial and social standpoint, a will is one of life’s essentials, as well as one of death’s. Certified life underwriter Norman Kamerow has seen the problems of dying without a properly drawn will and observes: “People will spend 85,000 hours building up an estate and won’t take the 10 hours needed to develop an estate plan.”

A will is a simple document, consisting of the following parts: renouncing all previous wills; naming an executor to handle your estate and granting him all requisite powers over that property necessary to dispose of it; making specific bequests and naming a residual beneficiary (who gets what’s left after everyone else has been given his share; naming a guardian for any minor children; and creating trusts. (Often, however, trusts are so complicated that they should be separately drawn and referred to in the will.) Alternate selections for executor, guardian, residual beneficiary, and trustees should be named.

I once knew of a vindictive old lady who made it clear to her would-be heirs that her personal property would go to whoever was in her good graces on any given day.

Every item of furniture in her house was marked with a piece of tape on which was the name of an heir. Turn over a chair, and you might see that a niece was destined to inherit it. Depending on her mood, the old lady would rearrange the pieces of tape. It was hardly a valid testamentary procedure, but it wasn’t a bad idea; it is often impossible to detail in a will the division of personal property without troublesome codicils (additions to the will), each of which requires the same amount of ritual as the original will. A suggested approach is to write a letter to the executor, outlining your wishes in regard to the division of personal items, and trust that he will respect your legally unenforceable intentions; only the baddest of apples would fail to do so. If you change your mind, simply write a new letter.

Several years ago, I advocated the return to literary wills, ones that give a personal touch – whether laudatory or scathing. In this day, however, such a will is but an idealist’s conceit. My recently acquired will was composed entirely by my uttering four or five bits of information – name of executor, possible guardian for minor, wife, etc. – into the ear of a computer operator; three minutes later I had my last testament.

Nevertheless, the will remains the repos-itory of one’s last thoughts -the rewarding of the faithful, the punishment of the untrue, the fostering of dreams. Consider the poignant tale of poor Bill Lear, the genius who invented the Lear jet, as well as the car radio and the eight-track stereo. In the last years of his life, he had yet another dream: a plastic airplane. When he became terminally ill, he became even more obsessed with its development, working madly to beat the grim reaper and rewriting his will to create a giant trust to fund further development of his plastic airplane. He was finished, but his work was not; on his deathbed, he uttered his final words, “Finish it, finish it,” and expired knowing that work on the plastic airplane would go on, thanks to his will.

Unfortunately, his two daughters had other ideas and contested the will on the grounds that he was crazy, and who needs a plastic airplane? Whether Bill Lear’s deathbed wish will be fulfilled remains very much up in the air.

Wills are cheap; a “simple will” is advertised for $30 to $40 in local newspapers. Remember, however, that this is a will devoid of tax-avoidance schemes developed by expert estate planners. Before uttering four or five words into the ear of a computer operator, you should assess whether your estate situation -in terms of taxes and intricacy of family needs-is such that a bit more legal advice is required. A will is not a document for all time; it should be reviewed every few years, and certainly upon any monumental life event such as marriage, parenthood, or divorce.

Now, here’s a little secret: Some lawyers would probably write you a will for free. Don’t let them do it. There’s motive in their madness.

No discussion of the probate process would be complete without a nod in the direction of Norman Dacey, author of How to A void Probate. Dacey is a much-maligned, much-misunderstood man. I will attempt to make him understood, and then I will malign him some more.

Dacey’s premise is that all property should be taken out of a person’s estate before the person dies, so that there is nothing to pass through probate. Probate to Dacey is a procedure ranking just above child molestation in social desirability. His complaint: Probate is expensive; it violates privacy (your extensive collection of erotic leather devices, as well as all the money in your bank account, is laid bare on the public record); and it creates a delay of the distribution of assets during a period when money is most needed to keep a family going.

Dacey’s solution is to create a series of “living trusts” into which all your assets are placed. Your home is placed in one trust; your car is placed in another trust; your golf clubs are placed in another trust. Either someone else or, in a “one-party trust,” you yourself is named the trustee. Whoever you want to get the property at your death is named the successor-trustee and beneficiary. When you die, your beneficiary takes over the property through the trust succession rather than by a will going through probate. To facilitate the creation of these trusts, Dacey provides snap-out forms in his $14.95 book, How to Avoid Probate- Updated!

“Charlatan” is the kindest word describing Dacey I have heard from the estate planners I interviewed for this article. The critics’ point is that Dacey’s snap-out forms produce a false sense of bravado, failing to indicate to the unwary reader that trust and estate law varies widely from state to state, that trust agreements need expertly crafted language to satisfy legal requirements, and that the planning of any estate of appreciable size should not be accomplished through reading a $14.95 book (or an article in a $1.75 magazine, for that matter).

Perhaps the most important thing to remember about the How to A void Probate phenomenon is that even if you can manage to avoid the probate process through the use of living trusts, you do not avoid estate taxes. All those living trusts are revocable, and thus ownership passes only at death. Property passing to the successor-trustee via the snap-out concoctions is still subject to taxation by the state and federal governments. Estate taxes are essentially transfer taxes; every time there is a transfer of ownership, the tax man will show up.

Which leads us to the rather unpleasant, if inevitable, subject of death and taxes.

What is the difference between President Dwight Eisenhower and Senator Robert Kerr, the late chairman of the Senate Finance Committee and one of the trickiest tax-writers of this century? One was smart enough to take advantage of the intricacies of the federal inheritance tax laws, creating smart end-runs around the almost indecipherable tax code, while the other foolishly ignored the loopholes and left his heirs to witness his estate dwindle by 47 per cent at his death. One, in short, was clever and the other was a dodo.

Ike was the clever one; his lawyers carefully planned his estate so that when it was settled, the tax man and administrators were able to gouge only $671,429 of the $2,905,857 Ike left-a mere 23 per cent shrinkage. Legend has it that Kerr was too busy to sign the tax-dodging documents that sat on his Senate desk for seven months prior to his death -including a will and trust agreements that would have taken maximum advantage of the tax code he helped engineer at the behest of the du-Ponts, the Rockefellers, and the other rich families whose major contribution to our country was the creation of the inheritance-tax loopholes. Kerr was wealthy because of his holdings in Kerr-McGee Oil. His heirs were less wealthy, as the $20,800,000 he had accumulated in his lifetime was whittled away to $10,960,000.

The federal estate and gift-tax laws were overhauled in 1976 in a populist effort to exclude most middle-income families from such taxes and to put the burden on the wealthy. Nevertheless, you don’t have to be a Vanderbilt to be hit hard by the tax man at death. Just as the modern-day inflationary spiral has enabled us all to live in more expensive neighborhoods without the burden of moving, so too have our estates increased in dollar value – if not in real worth.

Although Ronald Reagan drew heavy applause when he proposed repealing estate taxes altogether, further reform is likely to be slow. The level at which federal estate taxes begin to be assessed is likely to remain constant while the dollar value of each estate is likely to continue to rise due to inflation. The result: Middle-class estates will be taxed.

And what is the level at which federal taxes begin? If you are single, you can now leave an estate of up to $175,625 without hearing from the federal tax authorities; if you are married and all or most of your property is separate property, you can leave an estate of $425,625 before the bite comes. Texas is a community property state, which treats all property earned during a marriage as owned one half each by the two spouses; on the death of a spouse the survivor’s one half is not subject to death tax. Above those amounts, taxes are due, beginning at 18 per cent and rising to 70 per cent of all amounts above $5,000,000.

Some explanations are in order. First, your taxable estate is that amount of property that is left after all bills, loans, and mortgages are paid, after your funeral costs and executor’s and lawyer’s fees are paid, and after any credits and deductions allowable by current law are taken.

There are two major allowances granted by current law applicable to most estates. Everyone gets a tax credit of $47,000 – which would have been the tax on $175,625.

Additionally, a person can give a tax-exempt bequest of $250,000 or half his estate, whichever is larger, to a surviving spouse-the so-called marital deduction. In Texas, a community property state, this marital deduction will usually be limited to an amount equaling half of the deceased spouse’s separate property.

Still, half a million dollars isn’t what it used to be. That two-bedroom house you bought in Highland Park 10 years ago for $60,000 now represents half of it.

Estate planning should implement two strategies in order to lower taxes: minimizing the amount of property transferred and minimizing the number of times property is transferred.

Strategy Number 1: Shrink Your Estate. There are several ways to minimize the taxable estate, but the one most often practiced by the populace-joint ownership-doesn’t usually work.

A husband and wife frequently own their home jointly “with right of survivorship,” meaning that at the instant one spouse dies, the other gains complete title to the property. The property does not pass through the will. Nevertheless, it is subject to taxes, because the estate taxes are essentially transfer taxes, and the tax collectors are not picky about how the property is transferred.

And what is worse: The IRS assumes that the first spouse to die really owned it all unless the second spouse can prove a significant and documented contribution to the acquisition of the property.

Consider this actual horror story: A hard-working couple had a mom-and-pop store in the Forties in the slums of Washington, D.C. Side by side, mom and popput in long hours at the store. Whenever they got a little bit ahead they would put a down payment on a building in the block on which their store was located. Gradually, they acquired ownership of the entire block, renting out the buildings and making a small profit.

Along came urban renewal, and mom and pop cleared $1.5 million. Shortly thereafter, pop dropped dead. Along came the IRS, which told mom she had just inherited $1.5 million, and here’s your tax bill. Mom almost dropped dead. Her battery of lawyers protested that half of that property was hers to begin with -she jointly owned and earned it, having worked those long hours in the store. Deliverymen, customers, and accountants verified mom’s side. Mom lost, and she had to pay taxes on the total.

If this doesn’t sound fair, bear in mind Tax Rule Number One: The IRS is not in the business of being fair. It wants tax maximization, just as you want tax minimization. The moral of the sad tale of mom and pop is that the survivor’s contribution to jointly held property (whether real estate or a bank account, another often jointly held asset) must be proven or the entirety of the property will fall into the decedent’s estate and be subject to taxation.

A more effective means of minimizing the taxable estate is to make sure that any life insurance polices are “owned” not by the decedent but by the beneficiaries of the policy. The rule is: If the life insurance is payable to the estate of the deceased or if the subject of the policy retains such indicia of ownership as the right to change the beneficiary or the privilege to borrow against it, the life insurance proceeds are included in the taxable estate. Generally, the husband is more heavily insured; actu-arially, he is the first to go and historically, he is more likely to be earning the lion’s share of the family income. In such a situation, the wife should take out the insurance policies on his life. The IRS has been known to fight over ownership of life insurance; outfox them by having the wife pay the premiums from her separate property and the husband pay for the groceries.

Perhaps the simplest means of minimizing the taxable estate is just to give the whole damn thing away before you go. Well, maybe not all of it, but the IRS allows you to give $3000 tax-free per person per year ($6000 per year if you are married).

Consider the situation in which a married couple has three children and an estate sizable enough to be subject to taxation. They can reduce the taxable estate by $18,000 ($6000 to each child) per year; in 10 years $180,000 would be freed from the clutches of the federal government.

But, you say, you aren’t that liquid, much of your property being tied up in real estate or other non-fungible assets. You might consider selling the real estate to your heirs through a series of notes and then forgiving the notes as they come due. For example: You have a house in Oak Lawn worth $100,000 (it lacks plumbing) that you want your son to inherit eventually. You have enough of an estate to create federal-estate-tax problems upon death. You can execute a series of notes with your son, by which he pays you $3000 a year toward the purchase of the house – $6000 if you are married. Each year you tear up the note as it comes due. Even if you die midway through the 16.5 years it would take to complete the transfer, you would come out ahead; the amount remaining on the deal could be given as part ; of his inheritance (subject, of course, to taxes).

This last bit of advice is tricky, however; it cannot be a sham transaction, or the IRS will cry foul. It has to be an “arm’s length” transaction, and tax lawyers should get involved in developing such a plan. I offer it to show the ways in which gift-giving can be creative.

One final wrinkle that should be noted in gift-giving is the right to give a spouse $100,000 tax-free during your lifetime (in addition to the $3000 each year you can give him or her). This $100,000 counts against your marital deduction. So what is the advantage? Simple: By giving money to your spouse, the two of you can end up with estates the same size-so you can take maximum advantage of the tax laws. Evening up the estate is a good idea to protect against the adverse tax consequences that occur when the spouse with less than the full amount of tax-free assets dies first.

In all pre-death gifts, there are tax traps for the unwary. Remember, once more, that governments like to tax transfers. You cannot merely redraw a deed from single ownership to joint ownership without incurring tax consequences. If you own Reunion Tower outright and in a magnanimous gesture to your new bride redraw the deed, you have given her a gift worth half the value of Reunion Tower. Sounds of glee arise from the IRS.

If “transfer” is the operative word to trigger taxation, then it follows that the fewer the transfers, the better off you are – which is precisely what I said was one of the twin goals of good estate planning. Here is where the magical word trust comes in.

Strategy Number 2: Minimize the Number of Transfers. Alas, the plight of poor Phil Wrigley. The chewing-gum magnate and owner of the Chicago Cubs, Wrigley died in 1977, leaving a wife, three children, and about $100 million. Although reports are sketchy about the exact size of his estate and the devices he used, news stories emphasized that Wrigley had not bothered to create a lot of tax-dodging trusts. What do you expect from a man who wouldn’t put lights in his ball park? For the sake of argument, let us assume that he left it all to his wife.

Half of the $100 million is tax-free-compliments of the marital deduction. If we assume that the final tax bill on the remaining $50 million is 50 per cent, she inherits a total of $75 million. But when Mrs. Wrigley dies, she does not have the benefit of the marital deduction; except for that $175,625 exemption that everyone gets, the IRS can tax the whole estate. If the tax is 50 per cent, when Mrs. Wrigley dies her $75 million will shrink to about $37.5 million.

In point of fact, a couple of months after Phil Wrigley died, his wife also died. Double death, double tax, double bad news. Three years later, the family is still struggling to come to terms with the IRS; as son Bill plaintively commented at the time of the second death. “The problem for us is having to come up with taxes on the second half sooner than anyone expected.” The family will probably be able to keep the Chicago Cubs, but the estate problems have gotten awfully sticky.

Part of the mess could have been avoided simply by minimizing the number of property-ownership transfers. Assume that instead of leaving the second $50 million to Mrs. Wrigley, Mr. Wrigley had left it to the kids. They would have received about $25 million (after the 50 per cent to the tax man). When the wife died, they would have received another $25 million (the wife’s original $50 million minus the 50 per cent tax). Simply by bypassing the wife, Mr. Wrigley would have saved his estate $12.5 million, his children inheriting $50 million instead of $37.5 million.

Back to the reality of the rest of us, those without millions to leave. It may well be that your surviving spouse needs the income from all your estate to keep going. The answer: Create a testamentary trust, with income to the surviving spouse and principal to the next generation upon the death of the spouse. Ownership of the principal transfers once, at the time of the death of the first spouse; taxes are due once. The bypass trust is the most common and most effective means of minimizing federal estate taxes for the middle-income level.

A trust is a bucket, into which are poured assets and on top of which are printed directions on how to use those assets. Trusts are separate entities, often controlled by third parties for the good of the trust beneficiaries. Trusts are useful not only for minimizing taxable transfers, but also for conserving the estates of minors or incompetents and for placing a limitation on the use of the assets held -remember Bill Lear and his plastic airplane? Trusts provide outside management.

At a price. The bad news about trusts is: They cost money to set up (lawyers’ drafting fees and advice); if professionally managed, they cost money to run; they place sometimes cumbersome burdens on the heirs’ right to use the money. Financial columnist Jane Bryant Quinn warns potential trust makers: “Some people are so bent on avoiding taxes that they make pretzels of their estates. Don’t lose sight of your human objectives. It’s better that your estate pay a little extra in taxes than to lock your heirs into a planner’s prison.”

A trust is a flexible creature. The trustee can be almost anyone, professional or volunteer. In many situations the trustee department of a bank is the perfect third-party manager of the assets, always trustworthy, always there, not going to die off on you or vanish to South America. On the other hand, the investment record of trust departments is not outstanding. Present laws allow the recipient of the income of a trust to act as trustee and even to invade the trust to a limited extent. For example, if you establish a trust for your children, with income from the trust to your spouse during her lifetime, the spouse can be the trustee. She can invest the funds, change the beneficiaries (to a limited extent), and spend the assets. There are limits; a common arrangement is called the “five and five rule,” whereby the trustee can devour $5000 or 5 per cent of the assets per year, whichever is greater, and even more if shown to be used for the welfare of the ultimate beneficiaries.

Last year the madmen at the National Lampoon put out a satirical version of a newspaper, including an advice column called “Your Family Dentist,” sponsored by the “Family Dentist Association.” The answer to every query about tooth care- including what was the best color toothbrush – was: See your family dentist. I feel much the same way in advocating: See your family lawyer.

In the thorny area of estate planning,however, consultations with a tax attorney- together with an accountant, an insurance expert, and possibly a trust officer ata bank -are essential. I can hint at someof the problems and solutions, but I cannot be exhaustive. Such subjects as the orphan’s deduction, the generation-skippingtax, and the capital-gains problems of inheritance must be left untouched.