Archive for April 2016 | Monthly archive page
TRUST AND ESTATE ACCOUNTING BASICS
FOR SURROGATE’S COURT PRACTICE♦
OUTLINE
ESTATE ACCOUNTING
A. TYPES OF ACCOUNTINGS
1. Informal (non-judicial) settlements. Why do them? To avoid the cost, expense and publicity of a judicial account.
a. Receipt and Release Agreements, coupled with Indemnities and Waivers of Process:
Two approaches:
i. Receipt and Release Agreements with formal accounting schedules in judicial form. (See Receipt and Release in the John Case Estate attached as Exhibit 5A); and
ii. Receipt and Release Agreements with alternative financial reporting backup (e.g. copies of brokerage firm account for estate with cash management account showing receipts and disbursements, but no schedules). (See Receipt and Release in the Thomas A. Jackson Estate attached as Exhibit 5B.)
Q. Why does a Receipt and Release work, legally, to protect the accounting executor (or trustee) without a court proceeding?
A. Because it’s a binding contract, with consideration (the Executor’s willingness to accept a contractual settlement of his account in lieu of his right to a judicial settlement).
Considerations in using Receipts and Releases:
- There has to be sufficient disclosure to the releasing parties so that they can give up their rights to an accounting and their discharge of the Executor/Trustee is essentially an “informed consent.”
- It helps if all parties are adult and competent. If not, adult parties can agree to use their best efforts to get their minor children to sign when they reach age 18.
- Indemnities as a way around the need to get approval from minor or incapacitated beneficiaries.
- Who can indemnify? Typically an adult party – often a parent of a minor. Remember that an indemnity is only as good as the indemnitor. It helps here to have adult family members with financial “heft.” If you are trying to protect against a minor who will grow up to complain about the account, getting his/her parent to block for him/her by an indemnity is a good approach.
- Other considerations: What if you have a 16 year old residuary legatee of an estate? If you account judicially you have a guardian ad litem. If you can wait, you can account to an 18 year old in 2 years.
b. Receipts, Releases and Waivers [SCPA § 2202]. An informal accounting can be filed as part of RRW.
c. Affidavit of Completion of Estate Proceedings.
d. Judicially approved informal accounting [SCPA § 2203].
2. Formal accounting (Erica DeTraglia, Esq.)
a. Voluntary [SCPA § 2208]
Voluntary doesn’t really mean “voluntary.” Fiduciaries have a duty to account and should not wait too long to do so. (Example of Trustee’s accounts for 50-80 year. Risk of loss of records.)
b. Compulsory [SCPA §§2205/2206]
Highly useful as offensive weapon for aggrieved beneficiaries of estates and trusts to “smoke out” issues such as self-dealing, imprudence, incapacity, or failure timely to close estate administration. See Petition to Compel Account in Howard Jackson Estate attached as Exhibit 5C.
B. ACCOUNTANT’S POINT OF VIEW (Tammy Kirshon, CPA, CVA)
- Decide What Resources To Use for preparing the Accounting
- Obtaining Necessary Information and Organizing Documents
- Perform Due Diligence
- Techniques for Requesting Documents
C. THE ACCOUNTING (Panel)
1. Petition, Citation and Waivers. Use official forms as guideline. All forms can be found at: www.nycourts.gov
a. Are all interested parties accounted for in the petition?
i. Minor beneficiary(ies)?
ii. Has any beneficiary died?
iii. Whereabouts of the beneficiary are now unknown?
iv. Has any beneficiary become incapacitated?
b. Is the fiduciary’s appointment still active?
c. Have any claims been filed against the Estate/Trust?
d. Will all bequests be satisfied?
e. Is the Attorney General Charties Bureau required to be cited?
2. Review Will or Trust Instrument
3. The Schedules
a. Schedule A Principal Received
b. Schedule A-1 Realized Increases
c. Schedule A-2 Income Collected
d. Schedule B Realized Decreases
e. Schedule C Funeral and Administration expenses and taxes; Funeral and Administration expenses and taxes charged to principal
f. Schedule C-1 Unpaid Administration Expenses
g. Schedule C-2 Administration expenses chargeable to income
h. Schedule D Creditor’s Claims
i. Schedule E Distributions of Principal; Distributions Made (Receipt, Release and Waivers must be filed)
j. Schedule E-1 Distributions of Income
k. Schedule F New Investments, Exchanges and Stock Distributions
m. Schedule G Principal Remaining on Hand; Personal Property Remaining in Hand
n. Schedule G-1 Income Remaining on Hand
o. Schedule H Interested parties and proposed Distribution
p. Schedule I Computation of Commissions [SCPA § 2307]
(i) Executor’s commissions [SCPA § 2307]
(ii) Trustee’s commissions [SCPA § 2308 and 2309]
q. Schedule J Other Pertinent Facts and Cash Reconciliation
r. Schedule K Estate Taxes Paid and Allocation of Estate taxes
ATTORNEY’S FEES AND ATTORNEY-FIDUCIARY (Vincent Teahan, Esq.)
A. REVIEW LEGAL FEES REQUESTED
• An Attorney Affirmation of Legal Services is required for the Court’s consideration in all accounting proceedings.
• Must institute proceeding [SCPA § 2110]
1. Must include affidavits of legal services [22 NYCRR§ 207.45]
2. Elements for consideration. [Matter of Potts, 241 NY 593; Matter of Freeman, 34 NY2d 1]
3. May be disallowed for failure to file a report of estates not fully distributed. [22 NYCRR § 207.42]
4. Some disbursements may be disallowed as being attributable to “office overhead.”
5. See Affirmation of Legal Services in the Dorothy Decedent Estate, attached as Exhibit 6.
B. ATTORNEY-FIDUCIARY [SCPA §2307-A & 22NYCRR §207.16(E)]
1. An attorney-fiduciary should file an Affirmation of Legal Services (w/ copy of retainer if engaged other counsel).
2. Disclosure.
i. 207.16(e). If a person requesting letters to administer an estate as sole executor or administrator is also an attorney admitted in this State, he or she shall file with the petition requesting letters a statement disclosing:
(a) that the fiduciary is an attorney;
(b) whether the fiduciary or the law firm with which he or she is affiliated will act as counsel; and
(c) if applicable, that the fiduciary was the draftsperson of a will offered for probate with respect to that estate.
ii. SCPA 2307-a. When an attorney prepares a will to be proved in the courts of this state and such attorney, a then affiliated attorney, or an employee of such attorney or a then affiliated attorney is therein an executor-designee, the testator shall be informed prior to the execution of the will that:
(a) subject to limited statutory exceptions, any person, including the testator’s spouse, child, friend or associate, or an attorney, is eligible to serve as an executor;
(b) absent an agreement to the contrary, any person, including an attorney, who serves as an executor is entitled to receive an executor’s statutory commissions;
(c) absent execution of a disclosure acknowledgment, the attorney who prepared the will, a then affiliated attorney, or an employee of such attorney or a then affiliated attorney, who serves as an executor shall be entitled to one-half the commissions he or she would otherwise be entitled to receive; and
(d) if such attorney or an affiliated attorney renders legal services in connection with the executor’s official duties, such attorney or a then affiliated attorney is entitled to receive just and reasonable compensation for such legal services, in addition to the executor’s statutory commissions.
Dutchess County Bar Association
Guardian Ad Litem Training Program
April 27, 2016
ACCOUNTING PROCEEDINGS⇒
I. GENERALLY: TYPES OF ACCOUNTINGS
A. “Informal” Accounting
The account of a fiduciary is most commonly settled “informally” (i.e., non-judicially), due to the additional expense, delay and publicity of a judicial accounting. The operative documents in an informal account are usually:
(i) A “Receipt, Release and Refunding Agreement” (sometimes coupled with Indemnity provisions).
(ii) An “account”, which can run the gamut from (a) full schedules of account in judicial format to (b) statements of assets on hand at the beginning and end of the accounting period.
There is a large body of law connected with informal accountings. Since, however, a Guardian ad Litem would not be appointed in connection with an informal accounting (except perhaps in the most unusual circumstances),⇒ we will proceed to a discussion of judicial accountings.
B. Judicial Accounting
There are some situations in which a judicial accounting (SCPA 2208) is preferable or unavoidable. For example:
(i) Where an interested party is under a disability.⇒ A Guardian ad Litem would be appointed for a person under a disability.
(ii) Where intransigent beneficiaries can derail the informal accounting by withholding their consent.
(iii) Where the fiduciary has a conflict of interest.
(iv) Where significant amounts of money are involved, and the fiduciary wants the certainty of discharge from liability which is available with a judicial accounting.
(v) An interested party may also petition for a “compulsory accounting” (SCPA 2205). If the Court grants the relief requested, the accounting proceeds in the same manner as a voluntary accounting under SCPA 2208.
II. BASIC ACCOUNTING PROCEEDINGS
The most common types of Accountings are for Trustees and for fiduciaries of estates (e.g., administrators, administrators d.b.n., administrators c.t.a, ancillary administrators (d.b.n., c.t.a.), executors, preliminary executors and temporary administrators). Other fiduciaries who might account include guardians of the property of an infant or other incapacitated person, attorneys-in-fact (under a power of attorney) and donees under a power-in-trust.
III. BASIC JUDICIAL ACCOUNTING INSTRUMENTS
The three basic documents in a judicial accounting proceeding are a Petition, a Citation (or a Waiver of Citation and Consent), and Schedules of Account.
Attached as Exhibit “A” are copies of the following Official Forms Prescribed by the Surrogate’s Court Procedure Act:⇒
- JA-1 Petition for Judicial Settlement of Account
- JA-2 Receipt and Release
- JA-3 Waiver of Citation and Consent in Accounting
- JA-4 Trust Accounting with Instructions
- JA-5 Decree of Judicial Settlement for Executor with Trust or Trustee
- JA-6 Citation
- JA-7 Non-Trust Accounting with Instructions
- JA-8 Non-Trust Decree of Judicial Settlement
- JA-9 Compulsory Accounting Citation
- JA-10 Petition for Compulsory Accounting and Related Relief
You may also be able to access surrogate’s court forms on line at www.courts.state.ny.us/forms/surrogates. The forms for Schedules of Account require special mention.
A. “Form” JA-7 (“Non-Trust Accounting with Instructions”) isn’t actually a form: it is simply instructions. Form JA-7 is not helpful as a guide as to what schedules of account should look like.
B. There are two basic types of Schedules of account:
(i) Estates with no trusts
These schedules report income receipts separately (Schedule A-2), but otherwise commingle income and principal).
(ii) Trusts, and estates with trusts
Income and principal are important categories for trusts. These schedules report income receipts separately, and they also separate expenses chargeable against principal (Schedule C) from expenses chargeable against income (Schedule C-2), and report principal on hand (Schedule G) separately from income on hand (Schedule G-1).
Attached (as Exhibit “B”) for your reference is a website reference to Schedules for an estate with trusts.
IV. EXAMINATION OF THE ACCOUNT
An in-depth analysis of the subject matter of accounting schedules is impossible in the few minutes allotted to this presentation. This presentation will concentrate more on the types of issues a Guardian should be looking for in reviewing an accounting (only some of which are contained in the Schedules of Account). For a more detailed guide to the analysis of the schedules of account, see the attached New York State Bar Association “Practical Skills” outline (attached as Exhibit “C”) I prepared for a CLE program a number of years ago.⇒
A. Review Will or Trust Instrument
Your ward’s interests are usually created by a Will or Trust Instrument (for brevity’s sake, hereinafter collectively referred to as “Will”). It may seem obvious, but an essential first step is to review the Will. Some issues are basic (for example, if the Will says your ward is entitled to 1/4 of the residuary estate, the accounting should show that your ward will receive 1/4 of the residuary estate).
There may be other, less obvious, issues. Read the whole instrument, not just the limited portion which defines your ward’s interests. You never know what you may find there:
1. There may be a relevant provision located at the other end of the instrument (e.g., a definition of “issue;” an authorization of (or restriction on) discretionary income and principal distributions; allocation of commissions contrary to statute).
2. There may be something relevant hidden in the “powers” section (e.g., restrictions on types of investments).
3. There may be ambiguities which require a construction proceeding under SCPA 1420 (for example, recently when reviewing an accounting and the underlying Will I noticed an “anti-lapse statute” (EPTL 3-3.3) issue which the preparer had missed).
Let your imagination roam free. Don’t be confined by the section in which your ward’s interest appears, or by the description of your ward’s interest by the petitioner – there is no guarantee that the petitioner got it right.
B. The Total (of the Schedules of Account) Should Equal the Sum of Its Parts
Again, it may seem obvious, but the schedules should add up and cross-reference properly. While I am not suggesting that all the math be reviewed (especially when the schedules have been prepared using an accounting program), at a minimum the totals on each separate schedule should agree with the total shown for that Schedule in the Summary Statement.
It may seem even more obvious that the numbers in the Summary Statement should add up, and you should check to see that they do. In a judicial accounting I brought on recently the Schedules were prepared by qualified accountants using the latest programs, and but because of a glitch in the program the numbers in the Summary Statement did not add up.
C. Expenses (Schedules C [Principal Expenses Paid], C-1 [Unpaid Administration Expenses] and C-2 [Income Expenses Paid] and D [Debts]
1. Expenses and Debts In General
To make up a statistic which empirically sounds correct, 90% of potential objections to an accounting will be found in these Schedules. Large expenses/debts and “unusual” expenses/debts⇒ may require explanation or verification. Some random illustrations: Are cable TV bills or magazine subscriptions (or any other bills normally considered as personal to the decedent) still being paid a year after death? Are there any “5 figure” debts or expenses paid without explanation which are not legitimate on their face? Are storage charges for decedent’s tangibles being paid more than a year after death?⇒
2. Legal Fees
You are required to review legal fees (whether paid or unpaid). The attorneys will be required to submit an Affidavit of Legal Services.⇒
The standard for legal fees in estate proceedings is that of Matter of Potts, 241 NY 593, and Matter of Freeman, 34 NY 2d 1.
Uniform Rules for Surrogate’s Courts section 207.45 provides that if an estate has not been fully distributed (or judicial accounting filed) within 2 years of the date when permanent letters testamentary or administration have been issued (or 3 years, if a federal estate tax return is required), a statement as to the status of the estate must be filed with the court. Failure to file such a statement may constitute a ground for disallowance of fees.
3. Commissions
The area of fiduciary commissions is densely complicated. Some rules are arcane, others counter-intuitive.⇒ Some issues and areas to examine:
a. As Always, Check the Basics
Assuming there is no question as to whether the assets are commissionable, are the correct commission tables being used?⇒ Is the math correct? Are Executors’ commissions calculated separately on “receiving” commissions and “paying” commissions? When trusts are involved, are Executors’ commissions properly allocated against principal and income?
b. Specific Legacies; Real Property
SCPA 2307(2) provides that commissions are not payable on specific legacies. Commissions are payable on general legacies. See EPTL 1-2.8 for the definition of a “general disposition” and EPTL 1-2.17 for the definition of a “specific disposition.” Commissions also are not payable on real property, unless the Executors have in some manner exercised “dominion and control” over the real property (such as selling the real property to raise cash needed for debts, expenses and/or taxes).
c. Advance Payment of Commissions
SCPA 2307(1) prohibits payment of Executors’ commissions prior to the judicial accounting,⇒ unless application for advance payment was made pursuant to SCPA 2310 or 2311. Unauthorized advance payment of commissions can result in surcharge and/or payment of interest on unauthorized payments.
d. Commissions for Attorney-Executor
If an attorney is also acting as an Executor, SCPA 2307-a requires that the testator execute a written acknowledgment of disclosure that Executors’ commissions are payable in addition to legal fees (and requires certain additional information). In the absence of such disclosure, the commissions of an attorney who also acts as Executor shall be one-half the commissions to which he would otherwise be entitled.⇒
e. Trustees’ Commissions for “Old” Trusts
Commission rates and commissionability of trust assets (and the proportion in which commissions are charged against principal and income) have changed over the years. If a trust is old and there has not been an accounting for many years, you should check as to the rates used and the allocation of the charges for commissions.
Attached as Exhibit “D” is an analysis of Trustee commissions in periods before the present 1993 and 2001 amendments.
V. REVIEW FIDUCIARY’S CONDUCT
The fiduciary’s conduct should be reviewed as to the following areas, among others:
A. Self-Dealing
For example, were there any purchases and sales to fiduciary without court approval?
B. Conflict of Interest
For example, did the fiduciary steer business to himself or a relative, without an express exoneration of conflicts contained in the governing instrument?
C. Exercise of Discretion
For example, if you as Guardian ad Litem represent a remainderman of a trust, and there have been significant principal invasions to the income beneficiary, were such invasions authorized by the governing instrument?
D. Marshaling Assets
For example, are there assets on Schedule A (statement of original assets on hand) that are not on hand at the end of the accounting period, with no explanation as to their sale, distribution or other transfer out of the account? Also, Schedule A should be cross-checked against the estate tax return, or if none, against the Inventory of the Executor or Administrator required to be filed in Court (22 NYCRR section 207.20).
E. Payment of Claims
For example, have all the claims reflected in the accounting been paid or otherwise dealt with? Should the fiduciary have asserted a statute of limitations defense against a claim?
F. Tax Returns
Were the necessary tax returns filed (such as decedent’s final income tax returns, estate tax returns, fiduciary income tax returns)? Were penalties or interest paid for late filing?
G. Investment of Assets
1. Prudent Investor Statute (EPTL 11-2.3)
For example, did the estate contain disproportionate investments in 1 or 2 stocks or other assets which dropped significantly in value during the accounting period, which the fiduciary should have diversified, or were there other investments which dropped significantly in value? A drop in the value of an investment of, say, 25% may prompt the Guardian ad Litem to investigate more closely the fiduciary’s investment performance, and require the accounting fiduciary to provide an explanation of the loss. See Matter of Janes, 90 NY2d 41 (1997), in which the Court of Appeals surcharged the Executors of an estate that was over-invested in Kodak stock.
Did the governing instrument specifically permit retention of assets that originally constituted a disproportionate share of the estate – which although not a perfect defense to imprudent retention, nevertheless gives the fiduciary some ground to stand on?
2. Principal and Income Act
There can be Principal and Income Act questions under EPTL 11-2.1, et. seq. (prior to January 1, 2002), and under EPTL Article 11-A (on or after January 1, 2002). For example, were estate or trust expenses properly charged against principal or income? Were receipts properly credited to principal or income?
VI. THE GUARDIAN’S REPORT⇒
Your investigations will culminate in a report that you will submit to the Court. The Guardian ad Litem is required to file his or her Report or Objections “within 20 days after the appointment unless for cause shown the time to file such Report or Objections is extended by the Surrogate.” Your report should cover some or all of the following:
A. Qualification to Act as Guardian; Review of Court Files
The report should recite that the Guardian has filed his or her qualification papers, and reviewed the Court files.⇒
B. Jurisdiction
There are numerous jurisdictional issues and questions which may need to be addressed.⇒
1. Service on Your Ward and Necessary Parties
The citation should be served on your ward, unless he or she is an infant under the age of 14.⇒
If your ward is an infant, service should also be made on his or her parent (unless Petitioner is the infant’s parent).⇒
If your ward is institutionalized, process should also be served on an employee of the institution authorized to accept service of citation.
Admissions of due and timely service are not allowed. Waivers and Consents should also probably be avoided.
2. Service on Other Necessary Parties
The due diligence of Petitioner should be examined if Petitioner claims there are necessary parties who cannot be found. If Petitioner’s due diligence seems insufficient, the Guardian might contact the Petitioner, or report his or her concern to the Court.⇒
Timeliness and adequacy of service on other necessary parties should be examined.⇒
3. Review Petition
You should review the petition, to determine whether all necessary parties named in the petition have timely received citation in the accounting proceeding, or have waived process.
4. Jurisdiction As To Adopted Persons
In Exhibit “G” there were questions as to whether jurisdiction was required over a person who might have been “adopted out”.
C. Meeting With Your Ward
Your Report should discuss your meeting with your ward. A meeting with your ward can be significant, even if your ward cannot communicate or comprehend the substance of your meeting. What you come away with from the meeting which can be significant.⇒
D. Objections
Filing objections should be a last resort, and will be discussed in Section VII of this outline.
E. Recommendations to the Court
After discussing issues, you should make your recommendations to the Court. It is important to remember that, in addition to representing your ward, you are also an officer of the Court. It may be that your recommendations should be adverse to the interests of your ward.
“The primary allegiance of the guardian ad litem is the ward, but he or she has a concurrent obligation as an officer of the court to make a thorough, fair and objective report.” Guidelines for Guardians Ad Litem, May, 2003, revised and edited by the Committee to Revise Guidelines for Guardians Ad Litem, at Page 22.⇒
VII. OBJECTIONS
If there are imperfections in the accounting, the Guardian ad Litem should attempt to resolve the issues prior to filing Objections. If the issues cannot be resolved informally, the Guardian ad Litem can file Objections, either in his or her Report, or by separate Objections.
A. Deposition of Fiduciary Before Filing Objections
You can depose the fiduciary prior to filing Objections (SCPA 2211(2)). It may be that a deposition is necessary to determine whether Objections should be filed.
B. Basis for Objections
The basis for the Objections would be the lines of inquiry discussed above.
C. Your Ward’s Interests
It is worthwhile to observe here that your ward should have a pecuniary interest in any Objections you might file. Even if the fiduciary is clearly responsible for acts which require surcharge, as Guardian ad Litem you do not have the mandate to file Objections unless your ward’s economic interests are adversely affected.
Even if your ward’s interest is not sufficient to warrant the filing of Objections, you should raise your concerns in your Report.
D. Pretrial Proceedings; Settlement
If Objections are filed, you will be required to participate in pre-trial proceedings. As matters progress, you would do well to encourage (where circumstances merit) appropriate settlement of the matter, and participate in a settlement, though such controversies can only be settled with leave of court.
10 THINGS A GUARDIAN SHOULD FIRST CHECK IN AN ACCOUNTING
1. Jurisdiction
Has jurisdiction been obtained over all necessary parties (by citation or waiver and consent)? Were citations served within the time limits of SCPA 307 (10 or 20 or 30 days)? Were parents of minors served? Were infants 14 or older also served? Is required information about minors set forth in petition?
2. The Will
Does the accounting party have it right? Are all bequests properly shown in the schedules? Are the necessary people cited? Does the will contain any special fiduciary powers or authorizations? Read the whole will and not just dispositive provisions?
3. Numbers
Do numbers in Summary Statement match up with number totals in Schedules? Do numbers on the Summary Statement add up correctly? Do numbers in Schedules add up correctly? Is the cash reconciliation accurate? Zero sum: is every asset shown as received (e.g., Sch. A or A-1 [principal or income received] or F [new investment] shown as disposed of [Sch. A-1 or B-1] or on hand [G or G-1]?
4. Losses on Investments (Realized or Unrealized)
As a general rule of thumb, if there is a loss of 25% or more on an investment, a GAL should make inquiry as to the circumstances, and report on the results of that inquiry.
5. Proper Format
For estate accountings there are different formats for Estates without Trusts (Form JA-7) and Trusts and Estates (Form JA-4).
6. Family Tree
Required if (i) there are no distributees, (ii) only one distributee, or (iii) “where the relationship to the decedent is grandparents, aunts, uncles, first cousins or first cousins once removed” (Uniform Rule 207.16). This becomes relevant for accountings for administrators of intestate estates.
7. Due Diligence
Uniform Rule 207.16(d) requires that a petitioner exercise “due diligence” to find missing distributees. In some cases, the citation must be addressed to “unknown distributees” and the citation must be published. This becomes relevant for accountings for administrators of intestate estates.
8. Proposed Schedule of Distributions
Does it accurately set forth the way the assets should be distributed?
9. Commission Calculations
Are they accurate? E.g., are specific bequests and non-probate assets excluded from estate commissions? Are estate commissions properly separately applied to receiving and to paying? Are computations of interim annual commissions for trusts included?
10. Debts and Expenses
As a general rule, debts and expenses are the source of a majority of the problems with an accounting. Principal and income charges: are they accurate (e.g., trust annual commissions 2/3 to principal and 1/3 to income)? Are debts and expenses on the correct schedules? Are expenses proper (e.g., are payments shown for cable TV for years after death? Are there beauty parlor expenses as debts of a male decedent? Do professional fees (e.g., legal and accounting) look appropriate? Should affidavits of services be required?
EXHIBITS
- Copies of the Official Judicial Accounting Forms prescribed by the Surrogate’s Court Procedure Act
- Website address for Schedules of Accounts for an estate with trusts
- Outline 1994 N.Y.S.B.A. Practical Skills Course “Preparation of the Account and Filing the Accounting”
- Analysis of Trustee commissions in periods before the present 1993 and 2001 amendments
- Format of a relatively simple Report of Guardian Ad Litem (for the “Susan” Estate)
- Report of Guardian ad Litem with Schedule by Schedule comments
- Report of Guardian ad Litem with Extensive Discussion of Jurisdictional Issues
To download a complete copy of the 2016 Guardian ad Litem Training Program – Accounting Proceedings outline and exhibits, please click here.
THE CRITICAL YEAR
A Guide to Tax and Legal Planning For Persons Immediately Before Death and Shortly Thereafter♦
The period immediately before and shortly after a client’s death is crucially important for the client, the client’s family, and his or her professional advisors. Not much planning can be done (other than advanced planning) when a client’s death is sudden or unexpected. Increasingly, though, the progress of modern medicine has produced an extended twilight for many clients, and as a result, there is a longer period for planning – – often under stressful circumstances.
Though the client’s personal circumstances can be difficult, the planner, whether lawyer or other tax professional, can play a useful role for clients and their families here. Many opportunities present themselves for planners to unlock tax and other economic benefits during this period. Also, after the client has died, it is important to get the administration of client’s estate or now irrevocable trust off to a good start. There is enough trouble in the client’s family without having to worry about how the money is going to come in and go out or where the records are kept.
The purpose of this presentation is to give you, as tax professionals, a closer idea of what can be done during this critical period. We’ll touch on legal matters – – what I do – – but in a way that will involve numbers and tax approaches – – what you do – – so we can work more efficiently together. Where relevant, I will show you the legal papers behind some of the tax-driven measures connected with deathbed planning and estate administration, because law and tax are interrelated: tax and probate law drive the numbers, but the numbers also drive legal approaches that we undertake on behalf of our clients. I note at the outset that while I base my observations on nearly 40 years of law practice in the estates area, the materials in this outline aren’t meant to be exhaustive. You know tricks that I don’t know, and I’ll be interested in learning about them. That is why we are here.
In this presentation I’m going to handle things in three stages:
- ADVANCE PLANNING meaning steps we can take with our clients – – possibly years in advance – – to get ready for end-game planning.
- DEATH BED PLANNING meaning planning during the three-month period before death, which, while an arbitrary measure of time, could give planners and their clients an opportunity to rearrange matters in an advantageous way for the client’s family. Sometimes, of course, we will have only a month or less in which to help here.
- POST-DEATH PLANNING for the first nine months of estate or (formerly) revocable trust administration. While I use the nine-month period to round out the “critical year,” my choice of nine months isn’t entirely arbitrary, as this is the ordinary due date for the filing of estate tax returns.
Now to look at these subjects more closely:
1. ADVANCE PLANNING
Especially when clients get older, we should have a number of potential steps planned out in advance so that they don’t have to be taken on a rush basis. Also, it is a good way for us to work together productively for the sake of the client and his/her family. The reason why working together makes sense is that (for example) the lawyers might think that they is doing the best for the client, but acting on only partial information, which can only be provided the client’s tax professionals. We lawyers can be good at setting up legal structures, entities and providing the words of plans, but we do not often have access to the “music” of the client – the hard information that tax professionals know from their year-to year, if not day-to-day fingertip command of the client’s financial information (e.g., tax basis information). Zeroing in on some of these advance areas, let’s consider the following:
Power of Attorney/Statutory Gifts Riders
Clients, especially ones of substantial means, should give a trusted person or persons a power of attorney (POA). I view this as a mandatory step, because unpleasant and inefficient things happen in New York (in the form of an Article 81 proceeding to appoint a guardian under the Mental Hygiene Act) without a power of attorney – – if a client is incapacitated and unable to act on his own.
Let’s take a closer look at the New York statutory power of attorney carried below:
Changes to the New York General Obligations Law governing powers of attorney, enacted in 2001, allow a persons to supplement powers of attorney with a statutory gifts rider (SGR). With an SGR, the client’s agent can make annual exclusion gifts under the Internal Revenue Code — or even larger gifts – – especially where the client has become incapacitated. The agent can also be empowered to engage in a broader range of estate planning moves, including the creation and funding of revocable and irrevocable trusts.
POAs/SGRs work best if there is a pre-arranged plan for how to use them. So we have to consider what assets belonging to the client might be transferred for tax advantage, and how, mechanically, these transfers can be effected. It helps if the attorney and tax professional (and also possibly the investment advisor) can identify and possibly even segregate assets and accounts that would be the subject to future death bed gifts and have the agent, under the POA/SGR, primed to take action.
Of course, as part of planning for any end-game, we need to review the client’s estate plan, and gauge the client’s (or the agent’s) interest in carrying out tax planning – – the sooner the better. And our planning has to be in keeping with the client’s own personal, family and charitable objectives. After all, tax planning of the sort we are discussing isn’t the sole objective of estate planning, it’s just an aid to getting things done efficiently and economically, to accomplish the client’s goals. We have to pay at least periodic attention to the client’s plans, perhaps a lot more frequently than we do with clients who are 50, largely so that everyone can try to handle final planning well in advance. The more we help the client do sooner is the less we have to rush when the client’s time is short.
2. DEATH BED OR 3 MONTH PLANNING
Let’s say that the client’s matters have not been planned in advance, and we are faced with a client is likely to die over a short period. We only have a few months or weeks to help the client and client’s family to make things easier and more efficient after the client’s death. And we will not just be called on to assist in bloodless, technical planning matters. We will by necessity have close, personal dealings with clients and their families under the most difficult circumstances, which we will have to handle with decency and humanity and a maximum respect for the client’s dignity – all while getting our technical job done. This is hard work. In some sense, the technical stuff of this presentation is the easy part.
A. Review of Client’s Estate and Financial Plan
We should find out where the client’s original Will (or trust document) is kept and review a copy of all relevant papers. We have to check these instruments for “reality” – in terms of whether the legal document actually operates on the assets in question. For example, the creation of a testamentary trust won’t mean much if all of the client’s assets are held in a transfer on death account, and will pass automatically to named persons on the client’s death. If a power of attorney doesn’t turn up (and with it, a statutory gifts rider), we may have to take steps to help the client execute these instruments and to get them recognized by financial institutions, especially if the client immediately needs an agent to help him manage his affairs. In this connection, I note that while Powers of Attorney properly executed before 2010 under the “old” law can still be valid, these powers by definition cannot enable a SGR. So the client may have to execute and updated POA/SGR.
Once we have gotten the relevant estate planning instrument in hand, and are familiar with the client’s personal assets, we have to think about some of the matters listed below as potentially useful ways to use the tax laws to benefit the client.
B. Estate Tax Considerations
Unless the client has more than $5,250,000 in taxable assets ($10,500,000 for married clients), dealing with the federal estate tax has largely been removed as a planning imperative, thanks to the American Taxpayer Relief Act of 2012 (ironically but perhaps fittingly enacted in 2013). And unless Congress takes back this exemption, there is going to be an inflation adjuster that keeps boosting the federal estate tax exemption on an annual basis. (Do I think that the exemption will be rolled back? Not likely, but I do think there will be a backdoor attempt to boost tax by limiting the amount of step-up in basis at a client’s death, and this will show up within the next few years.)
C. Other Tax-Related Measures
(i) Charitable Dispositions
If a client’s plan contains charitable bequests, think about the following measures:
(a) Use IRAs, and not Will or trust bequests, to make charitable bequests. The charities involved won’t pay income taxes on them, as opposed to individual beneficiaries. Take, for example, the client whose Will leaves $100,000 to charity and the balance of his estate to his son and daughter. If the client has an IRA, he should strike the bequest to charity from the Will, and instead designate the charity as beneficiary to receive the first $100,000 of IRA proceeds. Under this approach, an added $100,000 will pass to the son and daughter ($50,000 each) on an income tax paid basis instead of getting IRD. The charity getting the IRA isn’t affected by the income tax.
(b) Consider the case of a client whose estate will not be subject to federal estate tax, and who wants to make charitable bequests. If he has spouse (or children) who will likely survive and who can be trusted to honor the client’s wishes, think about restructuring the client’s will or trust plan to leave the spouse/children the bequest originally bequeathed to charity, while indicating that the legatees are encouraged (morally bound) to use the bequest to make charitable gifts. Such a provision must of course not be legally binding.
Why is this a good idea? Because quite frequently, where a client is survived by a spouse, charitable bequests produce no or little estate tax savings – – there’s either no Federal estate tax, or at worst New York estate taxes levied at fairly low marginal rates. By contrast, a charitable income tax deduction is worth obtaining for the client’s surviving spouse or children. Their gift of their bequest from the client produces far better after-tax results than if the client simply names a charity to take a bequest in her will. Consider the following smart charitable bequest.
(c ) Where the client can’t make use of an IRA (or similar plan) beneficiary designation, he or she should try to use pre-residuary dollar bequests in Wills and trusts to “cash out” charities. If possible, the client should avoid residuary or balance-of-trust dispositions (especially of small percentages), because the New York State Attorney General’s office necessarily become a party to the settlement of the account of the client’s executor and trustee where there is a residuary bequest. To get around this, encourage the client to leave a pecuniary (fixed dollar denominated) bequest to charity instead. It’s much simpler. As an example of what not to do, consider this: Article Five: Distributions after Death of Settlor.
(ii) Securing a basis step-up
While some might find this ghoulish, gifts of highly appreciated property made to a person in poor health can produce big tax benefits. The reason for this, of course, is the step up in basis available under Section 1014 of the Internal Revenue Code for property passing through the taxable estate of a decedent. While Section 1014(e) of the Code denies a basis step up for property that is bequeathed back to the property’s donor within one year of the original gift, one can fairly easily avoid this trap if the donee bequeaths the property to non-charitable legatee who is not the original donor. Also, a bequest to a discretionary “sprinkle” trust for the original donor and other beneficiaries may work in avoiding the application of 1014(e), even if the donee’s death occurs within the year.
What sort of client can benefit from this type of planning? Consider a gravely ill client, who jointly owns her principal residence, with her husband. In this case, it’s a Manhattan co-op with a tax basis of $200,000 and current market value of $4,000,000. If the client’s husband survives her, and owns the property as a surviving joint tenant, his capital gains exclusion ($250,000), plus the step-up in basis to the property of $2,000,000 by reason of his wife’s death, will not provide a shelter from capital gains tax on a sale after the predeceasing wife’s death.
For an excellent discussion of section 1014(e) avoidance, see Mancini and Harris, “The Rest of the Story: Income Tax Issues Related to Transfer Tax Planning with Grantor and Non-Grantor Trusts” (pp 6-8)
(iii) Gifts to Reduce New York Estate Tax
New York clients holding significant wealth –- meaning ideally a federal taxable estate – – would do well to make lifetime gifts of cash or non-appreciated assets, especially if they are terminally ill and no longer need the assets for their support. Ideally, these gifts should sop up anything that remains of the client’s $5,250,000 in gift and estate tax exemption. New York of course has no gift tax, so its limited $1,000,000 exemption is irrelevant.
Take for example the agent who acted in 2012 under a statutory gifts rider and made a $4 million gift for a gravely ill person with $20 million in assets. The client was 100 years old and in poor health. Many of his assets were cash or cash equivalents (this is an important factor).
The additional $4 million death bed gift, while an “adjusted taxable gift” for federal estate tax purposes, did not enter into the calculation of New York estate tax after the donor’s death. The estate therefore realized sizable New York estate tax savings between a $16 million taxable estate (plus $4 million in adjusted taxable gifts) and a $20 million taxable estate (had no gifts been made):
A. $20 million taxable estate (no deathbed gift)
$4,274,620 Federal estate taxes due
$2,666,800 NYS estate taxes due
$6,941,420 Total
B. $16 million taxable estate with $4M in deathbed gift
$4,498,620 Federal estate taxes due
$2,026,800 NYS estate taxes due
$6,525,400 Total
Total savings produced by deathbed gift (A – B):
$416,000
Questions:
- Why does Federal estate tax increase, and New York estate tax decrease (though there is net savings) through deathbed gifts?
- Why should the deathbed gift approach only be used for cash or non-appreciated assets?
3. POST-DEATH PLANNING
It’s most important to get things going shortly after the decedent’s death, both for family psychological reasons (the survivors don’t need financial confusion to add to their feelings of grief over the loss of their loved one) and financial reasons (drift and indecision are dangerous – and a decedent’s assets accounts are often frozen upon his death). Attorneys for the estate (or a trust that became irrevocable upon the client’s death) and the tax professional involved with the estate/trust administration should work quickly, and together, to help deal with this situation.
If the deceased client had concentrated holdings of highly appreciated assets (which she could not sell during life because of the lock-in effect), the executor has to act fast
to free up these assets, so they can be sold (finally!) at no capital gains cost. I cannot overemphasize the importance of diversification and asset protection here.
I’ve been asked to give you a summary of the probate process, from a legal standpoint, and a glimpse at legal papers that are frequently relevant. So here one is, with a timeline for both “legal” and “tax” steps we need to coordinate:
LEGAL MATTERS (for us laywers)
During the First Month After Death:
- Take the Will to Surrogate’s Court for Probate, and if the Petition cannot be quickly granted, because of delays in serving citation upon nearest family members, get “preliminary letters testamentary”, which will allow the administration of the estate to go forward.
- Here are some probate papers, including an interesting “Affidavit of Heirship” that may be necessary if the client has a small family.
- Prepare table of assets and cash requirements for estate, including tax projections.
Four Months After Death:
Six or Seven Months After Death:
- Petition for Advance Payment of Executor’s Commission to split receipt of commission into more than one year.
- This proceeding often not and entertained until the end of the year. Calendar filing on November 1st at latest.
- Make sure that Order is followed and that executors are actually paid before the end of the year.
- Executors can only get partial commissions with leave of court. Here are specimen court papers.
- File estate inventory in Surrogate’s Court within six months♦ of letters testamentary or preliminary letters, whichever is earlier. This period may be extended if estate tax returns are to be filed – which will be likely in many cases.
- Here is the statutory Inventory of Assets.
- Surviving spouse’s right of election must be filed within six months of issuance of plenary (not preliminary) letters to executor or administrator.
- Pay cash legacies against Receipt/Refunding agreements (unless there is insufficient cash to pay estate taxes and administration expenses).
Nine Months After Date of Death:
- Prepare and file Renunciation and Disclaimer Surrogate’s Court within nine months of decedent’s death and obtain stamped receipt.
- Here are Renunciation and Disclaimer court papers.
TAX MATTERS (For tax professionals)
During the First Month After Death:
- Consider estimated tax payments for surviving spouse. Find out whether surviving spouse is US citizen and obtain proof of same.
- File notice of fiduciary relationship, IRS Form 56.
- Obtain taxpayer identification number through IRS Form SS-4.
- Get the attorney and tax Professional on Federal and New York State income and Estate tax powers of attorney (Form 2848 and Form ET-14).
Four Months After Death:
- Consider whether the estate should be on fiscal year or calendar year. Strategic choice of fiscal year. 645 Election.
- Consider execution of waiver of commissions by executor.
Six to Seven Months After Death:
- Computation of commissions. Prepare to send Form 1099 to Executor who has taken advance.
- Consider extension of time to File Federal return (Form 4768).
- Consider deferred payment of Estate tax because of closely held business assets under Section 6166 (Federal and State).
- Consider extension of time for filing/payment federal estate Tax (Form 4768).
- Consider additional time for filing/Payment of New York estate tax Return(Form ET-133).
- Consider use of alternate valuation date under Section 2032 (up to six months after date of death if aggregate estate values are lowered and estate tax can be reduced thereby).
- Consider Disclaimers/Renunciations under IRC Section 2518 and New York EPTL 2-1.11. Do legatees really need their legacies? Is there strategic gift tax purpose to disclaiming legacies?
Nine Months After Date of Death
- File estate tax returns (Federal and state) make tax payments or otherwise obtain extensions.