May 11, 2016
Revocable living trusts are a great estate planning tool. There is no more flexible legal instrument available to accomplish your objectives. But, a living trust enables a person to do things without realizing the consequences until it is too late.
Imagine Alan, the retired farmer. His several hundred acres are rented to son Bob. His cattle corporation, Alan Bovine Co., is run by daughter Dana. Alan still owns 80% of the stock. He is half-owner of a partnership with Fred, a friend. Alan has a $200,000 life insurance policy, and another $300,000 or so in personal assets: a car, home and furnishings, and savings.
Revocable living trusts are a great estate planning tool. But, a living trust enables a person to do things without realizing the consequences until it is too late.
Alan creates a living trust. It says his four children will receive assets of equal value, in trust (to be controlled by the child who receives it…Alan would never control from the grave) so as to be safe from divorce, lawsuits, catastrophic illness, etc. Since the children get along great, they can decide how to divide everything. Daughter Ellen will serve as Successor Trustee.
Alan transfers all of his assets, including life insurance, to his living trust. He did everything right. Then he dies.
Ellen, as Trustee, claims the life insurance, sells Dad’s car and house, and deposits the proceeds into the bank account. To do so, she had to obtain a taxpayer identification number (FEIN) for the trust, an easy thing to do online. She calls a family meeting. Even free-spirited Calvin shows up. Based on land sales in the area and cattle prices, the trust assets amount to $5,000,000. None of them bicker about details. Each should get $1,250,000, and they agree as follows. Bob gladly takes farmland. Dana gets the Alan Bovine Co., worth about $600,000, plus some land. Calvin gets cash, and a tract of land. Ellen gets Alan’s half of the partnership, plus some land. Within five weeks after Alan’s death, Ellen has signed Trustee Deeds conveying real estate to Bob, Calvin, Dana and herself. She transferred the Alan Bovine Co. stock to Dana. She assigned Dad’s interest in the partnership to herself, and meets with Fred as his new partner. She gave the cash to Calvin.
The children all agree: “We’re sure glad Dad had a living trust!”
This could really happen. So where is the danger?
Within weeks, Ellen learns that Alan had $7,500 in outstanding medical bills to pay. She learns she must file his final income tax return (he owed $42,000) and a tax return for the trust for the five weeks she was distributing everything ($500 in taxes due). Then she learned about the $270,000 Illinois estate tax on Alan’s $5,000,000 estate. The $320,000 should have been paid from Alan’s trust assets before things were divided. Ellen will be personally liable if it isn’t paid.
The next family meeting doesn’t go so well. Collecting $80,000 from each of the children to pay the taxes and medical bills was uncomfortable. But the worst was yet to come.
The following year, Ellen agreed to sell Bob her share of the land. On her tax return she reported gain of $200/acre, since that is how much Bob paid in excess of the agreed value at Alan’s death. The IRS assesses a deficiency notice: Ellen must pay capital gain taxes on the full sale price, because she had not substantiated her basis. She could not claim a “step up” because no federal estate tax return had been filed and no formal appraisal had been done.
Could anything else go wrong? Remember that Alan’s trust said each of the children was to receive a protective trust? But Ellen didn’t transfer the land, stock, partnership or money to any trust…she gave it directly to each child, and they accepted it that way. They didn’t know the difference.
So, two years later, when Bob had an unfortunate accident resulting in injuries to other people, the lawsuit exceeded his liability insurance and took his farm, including all of his inheritance.
When Dana was served with divorce papers, her land and Alan Bovine Co. should have been safe. But they weren’t.
When Calvin’s unhealthy life catches up with him, he needs long-term care. The inherited money was long since spent, but he still had the land. In trust that land could have been protected to eventually pass on to his heirs. But it wasn’t. Instead, Calvin must sell it, pay heavy capital gain taxes, and spend the proceeds on the nursing home.
The moral of the story? The probate process used to force families to get legal advice upon death. Living trusts let you “hang yourself” without knowing it. Be careful. Get advice.
- Curt Ferguson owns The Estate Planning Center in Salem. Learn more at thefarmersestateplanningattorneys.com.
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