Estate Planning: A Case Study By: Andrew W. Chandler and M. Jean Lee Evans, Carter, Kunes & Bennett, P.A. P.A.115 Church Street Charleston, SC (843) (Office) (843) (Fax) M, Jean Lee -

Meeting the Clients Ned and Caitlyn Stark have recently relocated to Charleston from North Dakota to get away from the harsh winters, and they plan to live out their remaining lives here. They both have Wills, Powers of Attorney, Health Care Powers of Attorney and Living Wills that were executed in North Dakota about 10 years ago. They have five children, ranging in ages from 18 to 30. Ned and Caitlyn have a combined net worth of approximately $8,000,000, consisting of real estate in North Dakota (in Ned’s name) and South Carolina (JTWROS) and liquid assets (cash, stocks and bonds) in their individual names. They wish to have their documents reviewed by us and obtain advice on what changes may need to be made to their estate plan.

Do the Starks Need New Documents? As a general rule, documents validly executed under the laws of another State are valid in South Carolina. Why do new documents? Make SC law apply Hospitals and Government Bodies are Familiar With the SC Forms Update terms of documents to current wishes and to address changes in names, tax laws, etc. Ned and Caitlyn have permanently relocated to SC, so new Powers of Attorney and Living Wills are recommended. Also, it has been more than 10 years since they last executed their Wills, so a review of their estate tax planning is in order.

Probate v. Non-Probate Property Primer Ned and Caitlyn each have Wills. Having advised them that they should update their documents, they want to know if they should have Revocable Trusts. Probate Property: property that passes pursuant to the terms of a Will or by intestacy Property solely in the name of a person that does not pass by beneficiary designation Property owned with another person as tenants in common (TIC) Assets paid by beneficiary designation to a person’s estate Non-probate Property: Joint Tenants With Right of Survivorship (JTWROS) Deeds in SC must expressly provide for the right of survivorship (Presumption is Tenants in Common or “TIC”) On death of first joint tenant, asset becomes owned by survivor by operation of law Beneficiary Designated Assets that do not name “Estate” as the beneficiary Retirement Accounts Life Insurance Payable on Death (POD) Accounts Assets in a Revocable Trust

Special Considerations for Non-Probate Property Generally, you should never designate your “Estate” as beneficiary of any assets Potential Adverse Income Tax Consequences (Retirement Accounts) Loss of Creditor Protection (Retirement Accounts and Life Insurance) Creation of a Probate Estate – additional probate fees Make sure your joint ownership and beneficiary designations are consistent with your overall estate plan Having assets titled incorrectly can wreck your estate plan Ned and Caitlyn own their home in SC as JTWROS Non-probate property on the first death Probate property on the second death Putting the home in one or both of their new Revocable Trusts during life results in the property being non-probate at both deaths Home would still qualify for 4% legal residence assessment if all other requirements are met

Will or Revocable Trust? Real Question is Will or Will Plus Revocable Trust Basic Purposes of Will: To name Your Personal Representative (a.k.a. “Executor”) To Direct Where Your Assets Go After Your Death If you don’t have a Will, then your probate assets are distributed per statute to your “heirs at law” If married with no children: all to spouse outright If married with children: Half to spouse outright and half to children outright If no spouse or descendants, then to your parents or if neither alive, to your siblings, etc. Potential Disadvantages of Just Having a Will: Lack of Privacy For Your Beneficiaries (Will and Inventory are required to be filed in the Probate Court – open to public inspection) Assessment of Probate Court Fees (0.25% of Value of Assets Passing Under Will) Full Probate Will Generally be Required Ancillary Probate in other States

What is a Revocable Trust? Also known as a Living Trust Created During Life to Hold Title to Assets Acts as a Will Substitute at Death Person Creating the Trust (the “Settlor” or “Grantor”) has full authority to revoke or modify the Trust during life and retains full authority to manage the Trust assets if acting as Trustee Does not need a separate Tax Identification Number – uses Settlor’s SSN Successor Trustee is named who can step in if the Settlor becomes incapacitated Becomes irrevocable at the death of the Settlor

Potential Advantages of a Revocable Trust: Privacy – the Trust does not have to be filed with the Probate Court or reported on the Inventory Reduction or Elimination of Probate Fees Assets that you transfer into a Revocable Trust during lifetime are not subject to probate fees (“Non-Probate Property”) Note: assets in a Revocable Trust are still included in your estate for estate tax purposes and are subject to the claims of creditors. No Need For Ancillary Probate If you own real estate in your individual name in another county in SC or in another State at the time of your death, then probate proceedings would have to be commenced in that other county or State in order to transfer title to the property to your beneficiaries. Real estate owned by a Revocable Trust does not require ancillary probate Summary Probate Process in SC may be available Some banks are prone to deal more easily with a successor Trustee of a Revocable Trust upon incapacity rather than an Agent appointed under a GDPOA

Potential Disadvantages of a Revocable Trust: Still need a Will Pour-Over provision adds assets to the Revocable Trust after death Potential Additional Cost (2 documents versus 1 document) – depends on what your attorney charges Mitigated by probate fees saved Extra work during life to transfer title to assets to the Trust Mitigated by “Declaration of Trust”

Reviewing the Stark Estate Tax Plan We have determined that Pour-Over Wills and Revocable Trusts make the most sense for Ned and Caitlyn Prevent need for ancillary probate in North Dakota for the real estate Ned owns there Save probate fees ($8,000,000 x 0.25% = $20,000) and minimize probate process Give beneficiaries privacy from swindlers “researching” the probate records Ned and Caitlyn had their Wills done 10 years ago, when the estate tax exemption was $2,000,000 per person. They have a plan that was typical for married couples at that time: Creation of Credit Shelter Trust (also called a “Bypass Trust”) for the benefit of the surviving spouse and issue to be funded with assets equal to the estate tax exemption of the first spouse to die Balance of assets to a marital deduction trust (also known as a “Marital Trust” or “QTIP Trust”) for the sole benefit of the surviving spouse At the death of the surviving spouse, remaining assets are to be divided equally among their children, with a trust for any child under age 25 The Credit Shelter/QTIP Trust plan is commonly used so that no estate tax is paid on the first death and the estate tax to be paid on the second death is minimized

Estate and Income Tax Qualities of Credit Shelter and Marital Trusts As a general rule, assets included in the gross estate of a deceased person receive an increase (or decrease) in income tax basis equal to the fair market value of such assets as of the date of the death. Result: Beneficiaries can receive appreciated assets without having to pay income tax on the appreciation accrued through date of death when the asset is later sold Ex. Caitlyn purchased stock in a company that makes wedding favors several years ago for $10,000. At the time of her death, the stock is worth $100,000. The new income tax basis for the stock thus becomes $100,000 and Caitlyn’s beneficiaries can sell the stock and pay no gain on the $90,000 in appreciation.

Credit Shelter Trust: Assets passing into this trust at death receive a basis adjustment on the death of the first spouse to die These assets do NOT receive a second basis adjustment at the death of the surviving spouse, because they are not included in the gross estate of the surviving spouse. Appreciation in these assets between death of first spouse and the death of the second spouse is not subject to estate tax in either spouse’s estate, BUT, there will likely be unrealized appreciation in these assets when they are inherited by the next generation Marital Trust: Assets passing into this trust at death receive a basis adjustment on the death of the first spouse to die These assets also receive a second basis adjustment on the death of the surviving spouse because they are included in the gross estate of the surviving spouse Thus, there should be no unrealized appreciation in these assets when they are inherited by the next generation

Recent Changes in Estate Tax Laws Current Estate Tax Exemption for US Citizens: 2012 saw passage of “permanent” estate tax law with a $5,000,000 estate, gift, and generation-skipping transfer tax exemption Indexed for inflation $5,450,000 per individual in 2016 Spousal Portability: To the extent the exemption of the first spouse to die is not fully used, an election can be made to have the unused exemption amount added to the exemption of the surviving spouse Such unused exemption amount is NOT indexed for inflation, however Election has to be made on a timely filed estate tax return, even if an estate tax return would not otherwise be required Current Estate and Gift Tax Rate: 40%

Analysis of Stark Plan under Current Tax Law Ned and Caitlyn have $8,000,000 in assets, split fairly evenly between them. Assume that Ned dies in 2016: Old plan requires all of his $4,000,000 assets to go into the Credit Shelter Trust There would be no excess to fund a Marital Trust (Possible Elective Share problem in SC) His estate would not use $1,450,000 of his exemption The assets in the Credit Shelter Trust receive an income tax basis increase to $4,000,000 Caitlyn dies ten years later: Assume that the assets in the Credit Shelter Trust have unrealized appreciation of $2,000,000 by the time Caitlyn dies If the Stark children sell those assets after Caitlyn’s death, they pay capital gains tax on $2,000,000 of appreciation.

Crafting a More Flexible Plan New Plan for clients like Ned and Caitlyn who have a net worth ($8,000,000) less than their combined exemption amount ($10,900,000 in 2016): On the first death, pay all assets to a Marital Trust for spouse Surviving spouse can disclaim some or all of those assets into a Credit Shelter Trust depending on estate tax laws then in effect or family situation Ex. Likelihood that assets in the Marital Trust will greatly appreciate between the death of the first spouse and the death of the survivor Marital Trust requires spouse be sole beneficiary and all income paid to spouse; Credit Shelter Trust can include children as permissible beneficiaries, so income (and associated tax) can be paid to persons in a lower tax bracket Portability is elected to carry over any unused exemption to the estate of the surviving spouse

Illustration of New Stark Plan Assume that Ned dies in 2016: All of his $4,000,000 in assets goes into a Marital Trust for Caitlyn; Caitlyn does not disclaim because she believes portability of Ned’s exemption will prevent any estate tax being due at her death His executor elects to port his entire $5,450,000 exemption to Caitlyn The assets in the Marital Trust receive an income tax basis increase to $4,000,000 on Ned’s death The assets in the Marital Trust counts towards satisfaction of the spousal elective share in SC Caitlyn dies ten years later: Assume that the assets in the Marital Trust have grown to $6,000,000 by the time Caitlyn dies; those assets are counted in her gross estate and receive a basis increase at her death Caitlyn’s own assets have grown to $5,000,000 at that time and also receive a basis increase at her death Her estate has a total estate tax exemption of $11,450,000: her then indexed exemption of $6,000,000 plus the $5,450,000 not used by Ned’s estate Result: total assets passing to the Stark children: $11,000,000 with no taxable appreciation as of Caitlyn’s death and no estate taxes due

Drawbacks of the “Flexible” Plan Requires the Surviving Spouse to Act: Surviving spouse will need to make the decision on whether to disclaim and whether to elect portability– advice of tax professional Strict requirements for a qualified disclaimer of assets if there is determined to be a need to disclaim Super-wealthy clients: Married clients with assets exceeding their combined exemption amount (ex. $20,000,000) Generally would still want to use the Credit Shelter/Marital Trust plan to save Estate Taxes on the death of the Surviving Spouse (in addition to other estate tax savings techniques) Portability is not a panacea Not indexed for inflation If a married couple have a net worth close to their combined exemption amount, appreciation in assets may outpace inflation adjustments to the surviving spouse’s exemption Does not apply to generation-skipping transfer tax exemption

Why Leave Assets in Trust for Spouse Rather Than Outright? Protection of assets: From spouse’s creditors If spouse remarries, from the spousal claims of that second spouse in divorce or at death You get to say where the assets remaining at your death go. For second marriages with children from a prior marriage – you can provide for surviving spouse for his or her lifetime and then provide remaining assets go to your children Again, how property is titled is crucial: if everything is JTWROS, it all goes to the surviving spouse outright and not into a trust for him or her and client loses the ability to control where the remainder goes

Why Leave Assets in Trust for Children? Ned and Caitlyn have 5 children. One is married to someone that they do not care for. Another child is physically and mentally disabled. Their current documents pay outright to a child at age 25. Leaving assets in trust for a child rather than outright can protect the assets in the trust from the creditors of a child (including a spouse in a divorce proceeding) Long-term trusts that hold assets in trust for multiple generations can delay the imposition of estate tax on those assets for years and, in some states, forever Trusts for a disabled child can protect those assets for the child and still allow the child to qualify for need- based government services, if necessary Incentive Trusts: terms encourage the beneficiary to achieve certain goals in order to receive greater amounts from the Trust (ex. Graduate from college, be productive through employment or other means, refrain from doing drugs)