Estate Planning for Second Marriages and Blended Families

Presenting a live 90-minute webinar with interactive Q&A

Estate Planning for Second Marriages and Blended Families Maximizing Tax Benefits, Incorporating Pre- and Postnuptial Agreements, and Meeting Obligations to Children and Spouses

TUESDAY, MAY 19, 2015 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Today’s faculty features:

Kristin A. Pace, Partner, Donahue Fitzgerald, Oakland, Calif. Todd J. Preti, Principal, Midgett Preti Alperin, Virginia Beach, Va. Bridget K. Sullivan, Member, Sherman & Howard, Denver

The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10. Tips for Optimal Quality FOR LIVE EVENT ONLY

Sound Quality If you are listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection.

If the sound quality is not satisfactory, you may listen via the phone: dial 1-866-961-9091 and enter your PIN when prompted. Otherwise, please send us a chat or e-mail [email protected] immediately so we can address the problem.

If you dialed in and have any difficulties during the call, press *0 for assistance.

Viewing Quality To maximize your screen, press the F11 key on your keyboard. To exit full screen, press the F11 key again.

Continuing Education Credits FOR LIVE EVENT ONLY

For CLE purposes, please let us know how many people are listening at your location by completing each of the following steps: • In the chat box, type (1) your company name and (2) the number of attendees at your location • Click the SEND button beside the box

In order for us to process your CLE, you must confirm your participation by completing and submitting an Official Record of Attendance (CLE Form) to Strafford within 10 days following the program.

The CLE form is included in your dial in instructions email and in a thank you email that you will receive at the end of this program.

Strafford will send your CLE credit confirmation within approximately 30 days of receiving the completed CLE form.

For additional information about CLE credit processing call us at 1-800-926-7926 ext. 35.

Program Materials FOR LIVE EVENT ONLY

If you have not printed the conference materials for this program, please complete the following steps: • Click on the ^ symbol next to “Conference Materials” in the middle of the left- hand column on your screen. • Click on the tab labeled “Handouts” that appears, and there you will see a PDF of the slides for today's program. • Double click on the PDF and a separate page will open. • Print the slides by clicking on the printer icon.

Estate Planning for Second Marriages and Blended Families

Crafting Estate Plans to Incorporate Pre- and Post-Nuptial Agreements Todd J. Preti

Overview

 “Marriage is the triumph of imagination over intelligence. Second marriage is the triumph of hope over experience.” – Oscar Wilde

6 Challenges and Issues

 Ethical Issues of Joint Representation  Titling of Assets  Beneficiary Designations  Choices of Fiduciaries

7 Ethical Issues of Joint Representation

 Model Rules of Professional Conduct

 Rule 1:7 – a lawyer shall not represent a client if the representation involves a current conflict of interest.  ACTEC Commentaries

 RE: MRPC 1.7: Some conflicts of interest are so serious that the informed consent of the parties is insufficient to allow the lawyer to undertake or continue the representation (a “non-waivable conflict).

8 Some Indications of Potential Conflicts of Interest

 Pre-Nuptial Agreement  Post-Nuptial Agreement  Either or both spouse has a child or children from a prior relationship  Great Disparity in Assets of the Parties  Great Disparity in the Ages of the Parties  Past Representation of a Single Party

9 Issues the Lawyer Should Consider

 Laws of Intestate Succession  Elective Share Laws  Statutes favoring “Omitted Spouses”  Joint Tenancy issues  Beneficiary Designations on Life Insurance and Annuities  Beneficiary Designations on Qualified Retirement Plans

10 Laws of Intestate Succession

 Statutory “will”  Is the share for the surviving spouse too little or too large?  How are children to be treated?

 Children from prior relationships?

 Children with surviving spouse?

 The spouse’s children from prior relationships?

11 Elective Share Laws

 Surviving spouse may be entitled to a percentage of the TOTAL estate, including non-probate assets  Usually involves litigation to determine

 Expensive

 Divisive

12 “Omitted Spouse” statutes

 Testator made a will (avoiding intestacy) but subsequently marries  Invokes statutory presumption that Testator did not intend to disinherit spouse

13 Joint Tenancy Issues

 Joint Tenancy with Surviving Spouse

 With Rights of Survivorship

 Without Rights of Survivorship  Joint Tenancy with Children

 With Rights of Survivorship

 Without Rights of Survivorship

14 Beneficiary Designations – Life Insurance

 Coordinates with Pre or Post Marital Agreements?  Who is in control of proceeds?  Balancing economic needs  Each policy must be examined and the beneficiary changed, if needed

15 Beneficiary Designations – Qualified Retirement Plans

 Consider Pay-out options available to surviving spouse  Who controls balance, if any, at survivor’s death  Trusts as beneficiaries

 “Oldest Beneficiary” rule for measuring lives

 Marital deduction issues – Battle between RMD and mandatory income payout. See Rev. Rul. 2006-26.

16 Issues the Lawyer Should Consider

 Presence and Effect of Pre- and Post-Nuptial Agreements  Presence and Effect of Divorce Decrees and Property Settlement Agreements  Buy-Sell Agreements

17 Issues the Lawyer Should Consider

 Family Dynamics

 Putting the “fun” in dysfunctional  “What we have here is a failure to communicate!”- from the movie Cool Hand Luke  Jealousy and Greed

 Control and Management

 Balancing the interest of “Yours, Mine and Ours”

18 Issues Relating to Children

 Title to Assets

 Joint Tenancy  Without survivorship  With survivorship

 Payable on Death or Transfer on Death Provisions

19 Issues Relating to Children

Beneficiary Designations  Life Insurance  Annuities  Qualified Retirement Plans  Outright payment  Conduit Trusts

20 Issues Relating to Children

 “Anti-Vulture” Distributions Leaving assets to children at death may eliminate potential conflict between the children (especially those from a prior marriage) and the surviving spouse by minimizing the necessity for the children to circle the spouse like vultures awaiting his/her death to “get our rightful inheritance”.

21 Issues Relating to Children

 Outright Distribution v. Use of Trust  Structuring Distributions in Trust

 “Pot” or Common Trusts v. Separate shares

 Handling great diversity in ages of children  Distributions upon attaining certain age  Distributions at specified dates

 Who should control?

22 Issues Relating to Children

 Child as an Agent under a Durable Power of Attorney

 Conflicts with surviving spouse

 Conflicts with other siblings – Whole/Half/Step

 Compensation Issues

 Communication/Reporting

23 Issues Relating to Children

 Child as an Agent under Advance Medical Directive

 Conflicts with surviving spouse

 Conflicts with other siblings – Whole/Half/Step

 Dealing with the Emotional Issues

 Communication/Reporting

24 Issues Relating to Children

 Child Acting as Trustee of Trust

 Control over the surviving spouse’s share?  Conflicts of Interest?  Contempt?

 Communication issues

 Compensation Issues

25 Issues Relating to Children

 Child as Executor

 Many of the same problems as serving as Executor

 Requires resident of state where Decedent lived

 Probate as a public forum for family disharmony

26 Estate Planning for Second Marriages and Blended Families Discussion of Prenuptial and Postnuptial Agreements

May 19, 2015 Bridget Sullivan, Esq. Sherman & Howard L.L.C. 633 17th Street, #3000 Denver, CO 80202 (303) 299-8130

Bridget K. Sullivan, Esq.

Bridget Sullivan is a Member in and the Department Manager of the Tax & Probate Department of Sherman & Howard’s Denver office. She practices in the areas of estate planning, wealth transfer planning, estate administration, trust administration, and litigation related to trusts and estates. Ms. Sullivan focuses on sophisticated estate planning techniques and prenuptial agreements. She has counseled clients on a variety of wealth transfer strategies and charitable giving techniques to accomplish family giving objectives while minimizing the impact of gift, estate, generation-skipping transfer, and income taxes.

Ms. Sullivan graduated from Yale Law School in 1990. She is named in Best Lawyers in America for Trust and Estates and is named as a Colorado Super Lawyer.

• The principal purpose of a marital agreement is to alter the rights otherwise provided by law of one or both spouses to the property of the other spouse, whether upon termination of the marriage by divorce or by death or both.

• Many states have a marital agreement act, which determines the rights of parties who have entered a marital agreement, the types of matters that parties may agree to and the enforceability of marital agreements.

• Create certainty with respect to the disposition of property at the end of a marriage. • Protect family legacy assets and provide assurance to the senior generation which may have built the family wealth. • Protect family owned or closely held business interests.

• Protect the interests of children from a prior marriage. • Protect family trusts in a divorce. • Provide security and certainty to the less wealthy spouse. • Simplify and reduce the expense that often accompanies divorce or litigation upon death of the spouse.

• Waivers of Surviving Spouse Rights – A marital agreement may govern the rights of the parties in the event of the termination of the marriage by death of either party. – The agreement may include a partial or complete waiver of property rights arising at death. – The agreement may also include a promise to provide for a substitute transfer of property to the waiving spouse.

– While both parties to a martial agreement may agree to waive – in whole or in part – their respective property rights arising at death, each party remains free to leave more property to the other than would be required by the agreement.

– A release and waiver of “all rights upon death” or equivalent language in a marital agreement encompasses the waiver of several statutorily granted spousal rights and priorities.

• Status as Surviving Spouse – A person who is divorced from a decedent or whose marriage has been annulled is not a surviving spouse. – However a decree of separation does not terminate the status of husband and wife for death purposes. A husband and wife are considered married regardless of whether a divorce action has been instituted. – A marital agreement can modify these provisions, stating specifically that a separation decree or the filing of an action for divorce terminates all surviving spouse rights.

• Intestate Share of Surviving Spouse – If a person dies without a will, the decedent’s property will be distributed in accordance with the applicable statute of intestate succession. – Under many states, the surviving spouse’s share of the intestate estate is dependent upon the circumstances of the parties, including whether there are adult or minor children of the marriage and whether the decedent has adult or minor children from another relationship. – Under the law of many states, the surviving spouse receives the entire intestate estate (1) when the decedent has no surviving descendants or ancestors or (2) when all of the decedent’s surviving descendants are also descendants of the surviving spouse and there are not other descendants of the surviving spouse who survive the decedent (i.e., it was likely a first marriage for both spouses).

• Spouse’s Elective or Statutory Share – Dower refers to the legal right or interest that a wife acquired in the estate of her husband. It consists of the right to one-third of the husband’s real property. Curtesy is the common law life estate given to a husband in the real property of a deceased wife. Many states have abolished dower and curtesy, replacing these common law rights with statutory rights to an elective or forced share. – Absent a marital agreement, the surviving spouse has the right to an elective share of the augmented estate. Uniform Probate Code states have adopted a right to elect an amount not greater than 50% of the “augmented estate”). Under the Uniform Probate Code, the percentage of the augmented estate to which the surviving spouse is entitled is determined by the length of time the spouses were married, but is essentially as follows:

If the Decedent and the Spouse The Elective Share Were Married to Each Other: Percentage Is:

• Less than 1 year Supplemental amount only • 1 year but less than 2 years 5% of the augmented estate • 2 year but less than 3 years 10% of the augmented estate • 3 year but less than 4 years 15% of the augmented estate • 4 year but less than 5 years 20% of the augmented estate • 5 year but less than 6 years 25% of the augmented estate • 6 year but less than 7 years 30% of the augmented estate • 7 year but less than 8 years 35% of the augmented estate • 8 year but less than 9 years 40% of the augmented estate • 9 year but less than 10 years 45% of the augmented estate • 10 year or more 50% of the augmented estate

• Augmented Estate – The augmented estate is comprised of property owned by the decedent at death as well as certain pre-death gifts to the surviving spouse and to third parties. The augmented estate is a statutory concept created to prevent disinheritance of a spouse through transfers to others while at the same time equitably accounting for inter vivos and testamentary transfers to the spouse. • Pretermitted Spouse – Absent a marital agreement, if a married person dies having executed his or her will prior to the marriage, and such will does not provide for the surviving spouse, then the surviving spouse has the right to take a share of the estate as a “pretermitted spouse.” The pretermitted spouse’s share of the estate is generally equal to the spouse’s intestate share.

• Family and Exempt Property Allowances – Absent a martial agreement, in many states a surviving spouse is entitled to the family and exempt property allowances. These allowances are in addition to the intestate or elective shares. These are generally modest amounts. • Priority to Serve as Personal Representative or Executor – In many states, the priority to serve as personal representative or executor is established by the decedent’s will. However, in the absence of a will or if the will fails to nominate someone who can act in such position, the surviving spouse has priority to act. This priority to serve can be waived in a marital agreement.

• Federal Law Rights to Retirement Plan Assets – The survivorship rights in and benefits under qualified retirement plans are governed by federal law, including ERISA and other provisions of the Internal Revenue Code, it is federal law, and not state law, that governs when and how a participant may obtain a valid waiver of survivorship rights and interests in such plans. – A participant in a retirement plan cannot obtain a valid waiver of spousal survivorship rights prior to the parties’ marriage. Thus, the general waivers of “all rights upon death” or even a specific waiver of rights to a retirement plan, will not constitute an effective waiver of spousal survivorship rights in a retirement plan. – Waivers in a prenuptial agreement must be coupled with mutual promises to execute separate retirement plan waivers after the parties are married.

• Waiver of statutory and common law rights upon death. – A release and waiver of “all rights upon death” or equivalent language in a marital agreement encompasses the waiver of state statutorily granted spousal rights and priorities. – Such waivers can be done in a general waiver or in a more specific laundry list of waivers.

– My laundry list (covering Colorado law) generally appears as follows: • “Specific Waiver. Upon the death of either of us, the other waives the following: – The right to take an intestate share under Colo. Rev. Stat. 15-11-102 or 15-11-301; – The right to an elective share under Colo. Rev. Stat. 15-11-201, and to take any interest in the augmented estate under Colo. Rev. Stat. 15-11-202; – The right to an exempt property allowance under Colo. Rev. Stat. 15 11-403; – The rights of an omitted spouse under Colo. Rev. Stat. 15-11-301; – The right to a family allowance under Colo. Rev. Stat. 15-11-404;

– The right to a homestead interest under Colo. Rev. Stat. 38-41-201 and 38-41-204 (as to each other, but not as to third parties); – The right to act as a personal representative or trustee of the estate or trust of the other, unless specifically nominated or designated by the other; – All rights to any pension plan, profit sharing plan, deferred compensation plan or retirement benefits and cash accumulations in life insurance which have or might have accrued for the benefit of the other, unless specifically designated as beneficiary; each of us agrees to execute the documents necessary to effectuate that waiver as required by the terms of the pension plan, profit sharing plan, deferred compensation plan or retirement benefit plan, state law or federal law;

– Any rights to contest any disposition of property by the other by any inter vivos trust; – Any provisions of the Colorado Marital Agreement Act, Colo. Rev. Stat. 14-2-301 through 310 in conflict with this Agreement; and – Any rights either of us might have to claim any portion of the estate of the other under the laws of any jurisdiction other than Colorado which are of like or similar purpose to the enumerated Colorado statutes that provide dower, curtesy, forced heirship, community property or marital property interests or any other right to claim against the estate of a deceased spouse by a surviving spouse.”

• Limitations on Waivers If There Are Children of the Marriage – Note, in cases of young couples marrying with family wealth who do not have children from previous marriages, sometimes these waivers of rights upon death are appropriate only if there are no children of the marriage. – However, if there are children of the marriage, it may not make sense to have the less wealthy spouse waive “all rights upon death.” If the wealthier spouse fails to follow up with estate planning or with proper estate planning, the less wealthy spouse, now the parent of the children of the marriage, may be disinherited.

• Community Property Waivers – I practice in Colorado, which has adopted the Uniform Probate Code and is not a community property state. An exhaustive discussion of community property is outside the scope of this outline. – Generally, community property is owned by both spouses equally. Community property does not include property owned by a spouse prior to marriage, property gifted from one spouse to the other, property inherited by a spouse or property which was separate property prior to the time the spouses moved to the community property jurisdiction. The titling of property is not determinative of its status. Earned income of the spouses is community property. Income from separate property is community property in some jurisdictions and not in others.

– Frequently, parties execute a marital agreement in one state and move to another jurisdiction. All practitioners should be careful to draft waivers of rights upon death broadly enough to cover rights granted in any jurisdiction. A well drafted waiver of rights upon death will include a specific waiver of any property rights based on the laws of community property. – From an estate planning perspective, one benefit of preserving community property is that the entire property receives a step- up in basis at the death of the first spouse. I.R.C. § 1014 (b)(6). Under Section 1014(b)(6), even though only the decedent spouse’s one-half interest is includable in his gross estate, the entire community property obtains a stepped up basis. This is perhaps the greatest advantage of community property. Because of this advantage, a lawyer preparing a marital agreement for clients in a community property state or clients who have migrated from a community property state will want to consider whether to retain the community property character of certain assets.

• It is common for parties who enter into mutual waivers of rights upon death to agree to make substitute transfer to each other, either during the marriage or at the time of death. Like most provisions of a marital agreement, the wealthier party may seek complete waivers from the less wealthy party in exchange for certain promised gift transfers during marriage and/or certain transfer upon death.

– Federal Gift Tax Marital Deduction Issues • Gifts to a Spouse During Marriage. Transfers to the spouse during the marriage will qualify for the unlimited deduction for gift tax purposes, so long as such transfers are made outright to the surviving spouse or to a qualifying trust. I.R.C. § 2523. • A gift of a life estate or terminable interest will not qualify for the gift tax marital deduction, unless such transfer is a qualified terminable interest as described in I.R.C. § 2523(f). • Outright gift transfers are obviously simplest from the perspective of qualifying for the gift tax exclusion. However, clients may be adverse to such outright transfers and may wish to make transfers in trust for the spouse. • If an inter vivos trust is created for the spouse, be sure the trust qualifies as a QTIP trust. If a QTIP trust is created and funded during the marriage, be sure to make a timely QTIP election. The IRS provides no relief for a late filed QTIP election for an inter vivos QTIP trust.

There are several significant advantages of a lifetime QTIP trust in a marital agreement setting. - It allows the wealthier spouse to provide an income stream to the less wealthy spouse during the marriage, after the wealthier spouse’s death, and in the case of a divorce (as maintenance). - At the death of the beneficiary spouse, regardless of the order of deaths, the trust assets will pass to the beneficiaries selected by the wealthier spouse (presumably the children from the first marriage). - The unified credit and GST exemption of the less wealthy spouse can be fully utilized, saving the wealthier spouse’s beneficiaries estate tax.

• Cautions. Be wary of provisions which transfer a property to the less wealthy spouse during the marriage, such as title to a residence, but provide that if a divorce were to occur the residence shall revert to the wealthier spouse. This may be attractive from an estate planning perspective and it may be attractive to the less wealthy spouse because she will hold the residence outright (rather than in a marital trust) at the wealthier spouse’s death. However, this arrangement may not qualify for the gift tax deduction as an outright transfer to the less wealthy spouse. Rather it will likely be treated as a terminable interest because the interest transferred to the less wealthy spouse will terminate or fail upon an event (the divorce) and because the donor retains in himself an interest in such property (the right of the property to revert to the donor upon a divorce). I.R.C. § 2523(b).

– Also be wary of drafting provisions which require the wealthier spouse to make transfers during the marriage or upon termination of the marriage to the children of the less wealthy spouse. Such contemplated gifts should qualify for the gift tax annual exclusion (currently $14,000 or $28,000 if the spouses will gift split) or the exclusion for payment of certain educational or medical expenses. I.R.C. § 2503.

– Gift Splitting. A marital agreement may request the less wealthy spouse to agree to gift splitting during the marriage, thereby allowing the wealthier spouse to maximize gifting to descendants. Be specific about whether the less wealthy spouse is consenting to gift splitting for annual exclusion gifts only or whether he/she is also consenting to use of his or her lifetime gift tax exemption.

• Federal Estate Tax Marital Deduction – The substitute transfer of property described in a marital agreement should qualify for the federal estate tax marital deduction. If the form of the transfer qualifies for the unlimited marital deduction, the property transferred will pass free of the federal estate tax at the transferring party’s death. When a martial agreement provides for a marital deduction qualifying transfer, such as a QTIP trust, the agreement should explicitly allocate liability for the estate tax arising at the survivor’s death (presumably from the assets of the QTIP trust). – The following common forms of testamentary spousal transfers will qualify for the unlimited marital deduction.

• An outright, unrestricted transfer of property; • A transfer for a qualified terminable interest property (QTIP) trust; • A transfer to an estate trust or a power of appointment trust; • A transfer to a qualified domestic trust (QDOT) for a non-citizen surviving spouse; • A transfer of the right to unitrust or annuity payments from a charitable remainder trust.

• QTIP Trusts – Estate planners frequently use QTIP trusts to provide for a second spouse, particularly when a party wishes to preserve wealth for children of a prior marriage. A testamentary marital trust, created under the decedent’s will or revocable trust will qualify for the marital deduction as a QTIP trust if: • Property passes from the decedent to the QTIP trust; • The governing instrument requires all income to be distributed at least annually to the surviving spouse; • No other beneficiary may have any rights in the trust during the surviving spouse’s lifetime; and • The personal representative or executor makes the corresponding election on the federal estate tax return filed for the decedent’s estate. I.R.C. § 2056(b)(7).

• The obvious benefit of the QTIP trust is that the surviving spouse need not be given a general power of appointment over the trust and therefore may be prevented from disinheriting the remaindermen of the trust (presumably, the deceased spouse’s children from a prior marriage). • Another advantage of the QTIP trust is that if the surviving spouse has a minimal estate of his or her own, the unified credit of that less wealthy surviving spouse can be utilized for the benefit of the wealthier spouse’s beneficiaries. The same is true of the less wealthy surviving spouse’s generation skipping transfer tax (GST) exemption.

– Standards and Guidelines for Principal Distributions. Provided that the surviving spouse is entitled to the income from the trust, at least annually, the surviving spouse need not be given any other beneficial interests to the principal of the trust. Additional access to principal, however, is frequently given to the surviving spouse for health, support, and maintenance. Many times the marital agreement will specify under what circumstances principal may be accessed by the surviving spouse.

– Selection of Trustees. • The marital agreement may specify that a third party will serve as sole trustee or as co-trustee with the surviving spouse to ensure better protection to the trust assets for the remainder beneficiaries. • “Neutral” trustees and successor trustees are generally advisable. The surviving spouse as sole trustee generally provides less protection to principal than the deceased spouse may want. • On the other hand, a child of the decedent (the step-child of the surviving spouse) as trustee may cause family discord. • A surviving spouse might be allowed to select a trustee among a group of mutually agreeable potential trustees. • Or, a surviving spouse could be authorized to appoint an institutional trustee.

– Selection of Assets. • The marital agreement may provide specific directions with regard to what assets will be directed into the QTIP trust for the benefit of the surviving spouse. • If there is a closely held business, both spouse’s may favor terms prohibiting such closely held stock from passing to the QTIP trust. • If the wealthier spouse holds promissory notes from children, the less wealth spouse may want to include a provision specifically prohibiting those types of assets from being used to fund the QTIP trust.

– Residence. • Frequently, the marital agreement will address the use and disposition of the residence by the non-owner spouse after the death of the owner spouse. • If the residence is transferred to the QTIP trust, it will be important to include provisions in the QTIP trust so that the surviving spouse’s rights to the residence will constitute the necessary qualifying income interest (i.e., the surviving spouse must have the right to demand that unproductive property be made productive).

• Use of Life Insurance in Conjunction with a Marital Agreement – Some parties to a marital agreement favor a waiver by the less wealthy spouse of all rights upon death of the wealthy spouse coupled with a death benefit paid to the surviving spouse pursuant to a life insurance policy. – If the wealthy spouse owns the policy and designates his or her spouse as the beneficiary, the policy proceeds will be included in the decedent’s estate, by will qualify for the estate tax marital deduction. – If the surviving spouse is both the owner and the beneficiary of the policy, the policy proceeds will not be included in the decedent’s gross estate.

– The parties to the marital agreement may want to address specifically what type of policy is to be acquired to satisfy the provisions of the agreement. Term insurance vs. permanent insurance. – The parties to the agreement also may want to specify that the beneficiary spouse be the owner of the policy. – The agreement should specifically address which party will have the obligation to pay the premiums.

– If you represent the beneficiary spouse, consider drafting a backstop provision which will give the surviving spouse a right to claim against the decedent’s estate if, for any reason, such insurance is not in place at the death of the spouse whose life was to be insured. – Consider using a QTIP trust or an irrevocable life insurance trust as the beneficiary of the insurance policy if the wealthy spouse wishes to have the policy proceeds remaining after the surviving spouse’s death pass to his or her children from a previous marriage.

• Joint Tenancy – Clients should be advised regarding the implications of joint tenancy and the possibility of defeating all of the careful planning for death in the marital agreement by holding property as joint tenants with rights of survivorship. – Consider including a provision in the marital agreement which gives the wealthier spouse credit for joint tenancy transfers against any required devises to the surviving spouse. I generally include the following language:

• “Effect of Jointly Held Property, Beneficiary Designation Property, or Transfer on Death Property Payable to Joe. If Jane predeceases Joe, the obligation to provide Joe with an outright disposition of cash or marketable securities having a fair market value of $500,000 under paragraph ______shall be deemed satisfied to the extent of the date of death value of any cash or marketable securities passing by beneficiary designation or transfer on death designation and to the extent of one-half of the date of death value of cash or marketable securities passing by joint tenancy or tenancy by the entireties as a result of Jane’s death.”

“If Jane predeceases Joe, the obligation to provide Joe with $2,000,000 in a marital trust under paragraph ____ shall be deemed satisfied to the extent of the date of death value of any property passing by beneficiary designation or transfer on death designation and to the extent of one-half of the date of death value of joint tenancy or tenancy by the entireties property passing to Joe as a result of Jane’s death. If the value of property passing to Joe by beneficiary designation, transfer on death designation, joint tenancy or tenancy by the entireties should exceed the required amount payable to Joe pursuant to paragraphs _____, then Jane’s estate shall have no further obligation to Joe under this Agreement, nor shall Joe have any obligation to return funds to Jane's estate.”

• Portability of a deceased spouse’s estate tax exemption was made permanent on January 2, 2013, with the American Taxpayer Relief Act. Now, Code Section 2010(c)(4) which allows the surviving spouse of a deceased spouse dying after December 31, 2010, to use the deceased spouse’s unused exclusion amount (DSUE) as an exemption against estate tax in the surviving spouse’s estate, is a permanent part of the estate tax law. • With the estate tax exemption now set at $5 million, plus inflation adjustment (currently, $5.43 million), the portable DSUE amount should be viewed as a valuable asset of the less wealthy spouse. For example, if the prospective wife has an estate of $10 million, and her prospective husband has an estate of $1 million, if the husband predeceases wife, his unused exemption amount or DSUE could be ported to the wife’s estate at her second death, allowing her to shelter over $4 million of additional assets at her death. • Because the portability election must be made by the Executor or Personal Representative of the first spouse’s estate, the parties should agree in the Marital Agreement that the less wealthy spouse will leave instruction in his or her estate planning document directing his or her Executor or Personal Representative to file the Form 706 and make the portability election.

• The development of the law in most states regarding treatment of interests in trusts as property for purposes of property division in a dissolution proceeding has been quite varied and, at times, inconsistent. • It is critical that the drafter of prenuptial agreements understand the law of his or her state which governs treatment of trusts in divorce.

• Best to address all trusts of which your client is a beneficiary (even a remainder beneficiary) in the marital agreement to ensure that those trust interests are not subject to litigation if the marriage ends in divorce.

Bottom Line: Your client should have a prenuptial agreement if he or she is the beneficiary of trusts.

© 2015 Sherman & Howard L.L.C. 70 8. DISCLOSURE OF ASSETS, LIABILITIES, INCOME, AND BENEFICIAL INTEREST IN TRUSTS • In order for a prenuptial agreement to be enforceable, each of the parties to a marital agreement will need to make full financial disclosure. Each party should prepare (or have prepared) the following: – A net worth statement, detailing with reasonable accuracy all assets, liabilities, financial obligations, and net worth. Hard to value assets such as closely held business interests, should be valued on a reasonable basis if no formal valuation exists. The basis for such “reasonable estimate” should be provided to the other party and his or her counsel. © 2015 Sherman & Howard L.L.C. 71 8. DISCLOSURE OF ASSETS, LIABILITIES, INCOME, AND BENEFICIAL INTEREST IN TRUSTS – CONT’D

– Income information for the last three years. – All beneficial interests in trusts should be disclosed, even if your client is a remote or remainder beneficiary. A copy of the trust agreement and a detailed statement regarding the assets of the trust should be included. • These should be provided to each party and the attorneys. They will also be attached as exhibits to the prenuptial agreement. • Failure to disclose adequately is a significant ground for challenge of marital agreements. Err on the side of over disclosure.

• Generally, prenuptial agreements define separate and marital debt, so that if there were to be a divorce, it is clear how debt should be allocated. – Generally, all debt which one party enters the marriage with is defined to be his or her separate debt, and vice versa. – You would then want to define debt which is incurred during the marriage as either separate debt or joint debt, depending on the nature of the debt, and the clients’ expectations for how that debt will be treated.

• Maintenance of Testamentary Documents – If the marital agreement requires that wills, trusts, beneficiary designations, deeds, or other documents be prepared to reflect the agreement reached, this can be done by one of two methods: (1) the marital agreement can be drafted as a specific roadmap which will contain the essential terms of the documents that will be prepared at a later date, or (2) the marital agreement can include concurrently prepared and executed documents as exhibits to the agreement. – If the parties execute a marital agreement which provides a general waiver or “all rights upon death” or similar language, be sure to advise your client to maintain updated estate planning documents after the marriage if your client does in fact wish to leave property to the spouse.

• Enforcement for Breach – If the marital agreement requires a spouse to devise property to the surviving spouse, the agreement constitutes a contract to devise property. – Be sure to consult your state laws regarding contracts to make a will or devise to ensure that the marital agreement satisfies any specific requirements. – The surviving spouse would then be treated as a claimant against the decedent’s estate and would have to comply with the claims statutes. – If you represent the spouse who is to receive the devise in accordance with the marital agreement, consider including language which extends the surviving spouse’s time for making a claim and which reimburses the surviving spouse for attorney’s fees incurred in connection with the claim.

• New Estate Planning Clients – Verify Whether a Marital Agreement Exists – New estate planning clients may not mention the existence of an old marital agreement. Estate planning attorneys should specifically confirm with clients whether or nor a marital agreement exists, and if one does, obtain a copy. – Have a discussion with both spouses about whether a joint representation makes sense in light of the marital agreement or whether one party may want to engage separate counsel to review the estate planning documents on his or her behalf.

• Estate Planning Clients with Grown Children – When preparing estate planning documents for wealthy clients with grown children, consider having a discussion with those clients regarding whether the children have or should have marital agreements in place. This may affect whether a client decides to leave property outright or in a lifetime trust to an adult child.

Tax Issues Unique to the Blended Family Structuring Estate Plans Using Trusts

Kristin A. Pace, Esq. Donahue Fitzgerald LLP 1999 Harrison Street, 25th Floor Oakland, California 94612 (510) 451-3300 [email protected] Tax Issues Impacting Estate Planning For the Blended Family

1. Increased Exemption 2. Portability 3. Focus Has Shifted to Income Tax Issues

79 Increased Exemption

• A Blessing and a Curse • Exemption amount is now $5.43 M indexed for inflation. • Return of the disclaimer plan: Does not work well for blended families because of control issues – no guarantee surviving spouse will follow deceased spouse’s wishes.

80 Incre ased Exemption Formula funding problems Under-funded spouse Gift splitting

81 Increased Exemption

• Formula funding problems

 Beware of unintended results  Depending on who the beneficiaries of the bypass trust are, spouse or children could wind up with a reduced share of the trust estate  Economic volatility can affect beneficial interests in the QTIP trust and the bypass trust depending on type of funding formula utilized (i.e. pecuniary marital vs. pecuniary bypass)

82 Increased Exemption

• Under-funded spouse  Outright gift to spouse during lifetime does not work well in the blended family setting  Transmutation Agreements  Lifetime QTIP trust as an alternative  Ethical issues

83 Increased Exemption

• Gift splitting

 Annual exclusion planning  Exemption planning  Ethical issues

84 Portability – To Port or Not to Port. That is the question…

• Made permanent by ATRA • Is portability right for the blended family?  Traditional Bypass Trust / Survivor’s Trust planning may not be advantageous because of loss in step up in basis per Section 1014. Consider inclusion techniques.  QTIP Trust / Survivor’s Trust planning could eliminate income tax concerns.

85 Portability – Bypass Trust Planning

Example: Mike and Carol are both married for the second time with 3 kids each from their prior marriages. Mike dies with assets having a value of $2M. Mike’s assets go into a Bypass Trust. Mike’s remaining $3.43M of exemption is “ported” to Carol as deceased spousal unused exclusion (“DSUE”). When Carol dies, the Bypass Trust assets have a value of $3M. Carol’s own estate has a value of $2M. No estate tax is due, but the beneficiaries of the Bypass Trust inherit those assets with an unrealized capital gain of $1M. The use of the Bypass Trust in this case created unnecessary income taxes for the beneficiaries.

86 Portability – Bypass Trust Planning

Inclusion of Bypass Trust in Surviving Spouse’s Estate or Trying to have it all…

• Practitioner’s like the attributes of the Bypass Trust

 Creditor Protection  GST tax exemption can be allocated to Bypass Trust  Remainder beneficiaries are set

87 Portability Basis Adjustment Mechanisms to Cause Inclusion in Surviving Spouse’s Estate: • Providing an independent trustee the power to distribute assets to the surviving spouse (no HEMS standard) • Creating a contingent general power of appointment • Naming a trust protector and giving the trust protector the ability to a general power of appointment in the surviving spouse • Intentionally violating the “Delaware Tax Trap” See article by Richard S. Franklin and George D. Karibjanian in September/October issue of Tax Management Estates, Gifts and Trusts Journal for in-depth discussion of these mechanisms.

88 Portability – QTIP Trust Planning • Review Example on p.9 of Power Point Slides. • Personal representative could instead make a QTIP election.  All income to surviving spouse, i.e., this will not work if Bypass Trust allowed for discretionary distributions of income by trustee.  There cannot be any other current beneficiaries of QTIP Trust.  Funding issues: partnership interests, IRAs, non-income producing assets.  Reverse QTIP election can be made to preserve allocation of deceased spouse’s GST tax exemption.  On surviving spouse’s death, all assets will receive a step up in basis.

89 Portability – QTIP Trust Planning • Disadvantages of QTIP Portability Planning:  Surviving spouse can consume DSUE amount of deceased spouse on split gifts with new spouse, but per Section 2207A, estate taxes will still have to be paid out of the QTIP trust assets.  Surviving spouse may use all his/her exemption plus DSUE because his/her estate has appreciated. Section 2207A applies.  “Last deceased spouse rule”: Surviving spouse remarries and new spouse dies first not leaving any DSUE. First deceased spouse’s DSUE is not available.

90 90 Use of Trusts in Creating Blended Family Estate Plans • Alternative Trusts to Bypass and QTIP Trust Planning

 Spousal Limited Access Trusts  Irrevocable Life Insurance Trust  Non-Charitable Unitrust  Charitable Planning

 Intentionally Defective Grantor Trusts: Planning for the Family Business

91 Alternative Trusts Irrevocable Life Insurance Trust • Create an inheritance for spouse or children • Especially useful when second spouse is close in age to children from first marriage • Advantage: No estate tax on proceeds if trust is properly structured • Disadvantage: Inflexibility if spouse is named as beneficiary – cannot act as trustee.

92 Alternative Trusts

Non-Charitable Unitrust • Advantage: Can help to alleviate tension between income and remainder beneficiaries Non-Charitable Unitrust Sample Provision: “The Trustee shall pay to or apply for the benefit of the Surviving Spouse each year the greater of (a) the entire net income from the Marital Trust or (b) four per cent (4%) of the fair market value of the Marital Trust determined as of the end of the preceding year, in monthly or other convenient installments as the Surviving Spouse may request, but in no event less often than annually.”

93 Alternative Trusts

Charitable Planning • Charitable Lead Trusts • Charitable Remainder Trusts

94 Alternative Trusts Intentionally Defective Grantor Trusts: Planning for the Family Business

• Can be used for succession planning (i.e. transfer of business to the next generation) • Advantages:  Spouse is entitled to income stream from  Promissory Note  Spouse’s status is reduced to that of a creditor  Children are left to manage the business without interference from spouse

95 Use of Trusts in Creating Blended Family Estate Plans • Who should act as Trustee?

 Need to consider the purpose of the trust  Need to consider the make up of the trust beneficiaries  Consider corporate or professional fiduciary

96 Use of Trusts in Creating Blended Family Estate Plans

Who should act as Trustee? Why is this important? • Trustee chooses the team:  Lawyer  Investment advisor  CPA • Trustee makes tax elections • QTIP Election vs. Bypass Trust • Trustee funds the trust • Trustee invests trust assets