September 17, 2014

Irrevocable Life Insurance Trust/Crummey Trust

An irrevocable life insurance trust, commonly known as an "ILIT," is a type of trust used to avoid the inclusion of life insurance proceeds in a decedent's estate.

Many people erroneously assume that life insurance proceeds are always non-taxable. This is not entirely accurate. Life insurance proceeds are not considered taxable income.  However, life insurance proceeds are considered part of the decedent's estate if there is incidents of ownership. For example, if John Doe purchased a life insurance policy in his own name for the benefit of his wife, the proceeds would be included in his estate at death. The inclusion of life insurance proceeds in a decedent's estate is a material concern because life insurance proceeds can easily be millions of dollars.

When a person passes away, the federal government imposes a tax on estates that exceed a certain amount. Your estate is everything you own at death essentially. Of note, California does not currently have an estate tax. This exclusion amount is $5.34M in 2014. This is pegged to inflation so it will increase in 2015. If you pass away in 2014 and your estate eclipses $5.34M, the estate tax will generally be imposed. Since life insurance proceeds can be in the millions of dollars, this can be the difference between an estate being below or above the estate tax threshold. Thus, some people opt to create an ILIT so as to avoid the inclusion of life insurance proceeds in their estate given the concern of the estate tax. Although there are additional benefits for an ILIT. 

A typical way to create an ILIT is as follows. 

Maude, a wealthy widow, has only one child, a son named Sam. Maude's estate is above the estate tax threshold. Maude wishes to reduce her estate tax liability and simultaneously benefit Sam.

Maude meets with an estate planning attorney who tells Maude about the advantages of an ILIT. Convinced of an ILIT's benefits, Maude decides to create one. The attorney tells Maude that it is best to create an ILIT by gifting the maximum annual gift tax exclusion amount, $14,000 in 2014, to her son each year through a Crummey Trust. The trustee of the Crummey Trust then uses Maude's $14,000 gift to Sam to purchase a life insurance policy for her life.

Many years pass by and each year Maude gifts $14,000 to Sam's Crummey Trust. In turn, the Crummey Trust's trustee pays the premium on Maude's life insurance policy. When Maude ultimately passes away, multiple benefits are realized. First, by gifting thousands of dollars to Sam's Crummey Trust, Maude's estate has reduced her estate tax exposure because of the decreased value of it. Second, the life insurance proceeds for Maude's policy are not included in her estate for estate tax purposes because there is no incidents of ownership. Third, Sam receives the life insurance proceeds tax free.

September 10, 2014

Undue Influence involving a California Trust

One method in which a testamentary instrument can be voided is if it is the product of "undue influence." California case law says that undue influence is dependent upon the facts and circumstances of the situation. Sparks v. Sparks (1950) 101 Cal.App.2d 129, 135. Thus, there is no set of elements which need to be established in order to show that undue influence has occurred.

However, there are situations which suggest a showing of undue influence. These include the following: (1) unnatural provisions cutting off from any substantial bequests the natural objects of the decedent's bounty; (2) dispositions at variance with the intentions of the decedent, which he or she may have expressed both before and after execution; (3) relations between the chief beneficiaries and the decedent that afforded the chief beneficiaries an opportunity to control the testamentary act; (4) a mental or physical condition suffered by the decedent that permitted the subversion of his or her freedom of will; and (5) the chief beneficiaries' active procurement of the contested instrument. (Estate of Lingenfelter (1952) 38 Cal.2d 571, 585.

An example of undue influence occurred in the case Arnold v. Fuller, Los Angeles Superior Court Case No. BP122665. Thelsey Fuller was the father of five children, Robert Fuller, Doris Fuller, Shirley Ritchey, Sandra Arnold and Steven Fuller. Prior to forming his trust, Mr. Fuller expressed his intentions to evenly divide his trust estate equally amongst his five children. Consequently, Mr. Fuller executed a trust on July 23, 2008 which evenly distributed his trust estate to his five children.

Only two months later on September 16, 2008, Mr. Fuller curiously amended the distribution clause in his trust. It read: "On the settlor's death, the remaining trust estate shall be disposed of as follows: [¶] Shirley C. Ritchey shall be given the amount of forty dollars ($40.00), Sandra Arnold shall be given the amount of forty dollars ($40.00), Steven A. Fuller shall be given the amount of ten dollars ($10.00). [¶] The remaining trust estate shall be distributed as follows: [¶] Robert Fuller shall be given fifty percent (50%) of the trust estate. [¶] Doris Fuller shall be given fifty percent (50%) of the trust estate." 


Shirley Ritchey and Sandra Arnold filed a petition to have the September 16, 2008 amendment voided, citing undue influence. The trial court determined that such amendment was the product of undue influence and voided the amendment. This judgment was upheld on appeal in an unpublished decision.  

An undue influence case can usually be easy to spot. For example, the cases I've seen involved a tortfeasor befriending an elderly person who amends their trust or will to the benefit of the tortfeasor at the cost of cutting out their children and/or grandchildren from his or her estate. Where there is smoke, there is usually a fire.......     

September 3, 2014

Business Transactions with a Client

State Capitol, Sacramento
When a client hires an attorney, a appreciable level of trust and respect is generally established. The client can expect the attorney to act in their best interest at all times. Similarly, the client can expect the attorney to not exploit them in any fashion. In legal terms, the attorney is the client's fiduciary. Unfortunately though, an attorney occasionally abuses the trust and respect a client provides them. The following is allegedly an example of such. 

According to the Sacramento Bee, Attorney Delbert Modlin was arrested on August 26, 2014 in Sacramento for felony financial elder abuse and grand theft charges. Allegedly Mr. Modlin had persuaded an estate planning client to liquidate their investments and then told the client's daughter to invest the $120,000 in a new cat litter box he had invented. The daughter said that Mr. Modlin promised to double the client's money in 4 years. Furthermore, Mr. Modlin did not reveal two prior bankruptcy filings and that he is awaiting trial on felony charges in Placer County.       

Besides the alleged criminal aspect to this circumstance, there are serious ethical issues raised here as well. A California attorney should seldom, if ever, enter into a business transaction with a client. The California Rules of Professional Conduct place explicit restrictions on such situations and require extensive disclosures for the few situations where it is otherwise permissible. Rule 3-300 reads:

A member shall not enter into a business transaction with a client; or knowingly acquire an ownership, possessory, security, or other pecuniary interest adverse to a client, unless each of the following requirements has been satisfied:

(A) The transaction or acquisition and its terms are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner which should reasonably have been understood by the client; and

(B) The client is advised in writing that the client may seek the advice of an independent lawyer of the client’s choice and is given a reasonable opportunity to seek that advice; and

(C) The client thereafter consents in writing to the terms of the transaction or the terms of the acquisition. 

Past estate planning clients have asked me to participate in business ventures or real estate deals (I have a real estate LLC). Given the inherent risk of such an endeavor, I naturally decline. The risk is simply not worth the reward and I cannot foresee a situation where it ever will be. 

August 27, 2014

Ancillary Probate in California

The ease in which people and capital can move from one place to another has naturally caused the accumulation of assets in multiple locations. It is relatively common for a California resident to re-locate to New York for a new job. While living in California, such person might have owned a home and then decided to purchase another home in New York as well. 

If the person passes away ("decedent") in New York while domiciled there, the administration of their estate is not as routine had they only owned assets in one place. That is, since the person owned property in two states, New York and California, probate is arguably required in each state. I say arguably because I cannot comment on the exact nature of New York's probate laws. Regardless, when a person passes away with California assets but is not a California domiciliary, ancillary probate is generally required. The California Probate Code defines ancillary probate "as proceedings in this state for administration of the estate of a nondomiciliary decedent." Prob C § 12501. In understandable English, this means that probate is required if, generally speaking, the probate estate is greater than $150,000 in assets. This $150,000 figure does not take into account encumbrances, i.e. a home mortgage. Thereby if the decedent's home is worth $500,000 but has a $400,000 loan, the conventional 80/20 home loan, probate is required because the value of the probate estate is $500,000. However, if the assets of the nondomicilary are less than $150,000, excluding real property, the assets can be collected via a small estate affidavit. Probate Code §§13100-13116. 

There are a couple of points worth mentioning about an ancillary probate. First, all the steps of a regular probate are required for an ancillary probate. There is no abbreviated ancillary probate procedure. I can assure you of this. Second, the fees for an ancillary probate are the same as a regular probate. Hence, there are only minor differences between an ancillary probate and a regular probate. Thus, the dreaded time and expense of a California probate also applies to a California ancillary probate.

This past spring I wrapped up an ancillary and regular probate around the same time. For the former case, the decedent was a resident of Maryland but had a large bank account at a credit union in California. Ancillary probate was then needed here in California even though the decedent had basically no connection to California except for one bank account, albeit a large one. Unfortunately the decedent did not list a beneficiary on his bank account which otherwise would have prevented the necessity of an ancillary probate. In doing the two probates simultaneously I saw few, if any, distinguishing features between the two cases. Each probate required the same steps: (1) collection and appraisal of assets, (2) payment of debts and (3) distribution of the remaining property to the beneficiaries.     

August 21, 2014

Fiduciary Duty Owed to a Creditor?

In a fiduciary relationship, the fiduciary is legally obligated to act in the bests interests of the principal. This relationship can arise in various situations. For example, a lawyer owes a fiduciary duty to a client just as an executor owes a fiduciary duty to an estate beneficiary. Given the privileged status of a principal in a fiduciary relationship, it is a very favorable position for the principal. That is, the law imposes a high standard of care on the fiduciary. However, not every relationship involves a fiduciary relationship. A recent California Court of Appeal decision illustrates this point.

Vance v. Bizek  ____ Cal App. 4th ___ (2014)

Dan Bizek obtained a judgment against Sally Gordon in the amount of $987,747. Mr. Bizek then tried to attach this judgment to Ms. Gordon's interest in the Wallace and Pearl Burt Trust, of which she was a beneficiary. Of note, Pearl Burt was Ms. Gordon's mother. Ms. Gordon was also the sole beneficiary of the Pearl Burt Trust. On April 6, 2011, Mr. Bizek's petition to attach his judgment to Ms. Gordon's interest in the Wallace and Pearl Burt Trust was granted. In turn, Ms. Gordon disclaimed her entire interest in the trust on the same day so that her interest passed to her daughter, Cyndi Vance (Author's comment: a disclaimer to avoid creditor attachment is surprisingly permissible in California under certain situations). 

Ms. Vance and Mr. Bizek then filed competing petitions to ascertain the validity of the disclaimer.

The thrust of Mr. Bizek's petition was that Ms. Gordon commingled funds as she was a trustee of both the Wallace and Pearl Burt Trust and the Pearl Burt Trust. Consequently, she had, inter alia, withdrawn money from the former and deposited it into the latter. The result, Mr. Bizek argued, was that Ms. Gordon had violated her fiduciary duty citing Probate Code § 16004. The relevant portion reads "a transaction between the trustee and a beneficiary which occurs during the existence of the trust or while the trustee’s influence with the beneficiary remains and by which the trustee obtains an advantage from the beneficiary is presumed to be a violation of the trustee’s fiduciary duties." Probate Code § 16004(c).

The problem with Mr. Bizek's argument though, as the holding of the case points out, is that Mr. Bizek was not a beneficiary of the Wallace and Pearl Burt Trust. Hence, application of Probate Code § 16004 was improper by the trial court. He was merely a creditor of the Wallace and Pearl Burt Trust, not a beneficiary. Thus there was no breach of fiduciary duty by Ms. Gordon to Mr. Bizek because none was owed to Mr. Bizek for purposes of the Wallace and Pearl Burt Trust.

A takeaway from this case is to keep in mind that a fiduciary duty does not arise automatically. Rather it arises in certain situations and close attention to detail is needed when determining whether it is invoked or not.

August 15, 2014

Is avoiding probate always positive?

One of the main reasons why a person writes a revocable trust is to avoid probate. The rationale is that once the person dies, the administration of their trust estate is typically a more expedient and economical method to administer than a probate estate. For example, probate takes 6-12 months to complete in California and the attorney fee is based off of the value of the estate. If the estate was worth $400,000, the statutory attorney fee is $11,000. This probate fee is higher than a trust administration fee in almost all cases because there are more steps to complete in probate than in trust administration. However, probate does have one mandatory aspect over trust administration that can be advantageous for beneficiaries, an avenue to address creditor claims.

When a person passes away, they will invariably have some outstanding debt. This might include a phone bill, a cable bill, a utility bill or a mortgage. These debts can range from the hundreds of dollars to millions of dollars, depending on the size of the estate. For instance, if a person purchased a multi-million dollar home, it would be easily conceivable that they had a $1M+ mortgage. 

The second step of probate is to satisfy the claims of creditors.  However, the manner in which these claims are addressed is not always the same for probate and trust administration.

In probate, the personal representative is required to provide notice to all creditors so they can submit their claim to the probate court. The personal representative can then either accept or reject the claim. Ultimately, before probate can be closed, the personal representative is required to state that all creditor claims have been satisfied. For example, in my petitions that I have I used to close probate, I say the following: "Petitioner has made all reasonable efforts to ascertain Decedent’s creditors. Notice of administration has been sent to all known and reasonably ascertainable creditors. More than 4 months have elapsed since the date letters first issued. The time for filing creditors' claims expired on January 18, 2014." 

Conversely, in trust administration cases, there is no requirement that the trustee have a creditor claim procedure, i.e. open probate. Instead, California law makes it optional for the trustee if they want to open probate. Probate Code § 19010. Thus, the trustee is free to satisfy creditor claims non-judicially. Alternatively stated, the trustee can pay debts without having to provide proof to a probate judge that they have done so. Occasionally this is not an issue if the decedent had few debts or their debts were easily verifiable. Issues arise though when the decedent had contingent or unknown debts, e.g. they were a defendant in a lawsuit. Hence, it cannot be said that opening probate is disadvantageous in every respect. By forcing the personal representative to address creditor claims before a distribution is made, the beneficiaries should feel confident that there is no lingering unaccounted for debt.