Funding Avoids Probate

Probate. In Living Trusts Do Not Avoid Probate, we discussed probate and living trusts. Probate is the court supervised process of transferring property after a person passes away and the property is in the name of the person at the time of death. The majority of people who die with assets have estates that have to go through probate; even though most people while they were alive did not want their loved ones to suffer through the costs, stress, delay and lack of financial privacy that is probate.

Living Trusts. A living trust is a legal entity you create when you sign a trust agreement with the required language and in some cases, when your transfer assets to the trust. Trusts are the first step to avoiding probate, but are not enough. To avoid probate, you have to take the second step to “fund” the trust.

Funding. Funding is the word that lawyers use to describe the transfer of assets to a living trust and the making the trust a beneficiary of qualified retirement plans and certain insurance contracts. My experience is that most non lawyers are not familiar with this use of this word. An example is where Ellen Smith signs a living trust agreement on Monday. On Wednesday, she goes to her bank, meets with an employee at one of the desks in the lobby and requests that the bank transfer the name of her account from her name individually to the name of her living trust. On the bank records, the name of her bank account was in the name of “Ellen Smith”. After the bank account is “funded” into the living trust, the name on the account will probably be “Ellen Smith, Tee (Trustee) utd (under a trust dated) 11/2/2009 (the date she signed the trust). Or, it may be “Ellen Smith Living Trust”.

Titling. The name of the owner of each asset of Ellen must be changed to the name of the trust for it to be in the trust. The title to her house, brokerage account, furniture, jewelry, vacation home, stocks, business and in some cases, insurance, must be changed to her trust. Each one of these assets has special rules as to how to complete funding. You do not transfer your pensions, IRAs or qualified annuities to your trust while you are alive, but do change the beneficiary designations of each of these accounts.

Bank Accounts. As an example, due to concerns about terrorists setting up bank accounts to finance terrorist attacks in the US, to change the name on your bank account to your trust, you have to physically go to the bank with your identification and all of the people who will be immediate trustees to sign the bank forms. An attorney can not do this for you. Some banks will make you open a new account in the name of the trust. Other banks will not make you open a new account, but will require that you obtain new checks with the name of your trust on your checking account. You would prefer not to have the name of your trust on your checks that go through all sorts of hands and businesses. Some stores are reluctant to accept checks from a trust because they think they may be business checks. You will prefer to work with a bank that does not require a new account or requires that you put the name of your trust on your checks. If one of your children or sister or brother is helping you with your banking now and is a co signer on your account, you will probably want to name that person a Cotrustee and they will have to go with you to the bank. Under IRS rules, because you have the legal power to revoke your trust at any time, you continue to use your social security number when your bank account is in the name of the trust.

Five Times the Insurance. There are many advantages to having a bank account in the name of your trust, rather than in your own name and the name of your cosigner. For example, in these times of failing banks, you can get five times the federal insurance against losing your money if you have your bank account in the name of your trust at no extra charge from the bank. More on this later.

Living Trusts Do Not Avoid Probate

Most, Not All. One of the primary purposes of setting up a living trust is to avoid probate. But, according to our informal survey of the experiences of thousands of estate planners nationally, most living trusts do not avoid probate.

Probate. When someone dies with property only in their name, then generally there is a legal process called probate. The designated person, often called the executor, if the person dying had a will, files the will with the court where the deceased lived. Then, typically, the executor or executrix must file an initial list of the assets in the estate, often called the inventory, and pay any court fees and applicable inheritance taxes. There may be annual reports and a later court approval of how the money is distributed to the heirs. The procedures are basically the same even if there was no will.

Dacey: Avoid Probate. Norman Dacey, who died on October 21, 2009, created a huge controversy when he wrote “How to Avoid Probate” in 1965. Dacey criticized the probate system and advocated that people use living trusts to avoid the costs, delays and publicity of the probate process. According to the New York Times, Dacey sold over two million copies of his book and was subject to lawsuits that claimed, because he was not a lawyer, he was practicing law without a license to do so. Dacey lost a case over this in Connecticut, but won one in New York. Many non lawyers saw this as an attempt by the Bar to protect the lucrative probate business of lawyers.

Living Trusts. What was new in 1965 for most Americans, the living trust, is now relatively commonplace today. This is part due to Dacey and the many attorneys advertising the advantages of living trusts. A living trust is a legal entity under US and English law which provides instructions for taking care of your property and you during your lifetime and after death. The way the trust avoids probate is that you change the title to your assets so that the trust is now the owner of your assets. When the person dies, the trust continues in existence and the designated trustees (usually children) take over all of the assets owned by the trust and split them up outside of probate.

Most Do Not Work. Many lawyers who write living trusts only provide the document and related will and powers of attorney. But to avoid probate, there must be an actual change of the title to the house, bank accounts, brokerage accounts and where appropriate, life insurance, to the name of the trust. If you have $100,000 in a bank account in your name only and you pass, then, in many states, probate has to be initiated before any of the $100,000 can go to your heirs. Of course, if the account was owned with someone else with right of survivorship, then the money would go to the survivor and not yet be subject to probate. The reason why most living trusts do not avoid probate is because the client or the lawyer does not take this crucial second step of transferring the assets to the living trust. More on this process called “funding” in future articles. The minority of living trusts – those that do own all of the deceased person’s property – do avoid probate.

Protect Your S Corporation with an LLC

Protect Your Shares. In our last blog, we showed how to Protect your Corporation with an LLC if you operate your business as a regular C corporation. One of these methods is to have an LLC own all of your shares in your C Corporation; such LLCs can have more than one member. You benefit from this because there is no real protection against a creditor getting a court order to seize your shares in a Corporation. In contrast, your membership interest in certain LLCs in Virginia, Delaware and some other states and countries should be protected against court seizure and sale.

S Corporation. The S Corporation is designed for the small business where the owners want to avoid the double tax of the C Corporation. Under normal circumstances, an S Corporation pays no tax. Instead, all of the income and most of the deductions usually flow though to the owners of the S Corporation. This means an annual savings of 15% or more of federal taxes on each dollar earned.

Real People Are Owners. The S Corporation comes with a lot of restrictions. The government does not want large corporations to use S Corporations to avoid paying corporate taxes. This means that the shares in S Corporations can only be owned by a human being or certain trusts for human beings. Shares in S Corporations can not be owned by C Corporations or partnerships or by many LLCs. So how can we use an LLC to protect your S Corporation stock?

Vanishing LLCs. Current tax regulations allow you to “check the box” as to whether you want your new business to be taxed under the partnership or the corporate rules. A partnership means there are two or more partners. You can not have a partnership with only one owner. You can have a Corporation and also an LLC with only one owner. IRS regulations say that where you have only one owner, called a single member LLC, the “LLC” is a “disregarded entity” for tax purposes. This means that as far as the tax man is concerned, the single member LLC does not exist for tax purposes even though it exists as a legal entity under state law.

Single Member LLC. Well then, could you have a single member LLC own the shares in an S Corporation, have the LLC disregarded, and treat the human being who owns 100% of the LLC shares as a human being that owns the S shares? The IRS has said yes in several private letter rulings. A private letter ruling is where someone writes to the IRS for a ruling on their situation. The ruling protects the persons who got the IRS blessing, but no one else. However, this has been a consistent position in several of these rulings and the logic of this is very sound. So check with your tax advisor, but one way you could increase the protections of your shares in your S Corporation is to have them owned by a single member LLC. One letter ruling even approved of a limited partnership owning S shares where the general partner was a single member LLC owned by X and X was the only limited partner. For tax purposes, the limited partnership was ignored, but should be treated as a limited partnership under state law.

Cautions. Single member LLCs may offer less protection than multimember LLCs. Also, if you forget and bring in another person (who is not a spouse) as a member of the LLC, you will immediately blow your S election because now a real partnership owns the S Corporation.

IRS Circular 230 Disclosure.

IRS rules impose requirements concerning any written federal tax advice from attorneys. To ensure compliance with those rules, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under federal tax laws, specifically including the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Protect Your C Corporation with An LLC

C Corporation. If you own shares in your own business, you should consider owning your shares in an LLC. This week we discuss regular C Corporations and not the special restrictions on S Corporations. A “regular” corporation is a corporation that is subject to paying corporate income taxes and is taxed under Subchapter C of Chapter 1 of the US Internal Revenue Code, hence the reference to “C” Corporations.

Transfer to LLC. If you own shares in any corporation and there is a personal judgment against you, then a court usually has the power to order a sale of those shares to pay off the personal judgment against you. This applies equally to your ownership in Google or Sam’s Deli, Inc. For an example, see Don’t Own Your Corporation. In contrast, with a LLC formed in Virginia, Delaware and certain other states, the court should not have the power to sell your membership interest in an LLC to satisfy a personal judgment against you.

Solution: Use an LLC to own your C Corporation shares. You do this by transferring your shares to the ownership of the LLC as long as you do not have the problems listed below.

Advantages:
1. Deter Lien Holders. It will be difficult to be able to take over your corporation if your shares are owned by your LLC.
2. Tax Neutral. If you select your LLC as a flow through entity, the ownership of the shares should not increase your taxes.
3. Spread Ownership. You can spread the ownership of your shares to family members without giving family members any rights to direct what happens with your corporation.
4. Income Tax Reduction. If some members of your LLC are in a lower tax bracket than you, this will reduce income taxes. This will be more important when dividend tax rates increase. Beware of the kiddy tax.
5. Estate Planning. The LLC can assist in the smooth transfer of shares in the event of death or disability and reduce estate taxes and avoid probate.


Cautions:
1. Make Sure Tax Neutral. Although such a transfer should be tax neutral, do not make this contribution until your tax advisors have reviewed it.
2. Buy Sell Agreements. If you have a buy sell agreement or other arrangement on share ownership with others, get their approval of the change. The LLC can be required to sell under the conditions of the buy sell agreement.
3. Corporations Owning Corporations. In many cases, there are tax advantages for one corporation to own its subsidiaries. You would probably use this LLC technique for the upper tier corporation. What we are talking about here is a closely held company without complex tiers of ownership.
4. Lender Restrictions. You may have to get permission of your lenders to do this.