Get Five Times the FDIC Insurance Against Bank Collapse by Use of Your Living Trust

Bank Failures. There have been over 100 bank failures this year and many more are expected next year. If you have deposits in a bank, what happens to your money when the bank fails? [click here for a list of bank failures throughout United States] Because of the run on banks in the Great Depression of the 1930s, the Congress established the Federal Deposit Insurance Corporation (FDIC) to provide insurance when a bank fails. If another bank does not take over the failing bank and guarantee all of the deposits of the failed bank, then the FDIC steps in and pays the consumers who had deposits in the failed bank up to the maximum insurance limit then in effect. Until January 1, 2014, when the maximum insurance reverts to $100,000, the present maximum insurance is $250,000 per person.

Auntie Mae. Auntie Mae is worried that she may live longer than her money. She keeps nearly everything in cash and money market accounts. Her life savings, everything she inherited from her sisters and deceased husband totals about $800,000 which she has in her checking, savings, money market and other accounts. She put $100,000 in eight separate branch offices of a local bank, thinking that would protect her. She didn’t want to have to deal with several banks which she did not know and trust. She was afraid to put her daughter’s name on the accounts because her daughter is a pediatrician and although her doctor daughter has not been sued, pediatricians are often targets of lawsuits. When her bank failed and closed its doors, the FDIC paid her $250,000, the maximum insurance under this federal guarantee system, and she lost $550,000, most of her life savings. Auntie Mae will have to get a job at Wal Mart because she does not now have enough money to live on.

The Living Trust Solution. For years, there was confusion and uncertainty as to how FDIC insurance worked for accounts held in living trusts. This was clarified last year by the FDIC and there is now a “five-times” rule. Under the five times rule, if you have five or more beneficiaries of your estate in your trust, then you receive at a minimum five times the current maximum level of insurance on all of your accounts at the bank. With the five times rule, you will have a minimum of $1,250,000 of FDIC insurance for accounts held in your living trust at a single bank. You can have more than $1,250,000 in FDIC insurance with a living trust, but if there are over five beneficiaries, the FDIC will look at the actual amounts left to all of the beneficiaries and limit the amount by the lesser of $250,000 per beneficiary or the actual amount given. There is no extra charge to you for this additional FDIC insurance. The $1,250,000 of insurance will take care of most accounts. After 2013, this is scheduled to reduce to $500,000.

How it works. Auntie Mae puts all of her checking, savings and bank money market accounts into the name of her living trust. She does this by going to her bank and having the ownership of the account changed to the name of her living trust. Auntie Mae has left 50% of her estate to her daughter Ellen, 20% to her nephew, $10,000 to the aide who helps her each week, $10,000 to the Salvation Army and $10,000 to a friend. This means she has five beneficiaries; the old requirement of family members as the only qualifying beneficiaries is gone. As a result, the bank and FDIC now provide her accounts up to $1,250,000 in FDIC insurance even though all of her accounts are in one bank. She does not have to spread her money into different accounts at different banks, which could lead to great confusion and complexity. If her bank went under, all of her $800,000 will be protected by FDIC insurance.

Transfer Your Bank Accounts to Your Trust Now. Many people put off putting their personal savings and checking accounts into the name of their living trust. Now, you have a very strong reason for doing this-getting five times the FDIC insurance.

Dad Died and the Bank Took Everything

Successful Contracting Company. Jimmy Jones had a successful contracting company which was worth several million dollars. Over his lifetime, he had seen the business go up and down with the economy. To put away some funds for the future, he bought an apartment building and a small shopping center. Jimmy worked until his seventies and never found the right person to take over his company. His daughter Jane is a successful CPA with her own practice but his son Jimmy Jr. drifts from job to job. Jimmy gave his children everything when they were growing up because he didn’t want his children to remember being poor as a child.

Great Banking Relationship. Jimmy has had a great relationship with his local community bank where he had his business accounts over the years. He had a line of credit and commercial loans on his apartment building and shopping center all with the same bank. He thought he saved on legal fees when he obtained or renewed his loans by not having a lawyer review the documents.

MegaBank Takes Over. On Friday the 13th of November, Jimmy had a heart attack and died. All of the loan documents for his business and his real estate have a clause in the loan documents which say that if Jimmy died, the bank could demand full payment immediately on all of his loans. Recently, his local community bank had been acquired by MegaBank which now has all of Jimmy’s loans. MegaBank has been kept out of bankruptcy by billions of dollars from the federal government. The federal regulators want MegaBank to have higher cash reserves in case of loan defaults and to get rid of all risky loans, which the regulators classify as including all commercial loans on local real estate to individual owners. Jimmy had always paid all of his loans on time and the business and real estate generated enough cash flow most months to pay all of the loans; Jimmy was an excellent credit risk. Now, because Jimmy has no successor in place to take over his construction business and manage his real estate, MegaBank feels itself insecure, is being pressured by the regulators and therefore declares due and immediately payable all of the loans that Jimmy had with the bank based upon the clause in the loan documents that the bank can demand immediate full payment if the borrower dies.

MegaBank Wins in Court. Jimmy’s daughter Jane hires an attorney to try to stop the foreclosures on the business and the real estate. Jane loses in court because the loan documents clearly allowed MegaBank to foreclose if Jimmy died. Jane pays $120,000 in legal fees out of her savings and MegaBank adds its legal fees of $150,000 to the balance due on the loans owed by Jimmy’s estate. Due to the depressed construction industry during the recession and the decrease in values for the real estate and the shortage of loan money, Jane can not get loans to stop the foreclosures. After MegaBank foreclosed, Jimmy’s construction company closed its doors and 32 people lost their jobs. The real estate was sold at fire sale prices for less than the balances on the loans. MegaBank came after Jimmy’s savings and wiped out any other money he had that did not go by right of survivorship to Gerry, Jimmy’s widow. Jimmy’s widow sells her house to have money to live on and moves in with her sister and her sister’s crude and rude husband. Jimmy’s children, who could have each inherited millions, will get no significant inheritance from their parents.

Prevention. This could have all been prevented. “Death is a default” is a standard term in commercial loan documents that can be removed through negotiations. If Jimmy had hired our firm to represent him with his commercial loans, we would have insisted that the loan commitment letter state that the loan could not be called by the bank if Jimmy died. We would have worked with Jimmy to have a business succession plan in place that we would show to the bank to convince them that they would still be paid if Jimmy died. We have always been able to obtain bank agreement that the loan could not be called in the event of the death of the principal borrower. MegaBank would not have had the right to foreclose and the Jimmy Jones family assets would have been saved and Gerry would not have had to move in with her sister and her rude husband. Many entrepreneurs do not use competent legal counsel to review the commercial loan commitment letter before their sign it. This story shows what can happen to a lifetime of work and a family if you do not obtain the proper loan terms.

Don't Put Children on Title to Your House

Add Ellen to the Deed. When I did a weekly talk radio show for WRC in Washington in the 90s on real estate, every week a little old lady would call me about putting her daughter (Ellen) on the title to her home. The mother wanted to do this as a cheap and easy way to plan her estate. If she died with the house in the joint name of her and her daughter with right of survivorship, the house would automatically go to the daughter. No probate, no will and no need for a living trust or to talk to a lawyer. I always spoke against this idea.

Joint Liability. When the mother puts her daughter Ellen on title, the daughter becomes a joint owner. As a joint tenant, most states treat this as tenants in common for the purposes of liability. Ellen has a car accident and a judgment for $2,000,000 is entered against her. Ellen’s insurance limit is $500,000. The trial lawyer who got the judgment comes after all of Ellen’s property. Now that Ellen is a co owner of the home, the trial lawyer can get a court order requiring the sale of Ellen’s interest in mom’s home and mom gets evicted from her home, or has to buy off the trial lawyer. If Ellen gets divorced, a half of mom’s house may be part of the divorce property settlement with the ex son in law.

Medicaid Denial. Under current Medicaid rules, a transfer to a child would be a gift and would disqualify the mother from Medicaid for up to five years, depending upon the appraised value of the house at the time of the gift and other factors.

Can’t Sell. Mom can’t sell the property to a legitimate buyer without Ellen’s signature. When the house is sold, Ellen is under no legal obligation to give any of the house proceeds to mom. What happens if mom needs the money for a nursing home and Ellen needs the money for a life threatening illness of one of her children? If mom has Alzheimer’s, has a stroke or becomes incompetent, no one can sell the house until Ellen engages in an expensive and time consuming guardianship court procedure. When parents put children on title to their homes and later take them off to get a loan or sell the property, we have often found that there are title problems that prevent a later sale.

Vulture Takes Mom’s Home. A vulture investor may be willing to buy out Ellen at bargain prices for a payment of quick cash to Ellen. Mom can’t legally stop the vulture investor from then obtaining a court order for the sale of mom’s home.

Gift Tax. Mom has made a gift to Ellen which will probably be subject to a gift tax. If mom’s house is worth $500,000 and she owns it without debt, the gift to the daughter is $250,000, $237,000 more than the annual exemption of $13,000 from gift taxes in 2009. Should mom file a gift tax return? If mom intended a gift, then she is required by the tax law to file a gift tax return and use $237,000 of her $1,000,000 exemption from gift taxes. If mom sells the house and Ellen agrees that all of her share, worth $250,000, should go to mom, then Ellen has given $237,000 to mom and should file a gift tax return.

Pay Capital Gains Tax Unnecessarily. If mom filed a gift tax return or if Ellen can’t prove to the IRS that mom didn’t really give her anything in the house, then Ellen received one half of mom’s house based upon her mother’s basis in the property. Mom and dad (now dead) had paid $50,000 for the house and Ellen can’t find the receipts for improvements made during the lifetime of her parents. Therefore, mom’s basis in the property is $50,000. Ellen receives a basis of $25,000 in Ellen’s one half interest in mom’s house; one half of the mother’s basis of $50,000 is $25,000. When Ellen sells the house for a net of $600,000 after mom dies, Ellen unnecessarily pays a capital gain tax on one half of the house of about $55,000 at current rates and more with higher rates in the future.

Loans. How it happens, I don’t know. But, there are cases where a child goes out and gets a loan on the house without telling mom, the child pockets the money and later is unable to pay the loan. Mom loses her house in her old age to foreclosure. Or, mom wants to get a reverse mortgage and can not because the daughter is on title to the house.

Family Destruction. Mom had two daughters and son and mom’s will says everything goes in an equal split one third to each child. But, mom’s house passes outside mom’s will so her daughter Ellen receives not one third of the house, but 100% of the house. The will usually does not equal this out. Ellen must now decide whether to take money from Ellen’s family and give two thirds to her siblings and use up part of Ellen’s gift and estate tax exemptions for her gift to her siblings. If Ellen doesn’t do that, her sibling will believe that Ellen plotted this from the beginning so that Ellen could steal mom’s house from her brother and sister.

Living Trust. If mom had instead set up a living trust and named herself and Ellen as the trustees of the trust, she could have avoided all of these problems. We will cover the issues later that arise from putting a home in a living trust. After mom got off the radio talking to me, did she follow my advice? Probably not.

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.