Leaving Your Estate to Charity

Consultation

Would you leave a $150 million estate to your hometown? David Gundlach did. Gundlach made his fortune through the sale of a highly profitable insurance company. He left no heirs and wanted to give his money away. Gundlach left his entire estate to the Elkhart County Community Foundation in Indiana. Not only was this an extraordinary gift in size, but it was very unusual for another reason. Gundlach did not leave any stipulations on the use of the proceeds; the Foundation can use the funds any way it desires. The WSJ profiled Mr. Gundlach and his significant gift last year.

Mr. Gundlach is not alone in leaving a significant gift to charity. Increasingly, we see clients without children of their own looking to leave a lasting legacy through charitable bequests. Rarely do clients leave all of their estate to one charity but rather most clients spread the distribution of their estate across a number of charities. Many clients like to include specific uses for their funds. We regularly see bequests made to educational institutions for scholarships for needy students. Pet charities are a common choice for clients who do not favor any particular educational or religious institutions. For those without a particular charitable objective, a community foundation can be a great choice.

The virtue of a community foundation is the close relationship with the foundation and the local community. Like Elkhart, Indiana, we too have a community foundation in northern Nevada; it is the Community Foundation of Western Nevada (“CFWN”). The CFWN has given over $65 million in grants to our local community since its establishment in 1998. The CFWN manages donor advised funds, scholarship funds, and nonprofit endowments. In addition, the CFWN offers educational workshops, provides hands-on giving experience to high school students, and promotes giving among charitable boards. All of these efforts and programs enhance our community and enrich many lives. If you have charitable desires, there are innumerable ways you can leave your assets to benefit others, even if your estate is more modest than Mr. Gundlach’s.

Bleak House

Bleak House Jarndyce“There are two motives for reading a book; one, that you enjoy it; the other, that you can boast about it.” -Bertrand Russell

As both a lover of great literature and a probate lawyer, I put Bleak House by Charles Dickens on my “to read” list years ago. My father had mentioned it to me several times, noting with amusement that the estate lawsuit at the heart of the novel didn’t end until the money ran out. At 989 pages, it’s not what you’d call a weekend read, but I finally hunkered down and plowed through it. While it is anything but a positive reflection on lawyers and the legal system of nineteenth century England, it is wicked funny and a great read. (Plus, I can boast about it.) G.K. Chesterton is quoted on the back cover as saying it was “Perhaps his best novel…when Dickens wrote Bleak House he had grown up.”

The novel opens on the fog that engulfs the Chancery Court in London where probate cases were adjudicated. The case of Jarndyce and Jarndyce has been in probate for generations; people literally are born into the suit and die before it is resolved. Dickens is pretty vague about the particulars of the case. One character tells us, “‘Why, yes, it was about a Will when it was about anything. A certain Jarndyce, in an evil hour, made a great fortune, and made a great Will. In the question how the trusts under that Will are to be administered, the fortune left by the Will is squandered away; the legatees under the Will are reduced to such a miserable condition that they would be sufficiently punished, if they had committed an enormous crime in having money left them; and the Will itself is made a dead letter.”

Many of the novel’s characters are beneficiaries under the will and spend their lives waiting for the lawsuit to be resolved. One unfortunate young man, Richard, drives himself to an early grave in his obsession to see the suit completed. Miss Flyte, another beneficiary, keeps a series of birds locked up in a cage, intending to let them free when she is free of the lawsuit and receives her inheritance.

Dickens is merciless about the purpose of all the delay: “The one great principle of the English law is, to make business for itself. There is no other principle distinctly, certainly, and consistently maintained through all its narrow turnings. Viewed by this light it becomes a coherent scheme, and not the monstrous maze the laity are apt to think it. Let them but once clearly perceive that its grand principle is to make business for itself at their expense, and surely they will cease to grumble.” Thus, as one character dryly remarks, “Equity sends questions to Law, Law sends questions back to Equity; Law finds it can’t do this, Equity finds it can’t do that; neither can so much as say it can’t do anything, without this solicitor instructing and this counsel appearing for A, and that solicitor instructing and that counsel appearing for B; and so on through the whole alphabet, like the history of the Apple Pie.”

Let’s just say it will not endear you to lawyers or the legal system; but mercifully, the 21st century American probate court little resembles its 19th century English counterpart. Our system is geared toward the timely resolution of disputes; and to the extent it fails, I have found that it is generally because angry litigants—not courts—want to use the legal system to wage Pyrrhic battles.

While the lawsuit in Bleak House forms the backdrop of the case, and gives Dickens the opportunity to train his savage wit on the English legal system, the heart of the story is not really about the lawsuit itself. Bleak House offers a wonderful panorama of characters and richly interwoven plots and subplots. It is partly narrated by Esther Summerson, one of the main characters, an orphan whose family origins are shrouded in mystery. It features unforgettable characters such as Lady Dedlock, the proud and aristocratic wife of Sir Leister Dedlock, who harbors a painful secret; Mr. Tulkinghorn, Sir Leister’s scheming lawyer who spends much of the novel hot on the tracks of Lady Dedlock’s secret, and whose death late in the narrative briefly turns the novel into a murder mystery; and Mr. Skimpole, the financially improvident rascal who remorselessly sponges off others while feigning a child-like innocence about the ways of the world.

Bleak House is well worth putting on your bucket list. And if you don’t want to invest the time reading it, I am informed that it was turned into a brilliant mini-series by BBC, though I have not seen it—yet. I’m putting it on my “to watch” list.

Who Gets Your Property if You Die Without a Will?

natasha_fatalle___boris_badenov[1]In my last installment (Who Is Qualified to Serve as Administrator of an Estate?), I wrote about Boris and Natasha and the Big Fight occasioned by Boris dying without a will. As you may recall, Boris had two adult children from a prior marriage when he married Natasha. He and Natasha had two children before Boris died without a will. His property was substantial and all of it was acquired prior to his marriage. What happened to the property on his death?

The good news is that no one was disinherited, and the property did not escheat to the state. Nevada law provides for property to go to your closest relatives if you die without any estate planning in place. In a community property state such as Nevada, a married person’s property may be either community or separate, or some combination of the two. Separate property is property acquired before marriage, as well as property acquired by gift or inheritance during marriage. All property earned during marriage, or purchased with earnings during marriage, is community property. These characterizations can be changed by a written agreement if the couple wishes.

For Boris and Natasha, all of Boris’s property was separate property and he left no will. Nevada law provides that in such case, the surviving spouse is entitled to one third of the separate property, and—because he had more than one surviving child—the children were entitled to equal shares of the remaining two-thirds. Boris did not put any of his assets into joint tenancy with Natasha, but if he had, Natasha would have succeeded to such assets. Once the estate administration finished, Natasha received one-third of Boris’s assets; the couple’s minor children received one-third subject to a guardianship or trust until they became adults; and Boris’s two adult children received the remaining one-third in equal shares.

‘Decant’ an Irrevocable Trust

Trust DecantIrrevocable may not mean what you think it means when it comes to trust planning.  Thanks to a process known as “trust decanting,” a trustee can change irrevocable trust terms. The decanting process occurs by figuratively pouring the trust assets from an old trust to a new trust agreement.  Just as one decants wine by pouring from an old bottle to a new one, a trustee can move trust assets to a new, more favorable trust. Nevada, along with 20 other states, has very favorable decanting laws in place. 

There are limits as to what can be accomplished with decanting.  Trustees cannot alter a beneficiary’s already-vested interests in a trust.  However, a trustee can push back the age at which the beneficiary receives a payout.  Importantly, the trustee can change the governing law of the trust by moving the situs of the trust.  Nevada is the premier domestic self-settled spendthrift trust state so many trustees look to move their assets to Nevada.  In addition, if there is no successor trustee named, decanting can make it possible to name a proper successor trustee. 

Nevada law is very favorable because there is no statutory requirement to notify beneficiaries of the decanting.  The trustee does not need to provide beneficiaries copies of the existing or new trust documents.  These privacy protections greatly favor the use of Nevada trust laws.  The trustee has discretion to seek court approval for the decanting process but is not required to do so.  In reality, the vast majority of trustees seek beneficiary approval before starting the procedure to decant the trust assets.

There are uncertain implications for gift, income, and generation-skipping transfers taxes. The Internal Revenue Service has not issued guidelines related to the federal tax issues presented by decanting.  However, the IRS has solicited comments for several years now and guidance should be forthcoming.  Even without federal income tax guidance, there are state income tax savings to be achieved by moving trust assets to a state like Nevada without income tax. 

5 Ways to Transfer the Family Business

The following article on business succession planning appeared in the February 10, 2014 issue of Northern Nevada Business Weekly:

JCM ProfileAs a business owner, you will have to decide when will be the right time to step out of the family business and how you will accomplish a successful transition. There are many estate planning tools you can use to transfer your business. Selecting the right tool will depend on whether you plan to retire from the business or keep it until you die.

The transfer can be an emotional minefield where some family members are participants in the business and others are non-participants.  Those participants may feel “obligated” to stay in the family business when they would rather do something else.  In addition, the transfer can be complicated due to estate taxes, gift taxes and capital gains taxes.

Moreover, sometimes the family business is only profitable enough to support one child, even though the non-participants may believe the business’ finances should support them. Or, only some or none of your children may have the abilities or skills to run the business.

Transfer of the family business is further complicated when – as is frequently the case – the family business represents all or nearly all of the parents’ wealth.  Passing the business on to one or more children, while treating all your children fairly, is not easy.

Transparency and communication are vitally important. To achieve the best result, the entire family should receive (1) an explanation of your plan and why you are undertaking a particular strategy; (2) sincere, personal discussions clarifying that you love them equally; and (3) a promise that you are doing your best to be fair to all, while ensuring the future viability of the business.

Here are the 2014 tax exclusion and exemption amounts to consider when analyzing the various alternatives available for the transfer of a family business:

  • The annual exclusion for gifts is $14,000 per donee (meaning husband and wife can each gift $14,000 to a recipient); and
  • The federal gift and estate tax exemption for transfers during life or at death is $5,340,000.

Business sale to the participating child through an installment sale.  This is considered one of the simplest methods of transferring the family business to a child or children.  You can sell shares or partnership interests to a family member.  The benefit of this method is that installments payments can be made over time, which provides an income for you after your retirement. Another benefit is that the purchasing child can better manage his or her cash flow and does not have to come up with a large sum of money at once. However, you will incur capital gains if the business sells for more than what you have invested.    

Gift the business to some children and give cash to the others. Gift taxes are likely to be incurred with this strategy. A more practical concern than paying gift taxes is the fact that you may not have sufficient cash to equalize the value of the business assets going to your other children. This dilemma can be solved with a sizeable life insurance policy which names the non-participant children as beneficiaries. There are various ways to handle the life insurance, including setting up an irrevocable life insurance trust so that the life insurance benefits are not included in your estate for estate tax purposes.

However, if you gift your business, your child will not benefit from the step-up in basis to the current fair market value that is allowed when the business is purchased or inherited. For capital gains tax purposes, your child will step into your shoes and own the business at the basis that you own the business. Assuming the business increases in value over time, your child’s capital gains taxes will be higher. Of course, if the business is never sold, capital gains taxes may not be a concern.

Divide the business: the participating children receive the operating company and the non-participants receive the land and/or buildings used by the business. You could retain the real estate but provide that your children who are not participating in the business inherit it. By retaining control of the real estate during your lifetime, you could collect rent from the operating business to provide income. Later, your children who inherit the facilities could charge rent to their siblings running the operating company. How well your children work together under this strategy depends on family dynamics.

GRAT or GRUT. A more sophisticated business succession tool is a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT). GRAT/GRUTs are irrevocable trusts to which you transfer appreciating assets while retaining an income payment for a set period of time. At either the end of the payment period or your death, the assets in the trust pass to the other trust beneficiaries (the remainder beneficiaries). The value of the retained income is subtracted from the value of the property transferred to the trust (i.e., a share of the business), so if you live beyond the specified income period, the business may be ultimately transferred to the next generation at a reduced value for estate tax or gift tax purposes.

Intentionally defective grantor trust.  Another sophisticated technique is use of an intentionally defective grantor trust (“IDGT”).  The trust is intentionally defective so the grantor pays the income tax on the assets that are no longer considered part of the estate.  You create the IDGT, lend the trust money to buy an asset (the business) you expect will appreciate significantly. In return for lending the trust money, you receive interest payments for a set number of years. The lower the interest rate, the less the trust must repay you — and the more your heirs stand to benefit.