The Best of Both Worlds

When setting up a trust-based estate plan, married couples* in Hawaii have always had to decide what to do about their real property that was held in the special tenancy known as “Tenancy by the Entirety,” or “T-by-E” for short. That was because T-by-E property enjoys special protections, including protection from either spouse’s individual creditors. So if a couple owns property in this manner, and just one of them gets sued or incurs a debt, the creditor cannot place a lien on the T-by-E property, or force it to be sold to pay the debt. There are other special properties of T-by-E ownership as well, and together these properties generally make T-by-E the preferred form of property ownership for most married (or civil union) couples. In fact, in Hawaii, ALL kinds of property – even personal property – can be held as a Tenancy by the Entirety.

But in order to put such property into a trust, and gain all of the benefits that trust planning provides (avoidance of probate, privacy, planning to use both spouse’s tax exemptions fully, providing a smooth transition in the event of death or incapacity), the owners had to give up the benefits conferred by the “T-by-E” tenancy. So couples owning T-by-E property have always had to choose between keeping their property in T-by-E (and risking a probate if they should die at the same time, or if the survivor should die before transferring the property into his or her trust, or creating a ‘Transfer on Death Deed’), and putting it into their trust(s) and losing the special benefits of T-by-E ownership.

But now they no longer have to make such a choice. And if you are in this situation, and previously set up a trust but elected not to put your home or other T-by-E property into your trust (or separate trusts), it’s time to reconsider that choice.

Why the change? Because this summer, our State Legislature passed a new law, which allows T-by-E property to be placed into the owners’ joint revocable trust (or, if they have separate trusts, 50% into each spouse’s or parther’s trust), and KEEP all of the protections afforded by the T-by-E form of ownership. To get the benefit of this new law, certain formalities must be complied with. If you put your property into a trust before July 2012, then you will have to transfer it BACK to your names as a “Tenancy by the Entirety,” and then put it back into the trust, to regain the protections of T-by-E. (But that’s not difficult; both deeds can  be prepared at the same time.) It may be necessary to change the name of your trust, and there is certain language that must be included in the deed in order for the new law to apply.

So, if you have a trust, or have been thinking about getting one, and also own real property here in Hawaii (or in one of the other states that recognizes the T-by-E form of ownership), it is definitely worth looking into this new law that allows you to now have “the best of both worlds.”

*This article also applies to civil union partners (who enjoy all of the legal rights of married couples in Hawaii), and those in “reciprocal beneficiary” relationships.

Hot Off the Presses: 2 New Laws

Hope you are all enjoying this lovely Memorial Day weekend. I am, thanks in part to having just learned about two new laws that have been sent to the Governor for signing. Each of these laws, if passed, will make our planning here in Hawaii much easier.

The first of the two actually solves a common dilemma for married couples (and reciprocal beneficiaries) – whether to continue to hold property as “Tenants by the Entirety,” keeping the creditor protection provided by that type of tenancy, or to put the property into a revocable trust, losing the T-by-E characteristics but obtaining the advantages of the trust. If this law passes, then it will no longer be necessary to choose; a couple will be able to put their “T by E” property into their trust (or even separate trusts), and still keep the creditor protection afforded by the Tenancy by the Entirety form of ownership.  (There are a few ‘hoops’ that have to be ‘jumped through’, however, so it is critical that this be accomplished with the assistance of a knowledgeable attorney – among other things, the trust(s) must be named properly, and there must be special language in the property deed.)

Couples who have already placed their property into trust(s) will probably have to re-deed it back into Tenancy by the Entirety, possibly rename their trust(s), and then put the property back into the trust(s), to get the benefit of the new law. Still, it will be great to have this extra option in our planning toolbox here in Hawaii.

The other new statute is yet another “second try” law, a phenomenon that seems to be getting more common. First there was the Asset Protection Trust law, which was horrible when first passed in 2010, and then not-so-bad after the Legislature fixed it up in 2011. Now we have “Hawaii Estate Tax, Version 2.0,” which seems to fix some of the more complicated and difficult-to-implement (not to mention plan for) aspects of the Hawaii Estate Tax (referred to in a previous post as the ‘Zombie Tax’). Although I have only perused it VERY briefly, and much more study is necessary, its major thrust seems to be bringing the Hawaii exemption in line with the Federal Estate Tax exemption, so that we will once again not be a “decoupled” state. This will make planning easier, as the trust provisions that help married couples eliminate tax on the death of the first spouse will no longer have to take into account a Hawaii exemption that could be lower or higher than the Federal exemption.

Now, if we could just get some certainty and stability in the Federal Estate Tax laws, we might be able to relax a little about all this tax nonsense and focus on what’s really important – helping people pass on their legacies, memories, and values to the younger generations.

 

The Zombie Tax

Years ago, Hawaii had an estate tax, but it was a “pickup” tax – the amount of the tax was offset by an equal credit against Federal tax, so it was not “felt” by the heirs as a separate tax. Then, the credit was eliminated, and the tax went with it.  But in 2010, it rose from the dead, like a zombie, and while it’s not hungry for brains, it IS hungry for a nice, juicy piece of the estate you were hoping to leave to your kids and other beneficiaries.  Here are a few tidbits about this ‘zombie tax’:

– The tax ‘kicks in’ when your total estate (which includes all of the property and assets you leave behind, including your retirement accounts and often the full proceeds of life insurance payable on your death) is valued at $3.5 million or more.

– Although Hawaii has no gift tax, due to a quirk in the way the law is written, your heirs may still end up paying Hawaii estate tax on your lifetime gifts, after you die. So you may have to include those gifts when determining whether the tax will apply to your estate.

– The Federal estate tax now has an exemption of $5 million per person (until 12/31/2012).So, you may not have an estate that is taxable by the IRS, but it may still be taxed by the state of Hawaii.

– Although (until 12/31/2012, if not extended) you may be able to use your deceased spouse’s unused FEDERAL exemption (that is, if he or she used less than the full $5 million exemption when he or she died, before you), there is no such “portability” of the Hawaii exemption. So if a couple does not plan properly, some of their total $7 million Hawaii exemption ($3.5 mil/spouse) could be wasted, and tax paid unnecessarily.

– If you (and your spouse together, if you’re married) have property worth more than $3.5 million, and you have will(s) or trust(s) that were prepared before 2010, your heirs may end up having to pay a hefty Hawaii estate tax if you don’t have your documents REVIEWED and UPDATED to plan for this ‘zombie’ tax.

– Properly drafted documents can help you to avoid any tax (even the zombie tax) when the first spouse dies, and to use both exemptions fully, to avoid paying any unnecessary tax.

– There are ways to avoid or minimize the taxes paid (both Federal and State), even you have a very large estate.

So, if you have not had your documents reviewed by an experienced estate planner in the past two years, you should do it now – or the Zombie Tax may devour your estate!

Hawaii Asset-Protection Trusts, Rev. 2.0

Well, despite having royally screwed it up the first time, it seems the state legislature has finally put together asset-protection trust legislation for Hawaii that is not altogether horrible. Although not quite in the league of Nevada, Alaska or South Dakota, Hawaii’s new domestic asset protection trust will no doubt be appealing to many who would like to have some home-grown protection for their local real property, and perhaps for other assets as well.

The new, improved “Permitted Transfers in Trust Act,” effective July 1, 2011, provides a welcome alternative for Hawaii residents, and non-resident owners of Hawaii real property, who are looking to shelter some of their assets from future creditors. Unlike the prior version of the law (which had much in common with many “1.0” versions of software, i.e., lots of bugs), the new law allows real estate to be put into a Hawaii asset-protection trust; eliminates the requirement that the trust property comprise no more than 25% of the settlor’s net worth; and – most significantly – repeals the 1% tax imposed on transfers into these trusts, which had rendered the prior law “dead on arrival”.

The new law allows the creation of an irrevocable trust, the corpus of which will, after two years, be protected from all new claims against the settlor except for  specified exceptions: alimony or child support; property division on divorce, IF the transfer into trust was made during the marriage or in some cases, within 30 days prior to it; personal injury or property damage claims arising from acts that occurred before the transfer into trust; debts secured (expressly or impliedly, not exactly sure how that will be interpreted) by trust property; and tax liabilities.

The settlor may retain significant powers and rights, including the power to veto distributions, to serve as investment advisor, to replace a trustee or advisor, a testamentary limited power of appointment, the right to all income (or to a unitrust amount not to exceed 5% annually), and the right to distributions in the discretion of the trustee, without losing the desired creditor protection.

Even if creditor protection is not required or desired, a trust that conforms to the statute may be of perpetual duration – thus, obtaining all of the benefits of a trust structure for multiple generations (i.e., a dynasty trust).  Specific allowance is made for the necessary provisions of a QPRT or GRAT, so that those types of trusts can also take advantage of the benefits conferred by the new statute. And, property held by a married couple as ‘tenants by the entirety’ will not lose the benefits of that tenancy when it is put into one of these trusts.

If you are concerned about the vulnerability of your property – including what we all hold so dear, that “little piece of Hawaii” that is our home or our living, in the form of business or rental property – to potential, future claims of creditors, OR if you would like to create a permanent legacy for your family in the form of a dynasty trust, that can carry the benefits of your hard work or good fortune through many generations, you might want to consider setting up a Hawaii asset-protection trust.   It is never too soon to get that two-year ‘statute of limitations’ running!

Is the IRS your favorite charity?

(… or, How to save some of those pesky taxes on IRA conversions, while also benefiting the charities of your choice.)

If you converted some or all of your IRA accounts to Roth IRAs in 2010, or plan to do so this year or in the future, you will be looking at a hefty add-on to your income tax bill in the near future. If you converted in 2010, and accepted the default of deferring the income recognition to 2011 and 2012, you may not have been thinking about those checks you will have to write to the IRS in 2012 and 2013.  But alas, time marches ceaselessly forward, and you’ll soon be feeling that deferred pain.

So, what if I told you that instead of paying all that cash over to the IRS, you could donate a chunk of it to your favorite charity instead?  That you could send it to the Red Cross to help with the Japan relief efforts, to the SPCA to save little puppies and kittens, to an organization that fights cancer, AIDS, or another nasty disease? Now maybe with our deficit being what it is, you might feel OK about sending your check to the IRS. But if you’d rather support your church, school or another tax-exempt charity over the next several years, while getting a hefty income tax deduction now to offset that pesky Roth income, read on.

Death and Taxes

Two things you can’t avoid, or so they say.  We’ll all deal with death someday, and most of us will deal with some kind of tax – if only sales tax. But what’s worse than having them both come together?  First, you lose someone you love; then you have to write a big check to the government because your parent, spouse or other relative actually cared enough to leave you something to help you get by, or to make your life a little easier.

Fortunately, most of us haven’t had to worry about estate or inheritance taxes – for years now, they have only affected those who are pretty well-off.  In 2009, only those with taxable estates over $3.5 million had to pay a tax, and for several years before that, the limit was $2 million. In Hawaii, there has been no estate tax at all since 2005, and even then it didn’t “hurt,” because there was a Federal credit that offset the entire tax paid.  But all that is going to change in 2011. (In fact, some of it has changed already.)

If Congress doesn’t act before the end of the year, beginning on January 1, 2011, a Federal estate tax will be owed by anyone leaving a taxable estate of just

Planning with Retirement Accounts

In recent years, classic pensions (with benefits based on years of service and salary levels only) have become less popular, often being replaced by tax-deferred “defined contribution” plans, such as 401(k) plans, deferred-compensation plans and Individual Retirement Accounts (IRAs).  With regular contributions and smart investment, these accounts can help to ensure a comfortable retirement.  And, unlike a traditional pension, the benefits do not end with the worker’s death; anything left in the account can be passed on, fairly easily, to one or more beneficiaries.

Naming Beneficiaries

Beneficiaries are typically named on a form that you fill out when you first get the account, and you can usually change them later on by filling out a similar form. If you are married, your spouse may have to sign also if you want to name someone else as beneficiary. You may be able to name more than one beneficiary, and indicate the portion of the account that will go to each (so you could split an account between several children, equally or unequally, or give a portion to charity).

If you have completed the forms necessary to name a beneficiary for the account, it’s easy for the beneficiary to claim the account after you die, simply by providing the plan administrator with proof of your death and proof of his or her identity. (For this reason, you should keep copies of your beneficiary designations, and the name and phone number of the plan administrator, in a place where your beneficiaries will be able to locate it quickly after you are gone. If you don’t have this information, you may be able to get it from your employer’s human resources department.)  If you have not named a beneficiary at all (or if the named individuals have died before you), the account will pass to your heirs, but it will take longer and could require a costly probate proceeding.

Even after you have named beneficiaries, it is important to review that information periodically. If your family situation changes (someone dies, marries, divorces, etc.), it is very important to check the beneficiaries of all your accounts (not only retirement accounts, but also “pay on death” bank and investment accounts, and life insurance), and make any necessary changes.  For example, if you divorce but don’t remove your former wife or husband as a beneficiary, he or she may still get the account when you die.

Maximizing the Financial Benefit of Tax Deferral

One of the biggest financial benefits of these retirement accounts is that no tax is paid on the money before it is put in, or on the interest it earns, until a withdrawal is made.  Consider an IRA with a balance of $100,000, earning 5% per year; if no withdrawals are made, after 30 years the balance will have grown to over $430,000.  (By way of comparison,

Worm food… or ‘crispy critter’?

OK, I admit, these terms are our mom’s perennial attempt at humor whenever we bring up the subject of what we want to happen to our mortal remains once we have shaken them off. In other words, burial or cremation?  And more interesting, from the lawyerly perspective, WHO gets to decide, and what if there’s a dispute?

I recently set out to find Hawaii’s answer to that question, since it differs from state to state. In NY, for example, as in many states, there is a specific statute that determines who has the right to determine the disposition of a dead body. I had a chance to become very familiar with that statute when working on a case (Maurer v Thibeault) where the decedent’s husband – who was under suspicion of having murdered her – wanted her body cremated and scattered on “their” farm, while her mother insisted that she would have wanted to be buried in the family plot, with her father, and as far away from the ‘estranged’ husband as possible.  The court found that this situation provided an exception to the general rule (in NY) that one’s spouse gets the final say, and allowed the mother to carry out her plans. (The husband was later convicted of having murdered his wife, and sentenced to 25 years to life; an appeal was taken and the conviction was affirmed.)

Back to Hawaii – where, my research revealed, there is no statute governing this issue. Nor does there seem to be much (if any) Hawaii case law on the subject. So where does that leave us?

Well, it leaves us with the general common law, which Hawaii courts tend to follow in the absence of other precedent. In this case, before states began to enact statutes governing the issue, there does seem to have been a general consensus that

What’s a trust, and why you might want one

A will determines ‘who gets what’ after you die, who is ‘in charge’ of handing it out (and paying your debts, taxes, etc., and all the other things that have to be done to tie up your affairs), and sometimes, who will be guardian of your children. A trust can do much more than that.  A ‘living trust’, which is a trust set up while you are still alive, can give someone the right and authority to manage your affairs while you are still alive (if you can’t, or don’t want to), and can make the transition of wealth and control easier and less costly when you die.  A living trust or a ‘testamentary trust’ – one set up by your will, that doesn’t come into existence until your will is probated after your death – can control not only who gets what, but WHEN they get it, and under what circumstances. Trusts can be used to transfer wealth while you are still alive, or upon your death.  They can provide for ongoing management of funds by skilled, careful individuals, for the benefit of others who might not possess the ability or control to act prudently. Some kinds of trusts can be used to save taxes, or to protect someone’s right to receive government benefits such as Medicaid or SSI. Trusts can sometimes be used to protect assets from creditors, including ‘involuntary creditors’ such as future ex-spouses, and lawsuit plaintiffs.  Trusts may avoid court involvement in the transfer of wealth, making it easier and less expensive.

So what IS a trust?

A trust is an arrangement whereby one person or entity, the “trustee,” is given title to and control over some assets (the “trust property”), which are to be invested, used, and distributed for the benefit of one or more other people (the “beneficiaries”). The trust document lays out the “rules” for how the trustee is to hold, invest, manage, and distribute the trust property. The trustee has a “fiduciary duty” – a very strict,

You can’t fix the roof when it’s raining…

… and you can’t do much to protect your assets from creditors after you’re already in financial trouble. But just like the fellow who never thought about his leaky roof when the sun was shining, many of us never consider our potential vulnerability when things are hunky-dory.  With a little planning during sunny times, though, your assets can be made much less vulnerable to judgments resulting from unanticipated lawsuits, downturns in the market leaving you “upside down” in real estate investments (and thus subject to deficiency judgments), or unexpected medical bills.

There are some viable asset protection mechanisms available, but the key is to take steps to protect your assets when you are not in, or even anticipating, any financial trouble.  If you are already in trouble with the tax man, falling behind in your payments, or have just been involved in a car accident, it’s probably TOO LATE to obtain any substantial protection.  Any attempt to shift ownership or control of assets at that point can probably be set aside by a creditor as a “fraudulent transfer”.  In most states, it is safest to take asset protection steps at least