Common estate transfer mistakes and how to avoid them.
If you're like three out of 10 Americans, Uncle Sam will be the clean-up hitter when you die. The game doesn't have to end like that, however, if you start making estate transfer plans now.
Procrastination is the leading cause of estate plans that never quite make it on paper, says Bob Fetsch, family life specialist at Colorado State University (CSU). He says too many producers have good intentions of preparing a will but don't get it done, and their children have to worry about the estate after they're gone.
"We create problems by waiting too long and because we don't want to talk about death and what happens after it," says Norm Dalstead, farm and ranch management economist at CSU.
In addition, Dalstead says most people don't understand what estate planning tools are available to them. And often, he adds, they don't know where to go to get qualified information.
Specialized attorneys, estate planners and accountants are good resources and usually can help you figure out how to keep your hard-earned estate from being over-taxed. Here are some of the most common mistakes - and solutions - experts routinely see.
1. Overuse Of Joint Tenancy With Right Of Survivorship (JTWROS). Joint tenancy is often called the "poor man's will." That's because whenever property is held by joint tenants, both essentially own it. So, upon the death of one joint tenant, the survivor immediately inherits the entire estate.
There are lots of reasons to think twice about owning property in joint tenancy with someone else, even your spouse, says Kathy Boyd, estate planner from Limon, CO. Here's a quick summary of the most important reasons:
* JTWROS only avoids probate on the first death. When the second joint tenant dies, the entire estate will go through probate.
* When a married couple uses JTWROS, they lose an estate tax exemption of $625,000.
* The spouse (joint tenant) who dies first has no say over how the jointly owned property will eventually be distributed. In JTWROS, those decisions can be made only after the death of one of the spouses. Thus, the surviving spouse has all the decision-making power over distribution. For example, if you should die before your spouse and your spouse remarries, people you've never even met could inherit your property, Boyd says.
Joint tenancy is a useful tool for husbands and wives with assets up to $625,000. But, it's a serious mistake to use joint tenancy between parents and children, says Eric Peterson, attorney with Liggett, Smith & Williams, P.C., at Fort Collins, CO.
"For example," Peterson explains, "a father puts his ranch in joint tenancy with his son in hopes of saving a few hundred dollars in probate costs. But, because of 'substituted basis' rules, the son stands to lose tens of thousands of dollars in income taxes versus what he would have paid if he'd inherited his father's ranch under his father's will."
When the father put his son's name on the ranch, Boyd explains that he technically made a "lifetime" gift to the son of half the ranch's value - as of the date the gift was made.
"Lifetime gifts do not get a step-up in cost basis," Boyd says. "All assets transferred as lifetime gifts carry the donor's basis over to the new owner. If the recipient ever wants or needs to sell, then he'll pay the same capital gains tax that his father would have paid had he sold the assets."
In another instance, Peterson recalls a farmer in eastern Colorado who had a federally taxable estate and a second wife. He knew he needed a good estate plan and got one - in the form of some living trusts. But five years later, after reading some recommendations about avoiding probate, he put all his property in joint tenancy with his second wife. So, in addition to disinheriting his children, he created the risk of a very large estate tax.
Probate is not always a bad thing, Peterson explains. "Old probate laws were designed on the belief that you couldn't trust anyone. In a time when estate values were much lower than they are now, allowing property to pass directly to the surviving tenant eliminated questions and confusion about who got what. Now, however, probate is saying that most people can be trusted.
"About half the states have the Uniform Probate Code, which streamlines the process of court approval for routine actions," Peterson points out. "You don't need to get attorney or court approval to do things. In the old system you paid a lot for court approval for routine matters because you paid the attorney on a percentage fee schedule."
Probate laws are state laws and have nothing to do with taxes. Tax laws are federal laws and uniform. Probate avoidance, Peterson says, doesn't do anything for tax avoidance. They're unrelated issues.
2. Pay No Attention To Who Will Handle Your Estate. The traditional choice, says Peterson, is to select the oldest child. "But, that may not be the best choice. What if that sets up friction with the other siblings? And, what if this child isn't up to the job and the beneficiaries have to go to court and get him or her fired?"
Also, if you die and have an insurance policy where your minor children are beneficiaries, neither the insurance company nor the probate court will turn the money over to them. Instead, it will be placed in a conservatorship for your children, Boyd says. "If you've failed to set up a trust and name guardians for your children ahead of time, the court will be forced to do so. That's why you'll probably want to exercise greater control over when and how your children receive those distributions than a beneficiary designation allows."
3. Prepare The Estate Plan Without A Clear Grasp Of The Facts. Many couples have simple wills leaving everything to each other. If this couple has substantial life insurance coverage, for example, disaster is looming. They need tax-planning wills, Peterson says. "What has never been explained to them is that life insurance passes on death to the beneficiaries 'income-tax free,' but can be subject to any applicable estate taxes."
Boyd adds that how the insurance is owned and controlled is the key. "If Dad is the owner and premium payer on a $1 million life policy, then he controls it. If he dies still in control of it, his taxable estate is $1 million higher," she says.
4. Sign Your Will Or Trust But Don't Do Any Follow-up. Peterson says a local man died, leaving a trust for his 17-year-old son. Unfortunately, the life insurance beneficiary made it payable to the son directly, and not to the trust under his will. So, a court-administered conservatorship had to be established to run parallel to the trust. (The son couldn't inherit directly until he turned 18.) The cost, he says, ran an extra $2,000-2,500 for set-up and termination costs, and to administer during the one-year existence of the conservatorship estate.
The classic story, Peterson claims, is a person who pays $1,500 for a living trust, but then fails to transfer any assets into it. A probate procedure, which could have been avoided, becomes necessary.
5. Lack Of Estate Liquidity. An estate plan can include all of the trusts, wills, powers of attorney and generation-skipping tools available. However, one of the most significant and overlooked problems, Boyd points out, is the lack of liquidity in the typical farm or ranch estate. "Everything is generally tied up in land, cattle, equipment, machinery, grain bins, corrals and a variety of other related assets. If there are estate taxes due, transfer costs to be reckoned with or uninvolved heirs to compensate - how do you pay them if there's no money?"
Assets must be liquidated at discounted prices - sometimes so much so that the entire operation is destroyed, Boyd says. A tax-free source of money, such as life insurance in an irrevocable life insurance trust, can be the difference between an agreeable transfer and a disaster.
6. Not Knowing What Options Exist. Many families leave their estate subject to taxation or dispute merely because they never find out what's available to them, Boyd says. Planning ahead by using the appropriate tools can literally save hundreds of thousands of dollars, not to mention preserving family harmony.
7. Estate Equalization. Farm and ranch couples continue to leave their primary asset - the farm or ranch - to all their children to be evenly divided. Boyd questions how fair it is to leave a large part of the family farm to an off-farm heir who has had little to do with it for years.
Boyd points to her family as a perfect example. "My brother has farmed and run cattle with my Dad for more than 20 years. I love to help with the cattle, but I have no risk or obligation. It would just not be right for me to inherit a one-third interest in the business. (There are three children.)
"In fact, it could put my brother out of business," Boyd says. "Parents could think about leaving the agricultural enterprise to those who deserve it and leave something else to the off-farm or non-ranching heirs."
8. Keep Your Beneficiaries In The Dark. While your beneficiaries have no legal right to know what your estate plans are before you die, Peterson suggests you tell them. Especially, he says, if the benefits are going to be distributed unevenly. Let them know while you're still alive to avoid hard feelings later.
9. Eliminating Small Or Non-Producing Assets. Retaining small and essentially worthless holdings, especially assets that require probate outside the home state, can cost your survivors a lot more than the assets themselves are worth, Peterson says. "It's better to give them away or sell them while you're alive and consolidate matters."
Another example, Boyd points out, could be non-producing mineral rights or just as important, "the 11/48 interest in the original family farm in Iowa."
If you have estate planning questions, let us know. There are no guarantees, but we'll ask our sources to help you solve them. Send your questions to Greg Lamp, BEEF, 7900 International Drive, Ste. 300, Minneapolis, MN 55425.
>From a "dug-out" in the hillside occupied by Uncle Jess
This cattle ranch was started in the frontier wilderness.
Then Dad came west from Iowa in the year of nineteen one
and built that old log cabin you see there basking in the sun.
It took determination to "make it" on a homestead claim
One hundred miles from civilization and the closest railroad train.
To keep his homestead going, Dad employed his many skills -
School-master, logger, freighter, and he built roads into these hills.
Dad bought out his brother in the year of nineteen four.
Jesse'd had a terrible wagon wreck, and lived but four years more.
He built a pond for holding water and filed a desert claim;
And started irrigating, which helped to supplement the rain.
Can you believe that Dad wrote letters for seventeen long years -
To tell his boyhood sweetheart of his hopes and of his fears?
Settlements developed, and at last the railroad came;
Perhaps that induced my mother to consent to change her name.
So Dad traveled to Seattle where Mom was teaching school,
And they started life together - living by the Golden Rule.
Dad called his outfit "Mystic" for his old home on Willow Branch;
And a new post office started in his kitchen at the ranch.
Mother was postmistress; and three daughters came to bless
Our Mystic House on Salt Creek - a cozy little nest.
Mom "home-schooled" my sisters - until I came along;
Then Dad bought this real hay ranch where Elk River sings its song.
Here we could ride horseback to a public summer school.
We skied around the ranch all winter - which we thought mighty cool.
Our hay ranch on Elk River for seventy years now has been "home;"
Mystic now is pasture - where our cattle love to roam.
Brother Jack helped Dad keep ranching while I was overseas;
Our sisters all had married (Frances raised nine ranch kiddies).
Jack and I went pardners, and bought our sisters out;
We both had started families - our sons would soon be big and stout.
Mom had passed away in the fall of fifty seven;
We knew she loved our meadow, as she looked down on it from Heaven.
But Jack was brilliant minded - a scientist was he;
He returned to making chemicals for the agri-industry.
Dad spent winters with my sisters, but summers at the ranch;
To help us hay and irrigate - he never missed a chance.
'Twas early in the summer in the year of sixty three
That Dad left us to join Mother in that range we can not see.
My folks were married to each other, but to the ranch as well;
Mom - all her forty married years, Dad - more than half again a longer spell.
As my loving marriage pardner has been for near half a century;
And my own roots go the deepest, for with me it's seventy.
It's where we raised our sons and daughter, home to more than ten "grands" too;
They hope to keep it in the family - so the question's what to do?
There's some would cash in for a fortune - take the loot and run
But we couldn't watch from Heaven, condos growing - and think the right
thing had been done.
So we sold a conservation easement - which is for eternity;
Used the dough to buy insurance which will pay the estate tax fee.
We may finish out our days as poor folks; but we still will ranch our land,
And when we gaze down from Heaven and see meadows and pastures grand
Instead of ugly condos or unchecked sprawl of town,
We'll thank God for ranches that can still be passed on down.
Bill May, rancher and poet from Steamboat Springs, CO, has spent a lifetime cowboying and spinning authentic tales of Western life. As he and wife Cynthia begin passing down their ranch, he's penned this salute to forefathers that toiled over the land he calls home.
For a review of the Mays estate planning process, see BEEF's March cover story, "Developers Can't Have It," page 28.