Friday, December 11, 2009

Know the Value of Your Business!

For many owners of closely-held businesses, their business is by far their most valuable asset. Given that both the federal and New York State estate tax seem destined to be with us for the foreseeable future, it is imperative that owners of valuable business interests carefully consider the potential impact of estate taxes on the survival of their business to the next generation.

Business interests – typically in the form of closely-held stock or limited liability company interests – are inherently illiquid. But when a business owner dies, the fair market value of such business interests will be included as an asset of the owner’s estate, notwithstanding such illiquidity. To satisfy the IRS and New York State that the business is valued accurately, the value of the business interest should be determined by an independent business appraiser. If the value of the business interests combined with the business owner’s other assets exceeds the estate tax exemption amounts – presently $3.5 million under federal law, $1 million for New York State – then property in excess of those amounts that pass to someone other than a spouse will be subject to estate tax. If the estate does not have liquid assets to pay the tax, then the heirs could be in a real bind. Estate tax payments are payable – in cash – within nine months after death. If not timely paid, significant penalties and interest will accrue.

Take the following example: In 1967, Louie Lucky started a medical supply business – Lucky Louie’s Medical Supply, Inc. (the “Corporation”). Over the years Louie’s business grew into a regional powerhouse. Like many owners of closely-held businesses, Louie poured most of his profits back into his business. When Louie turned 65, his business attorney and CPA advised Louie that he needed to do some serious estate planning. Louie brushed them off and found an excuse to change the subject.

Louie had married his high school sweetheart, Mary, in 1965. When Louie began the Corporation, his attorney issued stock certificates in Louie’s name only. Louie and Mary had three children, Robert, Michael and Nancy. Of the three children, only Robert worked in the business, starting as a salesman and eventually moving into a management role.

In 2005, Mary died suddenly of a stroke. Louie began taking a less active role in the business, with Robert assuming day-to-management of the company. Louie, however, retained all the stock in the Corporation. Despite Robert’s frequent nagging, Louie never got around to working out a business succession plan.

Louie died of a heart attack in 2009. His assets include a home in Orange County worth $500,000; a brokerage account with $500,000 in stocks and bonds; bank CD’s worth $300,000; and his stock in the Corporation. Louie’s will, which he signed in 1990, provided that if Mary predeceased him, all of his assets were to pass among his three children in equal shares. In his will Louie named Mary as the primary executor, with Robert and Michael to serve as successor co-executors.

The attorney retained to help administer Louie’s estate advised Robert and Michael that they needed an appraisal of Louie’s stock in the Corporation to determine the amount of estate taxes to be paid. The appraiser came back with stunning news: Louie’s 100% interest in the Corporation was worth $8 million. Combined with his other assets, Louie’s taxable estate was worth $9.3 million.

Since Mary had predeceased Louie, there was no opportunity to take advantage of any portion of the “unlimited marital deduction.” Accordingly, the full value of Louie’s estate was subject to estate tax. Michael, Robert and Nancy were astonished to learn that the combined federal and New York State estate tax on a $9.3 million estate for a decedent dying in 2009 is $3,633,260.
Since Louie had only $800,000 in liquid assets at the time of his death, the children faced a liquidity shortfall of approximately $2.8 million needed to cover the estate tax. Even if they could find a buyer for the Corporation after Louie’s death, they would almost surely have to sell it at a “fire sale” price in order to timely pay the tax within the nine months of Louie’s death, and Robert’s dream of continuing his father’s legacy would be shattered.

Thursday, November 19, 2009

Federal Estate Tax Developments

It is being reported that Democrats on the House Ways and Means Committee are proposing a one-year extension of the existing Federal Estate Tax levels, which would result in a $3.5 million per person exemption in 2010, rather than a one-year repeal of the Federal Estate Tax that is currently scheduled to take effect come January 1.

The plan is to apparently put the stop-gap extension in place during 2010 while a more significant tax code overhaul -- including a more permanent solution to the estate tax issue -- is taken-up by Congress. It is expected that the estate tax extension bill will be brought to the floor of the House after Thanksgiving.

Most estate planning practitioners had anticipated that 2009 would have seen a significant tax code revision including modification (but not repeal) of the existing estate tax legislation, but the health care reform debate has put this issue on the back-burner.

Why Good Documents Alone are Never Enough

I recently met with three brothers whose mother died this past spring. Their father had died in 2002. In 2000, their parents – who I’ll call Robert and Sandy Jones -- had completed an estate plan that included a joint revocable living trust. Most of their assets – which were comprised primarily of residential and commercial property worth approximately $1.25 million in 2000, plus a brokerage account worth about $150,000 – were “funded” to the trust by retitling the assets in the name of the revocable trust.

One can only assume what the Jones’ goals were, but experience tells me that there were probably two objectives:
probate avoidance and estate tax protection. In the end, neither objective was satisfied.

The first critical omission was the failure to properly apportion the assets funded into the joint trust between Mr. and Mrs. Jones. While joint revocable trusts are certainly valid in New York, to be fully effective the funded assets most be specifically allocated between the spouses. This is done by dividing the previously jointly-owned assets equally between the husband and the wife, and specifically identifying each spouse’s assets contributed to the trust on schedules appended to the trust. In this particular case, the schedules that were supposed to identify each spouse’s “portion” of trust assets were left blank.

When Mr. Jones died in 2002, Mrs. Jones probably assumed that since the trust already owned all the assets, there was nothing for her to do. She probably believed that her estate planning was a success, as she was able to avoid having to probate Mr. Jones’ estate since he owned no assets in his name alone. And, since the joint trust provided that upon her death, the trust assets would pass equally among the three sons as she desired, her estate planning was “done”.

Unfortunately, the absence of continued professional involvement with Mrs. Jones’ planning led to unintended results. Under the terms of the joint trust, upon Mr. Jones’ death “his” share of the trust assets was supposed to be funded into a “Family Trust” for Mrs. Jones’ benefit. Assuming a total estate value of $1.4 million in 2002, approximately $700,000 of assets – comprising one-half the interests in the real estate, plus one-half the assets in the brokerage account – should have been retitled in the name of the “Robert Jones Family Trust.” Mrs. Jones and her sons were to have been the Trustees of the Family Trust.

Between Mr. Jones’ death in 2002 and Mrs. Jones’ death in early 2009, Mrs. Jones acquired additional assets, including a vacation home in Florida. The newly acquired assets were titled in Mrs. Jones’ name alone, rather than to her “survivor’s trust” portion of the revocable trust. By the time of her death, her total estate – both the trust assets and the assets in her own name – were worth $1.8 million.

Since Mrs. Jones owned assets in her own name, the Jones’ three sons had to commence a probate proceeding in Orange County Surrogate Court to obtain “Letters Testamentary” that provided them with administrative control over Mrs. Jones’ investment and bank accounts, and most of the probate assets. However, because Mrs. Jones owned the Florida home in her name alone, there will need to be an “ancillary” probate proceeding in Florida, necessitating the hiring of a Florida attorney, and additional legal expense.

I had the sad duty of informing the Jones’ sons that, because their father’s Family Trust had not been funded at the time of his death in 2002, Mr. Jones’ estate exemption on the one-half of the trust assets that should have been allocated to the Family Trust was forfeited. Accordingly, the entire $1.8 million of assets owned by both the trust and in Mrs. Jones’ name at the time of her death are includable in Mrs. Jones’ taxable estate. Since New York’s estate tax exemption is capped at $1 million, the “extra” $800,000 that would otherwise have been owned in the Family Trust is fully taxable, resulting in a New York State estate tax obligation of approximately $85,200.

The moral of the story? Simply having good estate planning documents is not enough. Your estate planning must be regularly maintained and monitored to assure that all your goals can be satisfied both during your lifetime and after your death.

Sunday, November 1, 2009

Buy-Sell Agreements for Closely Held Businesses: Disability and Retirement

In a recent post I described why closely-held business owners need a “buy-sell” agreement to provide for the orderly disposition of a business owner’s interest in the business upon his or her death. Absent a buy-sell agreement, a deceased business owner’s interest in the business might well end up passing to a surviving spouse or children who have no involvement in the business. Bringing in “outsiders” to participate in an operating business is almost always a recipe for disaster.

While most of the focus in drafting a buy-sell agreement tends to revolve around the “death” issue, it is equally important that the agreement take into account other critical life events such as disability, retirement and sales of business interests to third parties.

According to the National Underwriter, a 42-year old is four times as likely to become seriously disabled then they will die during their working years. Most business owners I know work long hours, and if a closely held business were to lose the services of one of its key players for any significant period of time, the business’s operations would be severely hampered. The owners of a closely-held company should ensure that disability coverage is in place covering each of the owners. Such insurance might provide, at minimum, that income “lost” because of the absence of an owner due to disability is available to business to cover overhead. The firm’s buy-sell agreement can provide that the non-disabled owners would have the option to purchase the interest of a permanently disabled owner, and disability insurance can be obtained to help fund the purchase of those interests. Even if disability insurance has not been obtained, the cash value of any life insurance on the life of the disabled owner may be used to fund the buy-out. None of these options are possible, however, unless the buy-sell agreement has been drafted to include specific disability buy-out provisions.

It is also critical that in drafting the agreement the business owners address the common situation where an owner retires or otherwise leaves the business. I have seen many agreements incorporate a loosely based definition of “retirement” that essentially allows a business owner to walk away at any time, and requires the remaining owner or owners to immediately purchase the departed owner’s interest. Not only might the remaining owners have to come out of pocket with significant amounts of cash – or be burdened with large promissory note payments if the agreement provides for installment payments – but they must do so at a time when the business has lost the services of a key person. Properly counseled, very few business owners would opt for such a result.

One solution might be to permit a “retirement” only if an owner reaches certain milestones (for example, attaining the age of 62 with a minimum of 20-years service). The buy-sell agreement might specify that an owner who departs the business prior to the stated retirement milestones might have no ability to sell his interests to the other owners or to any third parties. Or, the agreement could specify that the remaining owners have the option to buy-out the departing owner, but are not obligated to do so if the economics do not make sense. Language can be included that provides that an owner who leaves prior to the “permitted” retirement date would not share in the appreciation of the business if it is sold to a third party at some future date, and might in fact be required to take less than the fair market value of their interest (valued as of the date of their departure) if the business’s value subsequently declines. This mechanism is designed to protect the remaining owners if the value of the business suffers as a result of the lost services and good will attributable to the departed owner.

Another important consideration in buy-sell planning is determining when, if at all, that an owner can sell his interest to someone other than another current owner. Owners in most closely-held business wish to restrict any sales to third parties except if the remaining owners unanimously agree to such a sale. While such restrictions impair the liquidity of an owner’s interest, they also ensure that all owners will be “partners” only with those persons with whom they are comfortable working.

The buy-sell agreement should also include address the concepts known as “tag along” and “drag along” rights. “Tag along” rights protect minority owners in circumstances were the majority owners contract to sell the majority interests to any third party. A tag along provision might provide that the majority owners can only sell their interests to third parties if minority owners are afforded the same sale rights and at the same sale price per share. Under a “drag along” provision, if the requisite percentage of ownership interests required under the buy-sell agreement vote to sell the entire company or its stock to a third party, then owners of the minority interests would be obligated to participate in the sale.

Buy-sell planning presents many unique challenges and opportunities. Successful planning requires that business owners commit the requisite time and resources necessary to engage in thorough discussions with their professional advisers. A well-designed buy-sell agreement can ensure that the business will survive beyond the current ownership group. But if a business has a poorly designed agreement – or like too many businesses, no agreement at all – then that business’s long-term survival will be questionable at best.

Monday, October 5, 2009

The Brooke Astor Fiasco

While it is not unusual for family members to fight over a deceased relative’s estate, it is rare to see a will contest result in a criminal prosecution. But that is exactly what has played-out this summer in a Manhattan courtroom as Anthony Marshall and his attorney, Francis Morrissey, are being tried for defrauding the estate of Marshall’s mother, socialite Brooke Astor, out of millions of dollars that prosecutors say Mrs. Astor had intended to go to numerous charities.

Mrs. Astor, who died in 2007 at age 105, was diagnosed with Alzheimer’s disease in 2000. Known as “the First Lady of Philanthropy,” Mrs. Astor had executed numerous wills over the years designating a significant portion of her estimated $187 million estate to go to a charitable trust. Marshall, her only child, was slated to receive in excess of $20 million.

Prosecutors allege, however, that Marshall decided that sum was insufficient to support his and his wife’s extravagant lifestyle. So, in early 2004 – and notwithstanding that his then 102 year-old mother had been suffering with Alzheimer’s for at least four years -- Marshall brought in a new attorney to draft a “Codicil” (e.g. an amendment) to Mrs. Astor’s will. The attorney (a well-known Manhattan trusts and estates attorney) drafted the Codicil without having met Mrs. Astor, and met with her for only about 15 minutes during the will execution ceremony. Nonetheless the attorney (who allegedly pocketed $1.7 million in legal fees) testified that Mrs. Astor was in fact competent to sign the will at that time, notwithstanding her advanced age and her prior Alzheimer’s diagnosis.

Regardless whether this case results in any convictions, the tawdry affair has been a boon to the tabloids, but an embarrassment to Mrs. Astor’s family and many of the professional advisers who participated in the events in question. The attorney who drafted her final will in 2004 has been criticized for apparently giving little consideration to Mrs. Astor’s obviously deteriorated mental condition and advanced age. Given that he was brought to the scene by a beneficiary who stood to gain millions from the change in the will, the attorney had a duty to conduct sufficient due diligence to determine Mrs. Astor’s capacity to sign a new will. It seems especially damaging to the attorney’s credibility that he stood to earn almost $2 million for his work on what appears to have been a fairly simple Codicil to the will.

Despite her millions, Mrs. Astor does not appear to have been well-served by her advisers. The current criminal case, as well as the previously well-publicized guardianship dispute between her son and grandson, revolves around Mrs. Astor’s mental competency and her ability to manage her affairs. Imagine that instead of relying upon a will-based estate plan that while she was in her 70’s or 80’s – and when there was no question regarding Mrs. Astor’s competency -- Mrs. Astor had executed a living trust agreement that included a “Disability Panel” designated to determine her mental capacity on an ongoing basis. The Disability Panel would have likely included her personal physician, her son, and one or more other close friends or relatives. As Mrs. Astor’s Alzheimer’s became more acute, the Disability Panel would have sprung into action to shift legal control of Mrs. Astor’s affairs from herself to her personally-designated successor Trustees. Once the panel had declared her “disabled” – which almost certainly would have occurred prior to the 2004 Codicil – it would have been virtually impossible for Mrs. Astor’s son to enrich himself by arranging for Mrs. Astor to modify her estate plan as provided by the 2004 Codicil.

You certainly don’t need Mrs. Astor’s millions to design an effective estate plan that incorporates comprehensive disability planning as well as death planning. But, you do need to work with an attorney who is as focused on planning for lifetime disability issues as on death planning.

Friday, September 11, 2009

New York's New Power of Attorney -- A Radical Change

On January 27, 2009, Governor Patterson signed into law a bill that radically overhauled the traditional New York “short form” statutory Power of Attorney (“POA”). The law, which went into effect on September 1, 2009, requires greater formality for signing the new POA than was required under the prior statute.

Some of the changes incorporated in the new statute include:

• A requirement that the designated agent or agents execute an acknowledgment of appointment that is contained within the POA in the presence of a Notary Public. The agent’s need not sign the POA at the same time that the principal signs, but the POA will not be deemed valid, and therefore cannot be used, until the agent has duly executed the acknowledgement.
• A requirement that the POA include a written notice to the agent explaining the scope of the agent’s fiduciary responsibilities. The POA also includes a warning to the agent that the agent may be liable for a breach of his or her fiduciary responsibilities.
• To limit perceived abuses by agents in making gifts of the principal’s assets to themselves or third persons under the prior statutory form, the new law requires that in any circumstance where the principal wishes to authorize an agent to make gifts of the principal’s assets, in addition to signing the new POA form, the principal must execute an optional document called the “Statutory Major Gifts Rider” (“SMGR”). The principal will need to carefully review the SMGR to determine which types of gifting authority, if any, that the principal wishes give the agent. In order for the agent to have each type of gifting authority, the principal must initial the corresponding section. For example, the principal must specifically initial a provision authorizing an agent to change beneficiary designations for life insurance policies and retirement plans if the principal desires that the agent have such authority. In addition, the principal must sign the SMGR, and his or her signature must be notarized and witnessed by two people not appointed as an agent.
• An optional provision for designation of a “monitor” to oversee the agent’s actions.
• Authorization to provide “reasonable compensation” to the agent for his or her services.
• Specific directions for revoking the POA.
• Expansion of the class of “financial institutions” that are required to accept the POA absent “reasonable cause.” Previously, the term “financial institutions” was limited to banks, but it now includes securities brokers, securities dealers, securities firms and insurance companies.

Many concerns remain among attorneys regarding how the new form will work in practice, and whether the new POAs will be readily accepted by financial institutions. As events unfold, we will keep readers informed regarding the effectiveness of the new POA

Sunday, September 6, 2009

Buy-Sell Agreements: Planning for a Business Owner's Death

In 1968 high school friends Sam and Larry started their plumbing supply business, Drainco Plumbing Supply, Inc., with the modest goal of providing a nice life for their growing families. Through hard work and good business sense, by 2009 Drainco Plumbing Supply – which now employs 35 people, including one of Sam’s sons and one of Larry’s daughters – has grown to be worth $10 million.

But Sam and Larry’s success comes with strings attached. Like most owners of successful closely-held businesses, the value of their business interests is by far their largest asset. Since the asset is illiquid, a premature death can prove disastrous, as the owner’s estate will need to pay what might be a substantial federal and New York State estate tax – in cash -- within nine months of the owner’s death. If there is insufficient cash to pay the tax, either the estate will need to sell the deceased owner’s interest in the business at a “fire sale” price, or pay the tax late with substantial penalties and interest. Tax issues aside, without planning a partner’s unexpected death may create a situation where the remaining owner is now a partner with the deceased owner’s widow, who may well have no experience with, or interest in, the business.

To ensure the preservation of the equity of their business as well as their legacy, business owners must plan ahead for the inevitable day when they will “leave” the business – whether vertically or horizontally!

All closely-held businesses should have a formal plan to ensure the preservation of the business upon an owner’s death. The Buy-Sell agreement is the planning tool used to provide the “road map” to address various contingencies such as the death, disability, or retirement of an owner, and those circumstances (if any) when an owner can sell their interests in the business to a third party.

Sam and Larry need to take time from their busy schedules and sit down with their attorney, accountant and insurance professional to devise a strategy to address the various life events that are part of any solid Buy-Sell agreement. A fundamental component of any Buy-Sell agreement is inclusion of a mechanism to provide for the disposition of an owner’s business interest upon death. A common scenario would be for Sam and Larry to purchase life insurance on each other’s life in a cross-purchase arrangement, with a death benefit equal to at least the value of each owner’s interest in the business. Since closely held businesses are often difficult to value, Sam and Larry are well-advised to use a business valuation specialist to determine the business’s actual value so that the appropriate amount of insurance can be purchased.

In a cross-purchase agreement, each owner is contractually obligated to purchase from the deceased owner’s estate (or trust, if applicable) the deceased owner’s interest in the business. In the event of Sam’s death, the business would need to be valued to determine the value of Sam’s interest in the business at the time of his death. Larry would use the life insurance proceeds from the policy he owns on Sam’s life to purchase Sam’s interest in the company from Sam’s widow, Sarah. If the life insurance is insufficient to pay the full amount of Sam’s interest in the company, the agreement should provide a mechanism – typically in the form of payments over a period of years pursuant to a promissory note, secured by Sam’s stock – to pay the balance of the purchase price to Sarah.

To help prevent a scenario where too much of the purchase price must be paid for via installment payments, it is critical that the owners’ assess their company’s value periodically, and increase the amount of life insurance on each other’s lives if feasible.

In businesses with three or more owners, it may be unwieldy to use a cross-purchase arrangement, as each owner would need to own a policy insuring the life of each other owner. An alternative to the cross-purchase arrangement is a redemption agreement in which the business entity (i.e., the corporation, LLC, etc.) is the owner of the insurance policies insuring the lives of each owner. Upon the death of an owner, the entity uses the life insurance on the deceased owner’s life to purchase from his or her estate the deceased owner’s business interest. For example, assume Drainco Plumbing Supply has a third shareholder, Kurt, with each shareholder owning 33 1/3 of the company stock. Upon Sam’s death, Drainco Plumbing Supply would purchase Sam’s stock from his estate. Larry and Kurt will now each own 50% of the remaining issued and outstanding stock in Drainco.

A third alternative is the hybrid, or wait and see arrangement. In a hybrid Buy-Sell agreement, the corporation has the first “option” to purchase a deceased shareholder’s stock. If the corporation does not exercise the option, then the remaining owners will have the option to purchase the deceased owner’s stock. If the individual shareholders do not exercise the option, then the corporation will typically be required to purchase the stock.

The hybrid agreement has gained greater usage over the past few years, as it affords greater flexibility to address the different tax impact of a corporation’s purchase of an owner’s stock as opposed to a purchase by the individual shareholders. Regardless of the structure used for the agreement, competent tax assistance is a must to ensure the best results.

Saturday, August 29, 2009

Uncivil Society?

There is something rotten in the air. Spend a few minutes listening to talk radio, surfing the political blogs, or watching cable news, and it is undeniable that hatred and anger is on the rise, and seemingly spiraling out of control. Both the extreme right and the extreme left share in the blame. But just as much at fault are our political "leaders" who stand by silently (or even worse, offer encouragement) when some nut-job spouts hateful rhetoric.

Just a few days ago, video surfaced from yet another Town Hall meeting, this time hosted by Wally Herger, a non-descript Congressman from California. An audience member proudly announces that he's a "proud right-wing terrorist" and goes on to spout the typical anti-government nonsense. So does the esteemed Representative chastize this creep for his hate-mongering? Does he report him to the FBI? To the contrary, Herger praises the self-proclaimed "terrorist," saying, "Amen, God bless you," and then telling the audience, "there is a great American."

Looking back on our history, it seems we are heading back to the days of the "Know Nothing" party from the 1840's and 1850's. There's little room for reasoned and rational political discourse, just a lot of noise and sound bites designed to frighten those too lazy or ignorant to think for themselves. And if we insist on electing lightweights the likes of Wally Herger to positions of power, we only get what we deserve.

Sunday, August 23, 2009

Health Care -- Facts and Lies

I have no idea if the health care legislation proposed by President Obama would be truly effective, and those who are skeptical may be correct that the plan would do little if anything to improve our health care system, lower costs, or achieve either objective.

But the hysteria seen in the Town Halls and on talk radio would be laughable if it weren't so dangerous -- and disingenuous. Having counseled seniors and baby boomers regarding end-of-life issues for the past 15 years, my experience is that all clients have an opinion regarding their preference for end-of-life care, and they are eager to sign living wills and health care proxies to effectuate their personal desires. The proposed legislation provides a forum for discussing end-of-life care for those who haven't addressed this issue previously, and would help avoid another Schiavo fiasco.

Also, those railing against "rationing" under any new system are either blind to the fact -- or consciously ignoring the truth -- that under our present hodgepodge system, rationing already occurs. Anyone who has dealt with an insurance company in trying to obtain approval for a course of treatment that the insurer considers outside the standard protocol recognizes this reality.

Having for the past decade served on the Board of a not-for-profit hospital, I have seen first-hand that our present system too often rewards procedures -- that is, payment-for-testing -- rather than successful outcomes. It is analogous to the situation in the legal field, where billing by the hour provides a perverse incentive for the attorney by rewarding inefficiency and punishing a successful result achieved expeditiously.

To be fair, I do believe that some type of tort reform should be part of any health care overhaul, and I fault the Democrats for not showing sufficient courage to incorporate tort reform in the proposed bill.

I don't profess to have the answers for our health care system. But I do know that what we have in place today is unmanagable and unsustainable, and far too many people remain uninsured. Given how far the United States lags behind other industrialized nations in terms of both costs and outcomes, there is no question that change in some manner is long overdue.

Friday, August 21, 2009

Focusing on the Results, not the "Documents"

For the past decade I've been fighting the same fight: namely, getting clients to stop thinking of their estate plans in terms of the type of documents they need -- e.g., "I need a will," or "I need a trust" -- and instead shifting the focus onto the client's goals and objectives. Once the goals and objectives have been thoroughly discussed between the attorney and the client, then an effective estate plan can be designed to meet the client's needs. The various legal documents are simply tools in the lawyer's toolbox for meeting the clients objectives. The attorney's real value is in helping the client understand the implications of the planning as it fits the client's particular family and financial situation, and then in crafting the appropriate planning tools to realize the client's desires.

Here's an analogy: assume you are hiring a contractor to build a house. Do you simply tell the contractor to start building the house as he sees fit, but to be sure to use only Phillips head screwdrivers a Husqvarna electric saw, etc.? Of course not; you would surely have a blueprint of the house prepared by an architect or similarly qualified source, and would rely upon the contractor to use appropriate tools to get the job done right.

Well, in a "traditional" estate planning scenario, clients seem to assume that they know the appropriate "tools' to use for the planning, rather than relying upon the attorney to use his or her professional expertise to select the proper planning tools. Just as absurd, in traditional estate planning, experience tells me that the attorneys all too frequently fail to provide adequate counseling to the clients to structure an appropriate estate plan for that particular family; instead, the attorney acts as a mere "scrivener" in producing a "word processed" estate plan.

Sunday, August 16, 2009

The Federal Estate Tax: Coming Down to the Wire

Back to blogging after time for some travel (business and pleasure) and catching up at work. As August reaches the half-way point (and it's finally hot), it's time to take stock of the state of the federal estate tax law. While healthcare reform is dominating the news, when Congress returns from the August recess, estate tax reform will almost certainly be on the agenda.

In 2009, the federal estate tax exemption is $3.5 million. That is, upon death every person can pass $3.5 million of assets to non-spouses free of federal estate tax. Assets in excess of $3.5 million are subject to tax at a rate of 45%. Many states, including New York, have separate state estate taxes; New York only permits $1,000,000 of assets to pass to heirs free of estate tax.

Under both state and federal law, an unlimited amount of assets can pass from a deceased spouse to his or her surviving spouse under a rule known as the unlimited marital deduction. However, upon the second spouse's death, all of that spouse's assets in excess of $3.5 million are taxable, including assets inherited from the first spouse to die. Essentially, a direct transfer of assets to a surviving spouse results in the "forfeiture" of the estate tax exemption of the first spouse to die.

Preserving the exemption for the first spouse to die is rather simple. An amount equal to the estate tax exemption (e.g., $3.5 million) can be funded into a credit shelter trust for the benefit of the surviving spouse and, if desired, other beneficiaries such as descendants. The surviving spouse can be the Trustee of the credit shelter trust; the spouse can be entitled to income from the trust, and principal distributions of any amount can be made to the surviving spouse or other beneficiaries for "health, education, maintenance and support." Maintenance and support are very broad terms and essentially mean that distributions of principal may be made for any need to support the beneficiaries' needs, including vacations, homes, cars, and the like. If that isn't enough, the credit shelter trust may be drafted to grant the surviving spouse a "5 x 5" power that permits the spouse to invade the principal of the trust for any purpose in an amount not to exceed the greater of $5,000 or 5% of the trust principal (typically valued as of December 31 of the prior year).

But all that may change dramatically come 2010 if Congress does not act. Under the existing estate tax legislation passed in June 2001, the federal estate tax is repealed for one year only; that is, assets of any amount may be passed upon death to both spouses and non-spouses free of federal estate tax. A downside of the existing law is that while the estate tax would be repealed in 2010, the current unlimited "step-up" in basis for inherited assets will also be repealed, with only $1.3 million of assets to be eligible for a full step-up in basis ($4.3 million if there is a surviving spouse), with any "excess" assets to be transferred at a "carryover" basis.

This rule has been tried once before in the mid-1970s and was quickly repealed as unworkable. Imagine trying to determine the basis of old AT &T stock purchased 50-years ago that has since split multiple times and been spun-off into numerous successor companies. The complexities of trying to determine cost basis of a decedent's assets will surely drive-up the costs of estate settlements and lead to howls of protest.

So with all the uncertainty, what's Congress likely to do? Given the timing, the current assumption is that while Congress wrestles with a long-term solution, it will extend for at least one year the current $3.5 million estate tax exemption, along with the unlimited step-up in basis.

Two of the most likely long-term proposals include:

1. "Freezing" the exemption at $3.5 million with a maximum tax rate of 45%, but also indexing the exemption for inflation; the proposal would also "reunify" the estate and gift tax credits (currently the lifetime gift exemption is $1 million), and permit "portability" of the estate tax exemption from one spouse to the other. However, the proposal would place limits on "valuation discounts" for planning vehicles such as "family limited partnerships" that are frequently used by high-net worth individuals to minimize estate and gift taxes.

2. Making permanent the exemption level at $2 million, indexing that level for inflation, and establishing progressive tax rates of 45 percent for estates valued between $2 million and $5 million; 50 percent for estates valued at $5-to-$10 million; and 55 percent for estates valued over $10 million. This proposal also includes reunification of the estate and gift tax exemptions and "portability" between spouses.

As Congress tackles this issue this fall, I'll keep my readers posted as to breaking developments.

Saturday, August 1, 2009

The Myth of Corporate Asset Protection

Most small to medium sized businesses are established as corporations. Many if not most of these businesses have just a few shareholders. For the principal owners of many closely held businesses, the corporate stock is far and away their largest single asset.

The corporate structure is touted to business clients by CPA's and attorneys to satisfy a number of objectives, but particularly as a means to protect the shareholders' assets. On a prior blog post, I recently discussed hearing a radio advertisement directed to the general public encouraging the use of corporations for asset protection purposes.

Unfortunately, the business owner who relies upon his or her corporation to protect their assets from creditors may be in for a rude surprise. While a corporation will shield the individual shareholder from liability against the corporation's creditors, the corporation will not protect the shareholder's stock -- which in almost every instance is considered personal property of the shareholder -- against claims from the shareholder's own personal creditors. We refer to this scenario as reverse veil piercing. Let's look at an example of the danger this type of exposure may pose:

Lou owns 100% of the stock in a plumbing supply company located in Orange County. Through hard work, integrity and good business practices, the value of Lou's company -- and the value of his stock -- has grown to $7 million. Lou is 63, and he is looking forward to being able to sell his business to a larger regional competitor and finally enjoy the fruits of his labor.

One day Lou and his wife, Monica, are babysitting for their 7-year-old grandson, Dylan. Having the attention span of a typical 7-year-old, Dylan leaves his skateboard by the front steps. Minutes later Lou's neighbor, Frank, comes by to drop off a flyer about the upcoming neighborhood block party. Frank is an orthopedic surgeon just entering the prime of his earning years. As he makes his way to the stairs of Lou's house, Frank trips over the skateboard and suffers a fractured vertebrae, leaving him paralyzed from the neck down.

After a trial, a jury awards Frank a $10 million judgment against Lou and Monica. Even with their $2 million umbrella insurance policy on top of their $1 million homeowner's liability insurance, Lou and Monica will still owe Frank $7 million to satisfy the judgment.

Well, at least Lou's corporation will protect his $7 million worth of assets in that business, right? Not so fast. All of Lou's personal property -- including his stock in his company -- can be seized by Frank to satisfy the legal judgment. Once Frank takes ownership of Lou's stock, Frank can appoint himself to the Board of Directors, fire Lou as President, and sell the company or its assets. Lou would end up seeing his entire life's work dismantled in a flash.

So, what could Lou have done differently to truly protect his business assets from his personal judgment creditors? Lou could have established his business as a limited liability company, or "LLC." LLC's were first created in Wyoming in 1987, and have since been statutorily approved in every state. Under the laws of many states, a judgment creditor cannot seize a membership interest in a limited liability company to satisfy a judgment. Instead, the judgment creditor is limited to what is known as a "charging order" that only permits the judgment creditor to distributions made to the judgment debtor from the LLC. If in our example Lou had established his business as an LLC, he would retain control over his company and can restrict distributions made to members from the business. Frank would not be able to require Lou to make distributions, and would be frustrated in his efforts to collect on the judgment. Frank (and his lawyers, who would only get paid by collecting on the judgment) would be more inclined to negotiate a settlement on terms favorable to Lou.

But what if Lou's business were already established as a corporation? Fortunately, Section 1003 of the New York limited liability law permits another "business entity" to be merged into an LLC, with the LLC to be left as the "surviving entity." Upon following the procedures outlined in the statute, Lou could have converted his corporation into an LLC formed under either New York law, or the law of another state if preferred.

In addition to the asset protection benefits inherent in the LLC structure, an LLC can be taxed as a corporation. In Lou's case, he would certainly elect to continue to be taxed as a corporation after the merger. There would be no difference if Lou's company were a "C" or an "S" corporation, as an LLC can elect to be taxed under either form. However, it is imperative to consult a tax professional before embarking upon a merger to avoid negative income tax consequences.

Given the LLC's many benefits, why would anyone consider establishing a corporation for their business? The only true advantage is that a corporate form is suited for entrepreneurs who intend to "go public" and sell shares in the company to a wide range of investors. LLC's are not structured to be publicly traded entities. However, for the remaining 99%+ of business owners who will always remain closely held, the LLC is the only way to go.

Wednesday, July 29, 2009

A Thought on Health Care Reform

I'm going off-topic here, but I want to add a quick thought to the national debate on health care "reform" (whatever that will mean). The Left is insisting on full coverage for all Americans, seemingly without regard to cost, with a "public option" a must. The Right is just as insistent that only "free market" solutions are acceptable, making all kinds of noise about "rationing of care".

I'm certainly no health care expert, but I do know that paying for a full family plan is awfully expensive (ours is now over $1,000 per month). On the other hand, having undergone extensive (and expensive) treatment for a serious illness, I sure do appreciate having had coverage. I also believe it is tragic and untenable that 50 million Americans (give or take) have no health insurance.

While I don't believe health care is a "right" to the same extent as basic Constitutional freedoms, I do believe that we' d be better off as a society if all citizens had at least fundamental basic coverage that would spread the cost and the risks amongst the entire population. However, people would have to understand that unless we want to break the bank, not all types of treatment should be covered under the "basic" plan. People would be free to purchase additional coverage (or keep their existing coverage), and could always go out-of-pocket for any treatments not covered by the basic plan.

Of course the "wealthy" would maintain access to more (and possibly better) care than their less well-off neighbors, but at the very least such basic coverage would allow everyone to have fundamental health care that might remove much of the burden from the Medicaid system and reduce the use of hospital emergency rooms as the "primary care" provider for so many of the poor.

Poor Planning Results in Family Discord

I've been retained to work on an estate plan for a single man who has amassed an estate in excess of $10 million. Much of his wealth is the result of the sale of a business he had founded, while a portion is derived from an inheritance from his father who died about ten years ago.

Over the years, my client had periodically worked with his brother and father in the father's business, while the brother had worked with the father his entire adult life. Prior to his death, the father had made some equal lifetime gifts to both sons. When he died, my client's father's estate plan provided an equal distribution of the father's assets to each of his two sons (the father was a widower at the time of his death).

The father's decision to treat each son equally -- which he must have believed was the "fairest" result -- led to a permanent rift in his sons' relationship with each other. My client's brother believed that because he had spent his entire career working in the father's business, then he was "entitled" to a larger share of dad's business assets. While my client doesn't agree with his brother's analysis, he told me he would have understood had his father left more of his assets to the other son.

As I see it, the father's biggest mistake was failing to have an honest and open conversation with his sons about the father's intentions regarding his estate. Unfortunately my client said that his father -- like far too many parents -- was secretive about his intentions, notwithstanding the significant impact his decisions would have on his family's future. While such a conversation might have been uncomfortable, such a discussion would have allowed dad and his two sons to lay all their cards on the table, and express their grievances and desires. A conversation may or may not have resulted in the father altering his plan, and may not have avoided the schism between his sons, but it would surely have given them a fighting chance to head-off the ultimately sad result.

Tuesday, July 21, 2009

A Fallen Hero

For NFL fans, Steve McNair was a throwback -- a gritty, tough-as-nails quarterback, and a great leader. Off the field, McNair was praised for giving back to the community through numerous charitable works.

Sadly, McNair's legacy has been forever tarnished by his tragic death -- killed by his 20-year-old mistress in a murder-suicide, as his wife and two of his children slept in the family home miles away.

Adding to the tragedy is the recent news that McNair died without a will, leaving his wife and four kids -- two of whom are from a prior relationship -- in a more difficult situation. Under Tennessee law, Mrs. McNair is entitled to only 1/3 of Steve's probate assets, with the remainder to be divided amongst the four children. If all the children are still minors, legal guardians will need to be appointed to administer their inheritances until they reach age of majority, which in most states is 18. Like most 18 years old, odds are that McNair's children will be ill-equipped to adequately handle what will likely be significant assets at that time, and they will surely be targets for scam artists and other predators. Also, because McNair's wife is not the mother of two of his children, their is a likelihood of tension between the interests of Mrs. McNair and her children, and the interests of Steve's children from his prior relationship. All of this will be subject to a public spectacle before the media hordes and an insatiable public.

For years McNair was one of the more highly paid athletes in the NFL, so it is likely he has an estate significantly in excess of the federal estate tax threshold of $3.5 million. Since McNair apparently had done no estate planning, 45% of his assets in excess of the $3.5 million threshold will be subject to federal estate tax, and a portion will likely be subject to Tennessee's own state estate tax as well. Depending upon the liquidity of the estate assets, it could be difficult to pay the taxes, which are due 9 months from the date of death.

Steve McNair's death has left his adoring fans in shock. Now his betrayed wife and children are left picking-up the pieces from Steve's failure to make even rudimentary arrangements to provide for an orderly transfer of assets to his family after his death.

Monday, July 13, 2009

Another Misleading Advertisement for "Self-Help" Legal Work

Last week I posted about the deficiencies of "do it yourself" estate planning. Today I heard a radio ad for a company that forms corporations to "help you protect your assets." The ad said, that while "we don't give legal or accounting advice," you certainly don't need a lawyer to establish your own corporation.

Well, certainly anyone can form a corporation in New York, and probably any state for that matter. The real question is, once the corporation is "formed" -- which I take it from the ad means that the corporation has been filed with the Secretary of State and the "customer" is provided with the basic "corporate kit" -- what then?

For many business law attorneys, the corporation is a little-used entity today. The limited liability company, or LLC, provides greater flexibility, and much better asset protection than a corporation. Understand that under the laws of most states, corporate stock is personal property that is attachable by the shareholder's creditors. So, imagine that you own 100% of the stock of your trucking business which is incorporated as XYZ corporation. XYZ Corporation in turn owns all of the business's assets such as vehicles, machinery and inventory. One day you have a party at your home (which is owned in your own name), and some inebriated party goer trips going out the door and breaks his neck. Because this person's cousin happens to be a high-powered lawyer, he is able to secure a judgment against you personally for $10 million. Even if you have a $2 million "umbrella" insurance policy, you're still $8 million in the hole.

Well, at least your business is protected, right? Well, not so fast. In most states, your judgment-creditor will be able to seize the stock in your corporation, fire you as an officer and director, and substitute himself in your place. Once in control, the creditor can liquidate the business's assets, or do anything else with the business that he pleases.

Had the business been established as an LLC, the laws in many states (including New York) provide that a judgment-creditor cannot seize the judgment-debtor's membership interests in the LLC, but is instead limited to the remedy of a "charging order" against any distributions made from the LLC to you as the member (as a caveat, we are now recommending that there be at least two members of an LLC, as at least 3 bankruptcy court decisions in other states have allowed creditors to liquidate assets of a single-member LLC, but would not have permitted such liquidation for a multi-member LLC). Since you would remain in control of the entity, you would stay in control of the entity's assets and can keep those assets at arms-length from your creditor, which may encourage a settlement for much less than the judgment amount.

So, I bet that corporation formation company will provide their prospective clients with a similar run-down of all the asset protection issues involved in selecting a business entity -- right?

Sunday, July 12, 2009

An American Classic

Last evening my wife and I had the good fortune of attending the New York Philharmonic's annual summer performance at Bethel Woods. For those who haven't been there, Bethel Woods is a magnificent performing arts center built on the Woodstock concert site. It is a treat just going to Bethel Woods to see the beauty of both the concert grounds and the natural surroundings.

As for the concert, the Philharmonic performed a number of well-known classical pieces from Carmen and Bolero. As the orchestra conluded with an encore of John Philip Sousa's Stars and Stripes Forever, the skies opened with a torrential thunderstorm. The thunder and lightning surrounding the ampitheater certainly made for a dramatic finish.

Wednesday, July 8, 2009

The pitfalls of do it yourself legal documents

Given the collapse of my beloved New York Mets, I haven't spent much time recently listening to WFAN. Scrolling the radio dial the other day, I came across Rush Limbaugh doing a commercial for For the uninitiated, LegalZoom allows people to create their own legal documents on-line.

In the ad, Rush describes how a friend told him that they created their own living trust at Legalzoom, and that the document looked almost identical to one prepared by a lawyer for another friend, but at a much higher cost. Sounds like a no-brainer, right?

Well, if all the lawyer did for the "other friend" was a "word processed" trust using a fill-in-the blanks structure, then the client did in fact overpay. But any estate planning attorney worth his or her salt will take the time to learn about the client's family -- the kids, grand kids, other family members, and what are the clients hopes, dreams and aspirations during their own lifetimes and the lives of their loved-ones.

We discuss with our clients the benefits of leaving assets in protective trusts for their children's lifetimes, which will protect the kids' inheritance from their "creditors and predators," including a divorcing spouse. Properly structured, such trusts can provide the child with access to the trust income and principal when needed. In my view, there is no real benefit to the traditional "outright" distribution of assets.

Also, we make sure that the clients' living trusts are funded with the clients' assets during their lifetimes; in fact, we have a full time "funding coordinator" on staff.

Finally, our practice features an ongoing annual maintenance program to ensure that our clients' estate plans stay current with the changes in their lives, changes in the law, and changes in our knowledge and experience.

Will our "up front" cost be greater than Legalzoom or the like? Well, sure. But an experienced and knowledgeable estate planning attorney can bring wisdom and guidance to the estate planning process that no computer program can come close to matching. And, when you factor in the costs of "death settlement" of an estate, the costs of the "inexpensive" planning compared to our comprehensive approach will, more than likely, no longer seem to be such a bargain.

In my view, on-line estate planning is suitable for those people who would never do any planning if they had to go see a lawyer. But for those who are serious about preparing a comprehensive and ultimately effective estate plan, there is no substitute for seeking appropriate counsel.

Thursday, July 2, 2009

Michael Jackson's Estate Plan

Every reporter or news anchor I have seen since the filing of MJ's will has breathlessly reported that the "King of Pop" has disinherited his father and his former "wife," Deborah Rowe. Well, that may or may not be true; the media doesn't understand that for all his other faults and flaws, Jackson had the good sense to create a living trust that is not required to be filed with the probate court. The living trust (named in this case the "Michael Jackson Family Trust") is where all the dispositive provisions regarding Jackson's assets are included. It is entirely possible (although unlikely) that the trust includes either his father or Debbie Rowe (or both) as beneficiaries. The filed will does not name any specific beneficiaries of assets, but is simply a standard "pour over" will that transfers any "unfunded" assets to the Family Trust after death.

Besides the pour-over provisions, the main purpose of the will here was to designate Jackson's preferred guardians of his minor children. Jackson's first choice as guardian was his mother, with his second choice being his old friend (and childhood idol), Diana Ross. It's hard to imagine any scenario in which the now 65-year old Ms. Ross would assume responsibility for these children in Jackson's mother were to die or become unable to be their guardian.

Saturday, June 27, 2009

The Great Estate Planning Fallacy -- Attorney as "Scrivener"

This past week I received an e-mail from the adult son of a client for whom I had done asset protection planning about a year ago. In his e-mail, "Frank" asked me, "how much would it cost to revise my will and do the other documents, such as a health care proxy?" Frank, who has never been married and has no children, had attached a copy of his will to the e-mail.

Frank is a successful entrepreneur with a net worth well into the seven figures. His existing will has numerous beneficiaries, both individuals and charities, and provides for many of the beneficiaries' shares to be held in trust.

In response to the "how much does it cost" question, I replied as follows:

For me to do planning work for you, it is not simply a matter of us sitting down and you telling me who you want to be the beneficiaries of your estate. Rather, to review and revise your planning, we would need to sit down and discuss your overall planning objectives. I would then be able to determine what planning tools (e.g., will, trusts, or other entities, health care documents, etc.) are required to satisfy your planning objectives. I would then be able to quote a fee for the counseling and design of the planning necessary to meet the planning goals. Of course you would be under no obligation to go forward with any of my suggestions or to pay any fee until retaining me for the work.

From my experience, many clients assume they “have it all figured out” until we have the conversation about what the client really is hoping to accomplish, and the planning often goes in directions the client had never contemplated. Bottom line, it is not as simple as you coming in and simply telling me what you want to do; in such a case you’d be overpaying to have me (or any lawyer, for that matter) serve as a mere “scrivener.”

I have attached our “Goals” form which will give you an idea of some of the key concepts that you should be considering in looking at your estate planning. Some of these may be ideas you’ve already thought about, but some of them may not have previously been brought to your attention.

If you would like to set up a meeting, let me know
Frank must have been satisfied with my response, as he has scheduled an appointment to review his goals and objectives.

Tuesday, June 23, 2009

Medicaid Planning 2009

Check out this SlideShare Presentation:

A familiar (and unfortunate) story

I met with a client in yesterday who is set to receive an inheritance of about $1.4 million from a trust established by her grandfather. We discussed setting up a revocable living trust as well as an irrevocable trust for asset protection/Medicaid planning purposes. This client (who is divorced) has a special needs child, and we will certainly be providing that, upon the client's death, the special needs child's share will be held in a supplemental needs trust to ensure that the child -- who is now an adolescent -- will remain eligible for governmental assistance throughout her lifetime.

My client also has a sister who will receive the same $1.4 million inheritance from grandpa's trust. This woman, like her niece, has special needs and is presently receiving governmental assistance. Unfortunately, grandpa's trust provides an outright inheritance for this woman. As a result of the inheritance, this woman will become ineligible for governmental assistance, including the all-important Medicaid benefits. To retain her eligibility, the special needs granddaughter will need to create a "payback" supplemental needs trust that, upon the woman's death, will require reimbursement to the state social services agency before any distribution can be made for the woman's heirs.

While this result may be good for taxpayers, it will not provide the optimum result for the family. Had the grandfather's trust provided that instead of an outright distribution, the share of any disabled beneficiary be held in a supplemental needs trust, then upon the granddaughter's death, the balance of the trust share could pass to other family members, rather than to the state.

While grandpa did not ensure protection of the family assets (was he even counseled about this planning option), his "well" granddaughter will be able to assure such asset protection for her own child.

Sunday, June 21, 2009

Getting the Show on the Road!

Having established my blog weeks ago, it's Father's Day and I'm finally ready to start posting. My hope with this blog is to keep readers up-to-date regarding developments and trends in estate planning, elder law and related topics. I also intend to offer commentary on interesting current events, political issues and cultural trends. I certainly hope to spur conversation and debate.

A short introduction: I am a partner with Blustein, Shapiro, Rich & Barone, LLP, a 10-attorney law firm in Middletown, New York. Our firm is soon to be moving to a brand-new building at 10 Matthews Street in Goshen; we anticipate a move sometime in early fall. I'm particuarly excited about the move because in our new space we will have a dedicated classroom where we will hold estate planning and elderlaw workshops for clients, the general public, and professional advisors. The classroom will comfortably host 22 people, and I anticipate that it will be used frequently.

Our firm web site is My practice is concentrated in the areas of estate planning, elder law and business planning (e.g. forming business entities and designing effective and practical business "exit" strategies for business owners).

The big news among the New York trusts & estates and elderlaw bar is the impending implementation of a new general durable power of attorney form. The new form, to be effective September 1, 2009, presents a sweeping overhaul of the existing statutory "short form" power of attorney. The new form includes an optional "major gifts rider" that is required to be signed by the principal if he or she wishes to authorize the agent to make gifts of the principal's assets. Such gifting powers are frequently used in "crisis Medicaid planning," and are, in my view, an essential feature.

While powers of attorney are useful planning tools, our preference is for dealing with a person's incapacity is for a well-drafted and funded revocable or irrevocable trust. Trusts simply provide more flexibility and planning protection than a power of attorney. Perhaps most important, trusts can include a "disability panel," of individuals who are authorized by the Trustmaker to declare the Trustmaker as "disabled," and transfer authority to a successor Trustee named by the Trustmaker. Powers of attorney have no mechanism for removing a principal's authority or control, often leading to scenarios where a person who suffers from "diminished capacity," may act irrationally. In but one recent example, a woman told me that her father, who sufferred from moderate dementia, has been going to the bank and giving his new healthcare aide substantial cash gifts. Even though the daughter is the agent under the father's power of attorney, there is no power to take away the father's authority and prevent him from continuing this pattern of financially harming himself. The only alternative is a costly, stressful and potentially contentious court guardianship proceeding.

If instead the father had in place a revocable living trust with a disability panel mechanism, the panel could have determined that the fahter is incapable of managing his financial affairs, with legal authority automatically transferred to a successor Trustee designated by the father in the trust document. All in all, a far better plan that leads to a more satisfactory result.