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.

Don't Own Your Corporation

Small Business Corporations. Many small businesses are run through corporations. You have heard the radio ads that you must protect your home and banking accounts from business liabilities by running your business though a corporation.

Stock Not Protected. But what protects your shares in your corporation that owns your business? In contrast to a Virginia or Delaware LLC, a court may order the seizure and sale of your corporate shares to pay judgments against you.

Peter Plumber. Peter Plumber has a successful plumbing company (Peter Plumber, Inc.) with 20 employees, ten trucks and $3,000,000 a year in sales. One night he has a terrible auto accident while he was driving home from work. He ends up losing the lawsuit over the accident and a judgment for $5,000,000 is entered against him personally. His auto insurance only pays $500,000 of the judgment. The trial lawyer for the accident victim comes after Peter for the remaining $4,500,000. The trial lawyer obtains a court order for the sale of all the stock Peter owns in Peter Plumber, Inc., in addition to losing most of his assets.

Just Another Asset. Whether in Microsoft® or shares in Peter Plumber, Inc., corporate stock is treated as an asset just like a bank account or real estate and can be sold on the courthouse steps. In my experience, most business owners do not know this.

What to do. To protect your shares in your corporation, here are some of the techniques. Each of them has advantages and disadvantages:
1. Buy Sell. Have a buy sell agreement that mandates the sale of your stock in the event it is taken as a result of a court judgment.
2. Use an LLC. Consider setting up your business as a Limited Liability Company (LLC) in a state where LLC interests are protected. Consider making a corporate tax election for the LLC. More on this later.
3. Convert. If you have a corporation, review with your advisors the feasibility of converting to an LLC. Be aware that the IRS considers such conversions a sale and do not do this if you have to pay a lot of taxes.
4. Segregate Assets. Have all of the assets that you use in the business owned by separate LLCs and rent those assets from these LLCs. For example, Peter Plumbing, Inc. does not own the vehicles or its warehouse. The vehicles are owned by a separate LLC as is the warehouse.
5. Have LLCs own your Shares. If you have a C Corporation that pays corporate taxes, have your shares owned by an LLC that is protected. If you have an S Corporation that pays no corporate taxes, there is a special type of LLC to use. More on this later.

You Used Your Name: LLC Mistake Number Three

Dr. Fred F. Funkel LLC. Fred F. Funkel sets up his own LLC to own his money market funds, stocks, bonds and savings accounts. Fred does this because he wants to protect these assets from a future creditor. Fred is a medical doctor who delivers babies and therefore is at high risk for medical malpractice claims. Fred proudly names his LLC the Dr. Fred F. Funkel LLC. Fred sets it up in a state where the state law is not clear as to whether a creditor is able to obtain a court order requiring that Fred’s LLC membership interest be sold on the courthouse steps. (See “You Choose the Wrong State: LLC Mistake Number Two” blog)

Investigator Finds Funkel LLC. A couple lost their baby while Dr. Fred F. Funkel was the attending physician. There is no clear medical reason as to cause of death and Fred does not think he is at fault. The grieving couple consults Tom Triallawyer to see if they should sue Fred. Tom does an asset search and does not find that Fred personally has much liquid assets. (Fred’s liquid assets are held by Fred’s LLC). Tom also does an internet and name search and finds that Fred owns the Dr. Fred F. Funkel LLC. Tom retains an investigator who finds out that the Dr. Fred F. Funkel LLC has about $2,000,000 of liquid assets. Tom looks at recent judgments in his state and finds that a botched baby delivery is getting an average of $5,000,000 in jury awards. Tom decides to take the case of the couple on a contingency fee basis-that is the couple pays the expenses of the lawsuit, but no legal fees unless Tom gets a settlement or wins the case.

Tom Files Against Fred. Tom Triallawyer files the medical malpractice case against Fred. Fred consults Susan Sharp, his own personal lawyer, separate from the lawyer appointed by Fred’s malpractice insurance carrier.

My LLC Was Supposed to PROTECT ME! “I thought my LLC would stop people from suing me”, Fred painfully complains to Susan. Susan sees Fred is in pain and doesn’t say “I told you that I should set up your LLC because of all of the mistakes you could make”. Instead, Susan says in a soft voice: “The investigator’s job was a lot easier finding you because you used your own name as the name of the LLC. I recommend that we change the name of the LLC in the future to make it harder to find your assets.”

My LLC is Secret. Fred replies: “Well, I will just won’t tell them what my LLC owns.” Susan: “At a point in the litigation, the other side will require a statement of all of your assets and at that point, the court can force you to list the value of all of your assets in your LLC. This can happen in any lawsuit, whether or not they know that you have an LLC.”

My Assets Are Safe in My LLC. Fred: “At least I have the LLC. My assets in my LLC should be safe even if I lose the lawsuit”. Susan: “Unfortunately, the law of Maryland is not clear on this point. In general, a state court judge has the power to enforce judgments and this may include the authority to reach the assts in your LLC. For example, if Tom Triallawyer obtains a judgment for $5,000,000 against you in the existing litigation and your insurance carrier pays $3,000,000 of the judgment, the remaining $2,000,000 could be collected against you. After entry of the judgment, Tom Triallawyer will schedule a deposition of you to force you under oath to disclose everything you own, including the assets of your LLC. If you have a bank account in your name, then Tom Triallawyer will request that the Judge place a lien on your bank account, remove the funds from your bank account and deliver the resulting funds to Tom Triallawyer. The general power of a judge may authorize the court to order that your membership interests in your LLC be sold to the highest bidder in a court supervised auction sale. Tom Triallawyer buys your membership interests at a low price at the sale, takes over your LLC, liquidates the LLC, retains a third of the proceeds and disperses the remainder to his clients.

Fix My LLC Now! Fred: “What can I do to fix this? Could I move the LLC to another state?”

Too Late for Now. Susan: "If you had formed the LLC in Virginia, Delaware and several other states, we would have a strong argument that the judge does not have the power under those laws to have your LLC sold. However, since you have been sued, we can not now change the state of your LLC because this could be held by the court to be an action that hinders or delays an existing creditor. This is called a fraudulent conveyance and may be grounds to set aside the move of the LLC from Maryland to Virginia.” (Susan says to herself that when Fred consulted her about setting up an LLC she told Fred about this and Fred decided to save some legal fees and set up the LLC himself.) Susan gently adds: “We need to examine a strategy for the future after this awful time is past you.”

Fred Loses $1,000,000 from his LLC. In the settlement of the case, Fred is forced to pay $1,000,000 out of his LLC because of the possibility that Triallawyer could penetrate the LLC. If Triallawyer didn’t know that Fred had an LLC with $2,000,000, Triallawyer may not have taken the case. If the LLC had been stronger, Triallawyer probably would have settled for just a payment from the insurance company without a significant contribution from Fred.

Don’t Use Your Name. Fred let his pride make the mistake of using his own name in his LLC that was intended, but failed, to provide protection of his cash and securities assets. Fred could have named it the FFF LLC, or Chesapeake Three LLC or some other name, not used or trademarked by someone else, which does not so quickly lead the asset investigator directly to Fred’s doorstep.

When to Use Your Name. This is different if Fred conducts his medical practice in an LLC. In that case, if Fred is promoting his name “Fred Funkel” as a preeminent obstetrician, the name of Fred’s medical practice would be the Dr. Fred Funkel MD LLC. Or, if Fred’s practice uses medically sound natural childbirth techniques, the practice could be the Natural Child Birth Center LLC. You should have a conversation with your advisors as to the best name for your LLC.

Insider Secrets to Maxing Your IRA

Little Used Powerful Tool. This is about a little known planning tool, the Retirement Benefits Trust, which can provide dramatic benefits for generations of your family.

Great Wealth Accumulation. There is a way to create great wealth using IRA (Individual Retirement Account) and other retirement benefit planning. This is basically done by using the tax deferral available from IRAs for multiple generations. It will become much more important because taxes on your earnings and the earnings of your children and grandchildren are going up dramatically in the coming decades. For many, income taxes will take away 50% of your income. Because you can roll over your company retirement plan to an IRA when you retire, your IRA can have millions of dollars. Without proper planning, most of your retirement savings could go to taxes.

Tax Deferral. People use IRAs for postponing paying taxes during their lifetime. What is not well understood is how your IRA can continue to save on taxes even after you’re gone from this Earth (I am not talking about space travel).

Traditional IRA. There are two types of IRAs: Traditional and Roth IRAs. Under the traditional IRA, you are able to deduct the contributions you make to the IRA, there is no tax on gains inside the IRA for qualified contributions and when someone takes the money out of the IRA, the tax must be paid on all distributions at the then current ordinary income tax rate. The owner of the traditional IRA must start taking required minimum distributions from the owner’s IRA April 1 of the year after the owner turns 70 1/2. You must take out each year the required minimum distributions based upon the applicable IRS tables that project how long you will live. If you live as long as the IRS thinks you will live or longer, you may have taken everything out of the IRA.

Roth IRA. For the Roth IRA, you do not get a tax deduction when you make the contribution, you do not pay taxes on the earnings inside the Roth IRA and when someone takes funds out there is no tax on the money put in or on the earnings. The owner does not have to take out minimum distributions during the owner’s lifetime. But after the owner dies, the person inheriting the Roth IRA must take out distributions over their life expectancy under the IRS tables.

Tax Free Growth Does It. The trick is to legally postpone taking distributions as long as possible. That is because you get wealthy by consistently making money over time, reinvesting the earnings, getting a healthy rate of return and not paying taxes on the earnings.

Stretch it Out. The goal, then, is to have the IRA go to the youngest person possible after the owner dies. This does not happen in most cases because people leave the money to their surviving spouse who is usually about the same age (Anna Nicole Smith being the exception) or to children, nieces or nephews who take out the money and spend it. Only a few advisors understand Retirement Benefit Trusts (RBT).

Willy Wise and his Retirement Benefits Trust. Willy Wise wants to provide a legacy for his children, grandchildren and a favorite niece. He can see for that for the next 50 years or so, federal and state governments will be imposing higher and higher tax rates on income. He sets aside a life insurance trust and other assets that provide for all the needs for his wife. He has eight children and grandchildren and his niece. He sets up a “Retirement Benefits Trust” for his eight children, grandchildren and niece during his lifetime. Willy can amend this Retirement Benefits Trust during his lifetime so if Willy Wise III turns into a bum, Willy can cut Willy Wise III out of his RBT. Willy leaves the largest percentages in his RBT to his grandchildren, thereby maximizing the tax deferral and the growth of the assets. Willy does this for both his traditional and Roth IRAs. Willy’s advisors prepare beneficiary designation forms for Willy using the same percentages for his IRAs as is set forth in his RBT. Willy’s IRAs provide for the future education, capital for investments and a sound retirement for his eight descendants and his niece. When Willy dies, his spouse, children and advisors take all the necessary steps for each of the nine subtrusts of the Willy RBT to qualify to be an IRA beneficiary.

Multiple Benefits:

1. Maximum Tax Savings. Each child, grandchild and niece can use their life expectancy to determine minimum distributions. So for ten year old Wonda, with a 100 year life expectancy, Wonda’s trustee would only have to take out 1/100 each year and the remaining amount accumulates tax free.
2. Asset Protection. The assets inside the IRA are protected from the creditors, predators, spouses and relatives of the child, grandchild or niece.
3. Heirs Can’t Blow the Money. The heirs do not have to have the power to take out all of the money and blow it.
4. The Other Guy’s Kids Don’t Get Willy’s Money. Willy’s heirs get the money rather than a second spouse of the surviving spouse or someone else’s children.

Watch for Announcements. There are downsides, details and technicalities that need to be discussed with your advisor. Look for announcements on valuable workshops we will be having on this topic.

The Big IRA Book. This discussion is based upon the Big IRA Book from experts Robert S. Keebler, Cecil D. Smith and Carol H. Gonnella, but none of these individuals are responsible for any of the content of this article.

Circular 230 Disclosure Notice
Pursuant to recently enacted U.S. Treasury Department Regulations, we are now required to advise you that, unless otherwise expressly Indicated, any federal tax advice contained in this document, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed in this document.