Estate Tax, Gift Tax and Generation-Skipping Transfer (GST) Tax have nothing to do with income tax. The recipient of a gift or inherited property does not owe income tax on the gift or inheritance. Gift taxes, if any, are the primary responsibility of the donor. Those taxes are totally separate and apart from income tax. One income tax-related point, however, is that the recipient of property which has appreciated in value since acquired by the donor, takes the donor’s cost basis for income tax purposes, instead of the value of the gifted property on the date of the gift, and if the recipient sells the property at a higher value than the donor’s cost basis, there will be capital gains tax upon the sale. When appreciated property is transferred at death, instead of by lifetime gift, the recipient’s cost basis is stepped-up to the date-of-death value.
The modern estate tax was enacted in 1916. It is a tax on the transfer of assets of substantial value by a deceased person to others. The tax applies to property transferred by will or to transfers at death under state law, such as the North Carolina Intestate Succession Act. It also applies to property transferred by beneficiary designation, such as retirement accounts and life insurance proceeds on policies owned by a decedent, as well as property owned jointly with right of survivorship, payable-on-death or transfer-on-death accounts, etc., at least to the extent to which the decedent contributed to joint accounts, and transfers passing at death under revocable trust agreements.
Proponents of estate taxes consider it to be a progressive, fair source of government funding, and a good way to break up large accumulations of wealth in wealthy families. Winston Churchill once described estate taxes as “a certain corrective against the development of a class of the idle rich.”
Not too long after the adoption of the estate tax laws, people started giving away assets during their lifetimes, often on their deathbeds, to avoid estate tax at death, as a result of which, federal gift tax laws were adopted several years later, covering lifetime gifts.
To encourage some lifetime gifts in limited amounts, the gift tax laws give some “wiggle room” in allowing gifts without gift tax ramifications. Gifts which are currently exempt from gift tax include: gifts from a donor to an individual recipient which do not exceed a total value of $15,000 in a calendar year, gifts to spouses who are US citizens, and gifts for tuition as an educational expense and certain medical expenses. But please note that educational and medical gifts may not be given to an individual who uses the money to pay those expenses. Instead they must be paid directly to the educational institution or medical provider. Medical insurance premiums qualify for the medical exception, if paid directly to the insurer. Tuition and medical gifts are described in more detail under another article.
After the onset of gift taxes, creative tax planners came up with other devices to avoid estate and gift taxes on the transfer of wealth from one generation to another: Gifts could be made directly to grandchildren, for example, instead of to children, which would eventually skip a generation for gift or estate tax purposes. Also, taxable gifts could be made to trusts, instead of individuals. The trusts would have beneficiaries of multiple generations, and would not become part of the taxable estates of one or more generations of beneficiaries to receive benefits from the trusts. The trusts could make distributions to beneficiaries of one generation, without the value of the trust’s assets being subject to estate tax for a beneficiary at the time of his or her death. The trusts could simply “hang out there,” not belonging to any beneficiary for estate tax purposes, for multiple generations, without being subject to estate tax at the death of any beneficiary. Under the terms of the trust agreements, distributions could be made in the trustee’s discretion to beneficiaries from any generation, but without the principal value of the trust ever becoming part of a beneficiary’s taxable estate.
To limit that from being abused, a “generation-skipping” transfer tax was adopted in 1976. There could be perfectly good non-tax reasons for some “generation-skipping” gifts, such as the protection of assets for grandchildren if their parent had financial or other personal problems. Consequently, generation-skipping gifts were not abolished for tax reasons, but they were limited instead.
The generation-skipping transfer tax laws are very complicated and are commonly used only by very wealthy families, so we will not discuss those laws in detail here, but we will focus on gift tax and estate tax laws and their unified tax system. We recommend that anyone who is interested in generation-skipping transfer tax planning should discuss the same with one or more qualified professionals.
Federal Estate Tax
The federal estate tax applies to the transfer of property from US citizens or residents at death. Under the Tax Cuts and Jobs Act effective in 2018, the estate tax exemption is now $11.4 million (in 2019) for single persons, and with effective tax planning, $22.8 million for married couples. That Act is currently scheduled to be effective only through 2025, during which time the exemption will be indexed annually for inflation. Taxes on assets in excess of the exemption are taxed at a 40% rate. However, if a decedent is married, he or she may leave unlimited assets in excess of that value to his or her spouse, either outright, in a “marital trust” or in a “Qualified Domestic Trust” (QDOT) for non-citizen spouses, free of estate taxes at the first spouse’s death, but which will later be taxable as part of the surviving spouse’s estate. For a marital trust or a QDOT to qualify for the estate tax marital deduction, certain rules must be followed. We have a separate article discussing QDOT trusts for noncitizen spouses.
The tax basis (for capital gains tax purposes) is stepped up to the date-of-death value, which means that any unrealized capital gains on that date are never subject to capital gains tax. Journalist Michael Kinsley called this the “angel of death loophole.”
The estates of both US citizens and US residents are subject to estate tax.
Please be aware that different rules apply to estate taxes where one spouse is a non-citizen of the United States, even if the non-citizen spouse has been a resident of the United States for many years. Transfers to a non-citizen spouse do not qualify for the estate tax marital deduction unless they are left to a QDOT trust, and a certain election is made on a timely-filed estate tax return. But if the spouse becomes a US citizen before the filing deadline for the estate tax return, those transfers would qualify for the deduction without a QDOT.
Also be aware that estates of non-citizens who are nonresidents of the United States (“nonresident aliens”) and who own certain assets located in the United States, are required to file estate tax returns (on Forms 706-NA) for those “US-situated” assets, if those assets exceed $60,000 in value. That is, the applicable exemption for nonresident aliens on those assets is only $60,000, in stark contrast with an exemption of $11.4 million in 2019 for US citizens or residents.
Federal Gift Tax
Congress enacted the federal gift tax to prevent US citizens and residents from avoiding estate tax by transferring their wealth before they die.
The federal gift tax laws currently allow an amount each year that may be disregarded for both gift (and later estate) tax purposes, called the “annual exclusion.” The current exclusion in 2019 is $15,000 per year for total gifts to a recipient made during the year, applicable to “present interest” gifts. That is, a gift which is to take effect in the future, instead of immediately, does not qualify for the annual exclusion. The annual exclusion is granted to a donor separately for each recipient. A married couple would each have annual exclusions, so the couple could collectively give $30,000 in 2019 to a recipient, and the collective gifts could be made either from their separate assets or from the assets of both spouses, to each recipient.
The gift tax laws also provide a lifetime exemption for taxable gifts made by US citizens and residents (currently $11.4 million per donor in 2019), which is the same amount as the federal estate tax exemption, and the gift tax laws and the estate tax laws are integrated into one “unified” system, i.e. – taxable lifetime gifts reduce the exemption amount available at death on the federal estate tax return, and any taxes actually paid on lifetime gifts are credited toward the federal estate tax at death.
Gifts to spouses who are US citizens are not taxable, and there is no limit to the amount which can qualify for the gift tax marital exclusion. However, the unlimited marital exclusion does not apply for non-citizen spouses, even if they have been residents for many years. Gifts from a US citizen or resident to a non-citizen spouse are exempt up to $154,000 per year in 2019, indexed for inflation.
Another rule applicable to noncitizen spouses: If a US citizen or US resident spouse deposits money into an account in joint names with a spouse who is a US citizen, there is no gift unless the other spouse withdraws money from the account; that is, if the spouse who transferred the money into the account dies, the entire balance transferred by the decedent is treated as part of the taxable estate of the deceased spouse. However, if the account is a joint account with a noncitizen spouse with right of survivorship, then the account is generally treated as owned one-half by each spouse, meaning that a taxable gift has occurred on the creation of the account, except to the extent that money was contributed by the noncitizen spouse, and would be treated as a taxable gift, to the extent that it exceeds the annual gift tax exclusion (of $154,000 in 2019, indexed for inflation). There is a narrow exception to that rule, however, if the parties can prove that their intent was that the money was not to be withdrawn by the noncitizen spouse except for a special purpose which had not occurred.
Gifts include more than just cash transfers. Gifts of assets other than cash (e.g., stocks and bonds, mutual fund shares, partnership or LLC interests, parcels of real estate, etc.) are taxed at their fair market value on the date of the gift. The payment of rent or similar expenses for an adult recipient would be a taxable gift. If someone lends a large amount of money to someone else, either interest-free or at a very low rate of interest (the US Treasury Department publishes an official rate of interest each month, called the Applicable Federal Rate (AFR); if you charge less than the AFR for loans of totaling more than $10,000 to the borrower, the difference is deemed to be a gift).
Gift Tax Marital Deduction for Same-Sex Marriages
North Carolina denied marriage rights to same-sex couples by statute adopted in 1996. A state constitutional amendment was approved in 2012 which defined marriage between a man and a woman as the only “domestic legal union.” This amendment was approved by North Carolina voters by 61% to 39% vote.
In 1996 a federal law was adopted titled the Defense of Marriage Act (DOMA), Section 3 of which defined marriage as the legal union of one man and one woman.
Since those dates, state and federal court decisions have affected federal gift, estate and GST tax laws as they apply to same-sex marriages.
In 2013 a US Supreme Court decision recognized same-sex marriages for gift, estate and GST tax, provided that those marriages were valid under the laws of the states in which those marriages occurred, and it made no difference whether either spouse was a resident of the state in which the marriage occurred. It also makes no difference whether same-sex marriages are recognized in the state of residence of the married couples.
In Notice 2017-15, the IRS described the procedures which same-sex couples may use to re-calculate the marital exclusion amounts for property transferred to spouses before the US Supreme Court invalidated Section 3 of DOMA in 2013, if the gifts did not qualify for the marital deduction for federal gift, estate or GST tax purposes, solely because of DOMA.
If the applicable limitations period has not expired, a taxpayer may file an amended gift tax return or a supplemental estate tax return, on which he or she may claim a refund for taxes which have been paid, as well as restoration of the taxpayer’s applicable exclusion amount.
After the limitation period has expired, no refund can be claimed, but Notice 2017-15 allows the taxpayer to recalculate his or her applicable exclusion amount as a result of recognizing the marriage, and may recalculate the taxpayer’s remaining applicable exclusion amount as directed by the IRS in its forms and instructions.
Many of the issues have been resolved in a taxpayer-friendly way.
This material is intended for informational purposes only and should not be construed as legal or tax advice and is not intended to replace the advice of a qualified tax professional.
The North Carolina General Statutes contain very detailed procedures for establishing or contesting the validity of wills. Wills must be “probated,” that is, found by the Probate Court (the Clerk of Superior Court) to be properly executed and valid, before an Executor or other personal representative will be appointed to settle a decedent’s estate.
There are two different procedures for determining the validity of a will, called 1)probate in common form, and 2)probate in solemn form.
Probate in Common Form
Almost all the time, wills are probated in common form, which is a relatively simple and inexpensive procedure in which a will is approved by the Probate Court when the paperwork is correct. The clerk of superior court must notify by mail all devisees whose addresses are known, but no formal hearing is required at that time.
Since those individuals have not been given an opportunity to contest the will, a will which has been probated in common form may be later challenged by persons who have legal standing to do so.
Occasionally a will which has already been probated in common form is superseded by a later dated will. Most jurisdictions permit a later-discovered will to be admitted to probate, even though a previously-probated will has not been set aside. There are no specific procedures in the North Carolina General Statutes dealing with the situation. The clerk of court is vested with exclusive original jurisdiction over wills, but will caveats or probates in solemn form can eventually be determined by a superior court judge. North Carolina case law appears to require the first will to be set aside before the second will can be admitted to probate, since the probate of the second will is considered to be a collateral attack upon the probate of the first will. This presents a conundrum, or a chicken-or-egg problem, concerning how one should proceed.
Since there are no specific procedures in the General Statutes, different counties may vary slightly in dealing with later-dated wills. We suggest filing the second will with the clerk of superior court, who may decline to proceed until a caveat or probate in solemn form of the first will has been concluded. But the upshot is that the first will can be set aside, and the second will can eventually be probated.
When an interested party contests the validity of a probated will, he or she must file a “caveat” with the Clerk of Superior Court. When the caveat proceeding has been filed, the Clerk of Superior Court orders the Executor to suspend the estate administration pending the outcome of the caveat proceeding.
A will caveat generally must be filed at the time of probate or within three years thereafter. If, however, a Caveator is under 18 years of age or is legally incompetent, then a caveat may be filed at any time within three years after that individual has reached 18 years of age, or within three years after his or her disability has been removed.
Caveats may be filed only by persons who are interested in the estate, such as heirs at law or next of kin, or individuals who claim under an earlier or later document which purports to be the will of the Decedent. If an original document purporting to be a will cannot be found, but a copy is available, there is a rebuttable presumption that the will was revoked, but the absence of the original document does not necessarily defeat the standing of those who present a copy of the lost will for probate. A copy of the missing will may be presented to the Court for probate, and evidence must be presented to support a finding that the original will was not revoked by the testator.
The validity of a purported will may be challenged for various reasons, but the most common are (a)undue influence, or (b)lack of testamentary capacity. A later-dated instrument purporting to be a will may be a third reason.
Some wills contain provisions intended to discourage will caveats, which provide that anyone that challenges the will, will forfeit any benefits which he or she would receive under the will. These are called “in terrorem clauses” and are intended to scare away any would-be challengers. Those forfeiture provisions may or may not be enforceable: if a court finds that a will caveat was in good faith and with probable cause, the in terrorem clause would likely be deemed to be unenforceable.
Probate in Solemn Form
If a person who files a will for probate wants to settle the issue of the document’s validity up-front, instead of having to hold his or her breath for three years to see whether the Will will be contested, the procedure for settling the matter sooner, rather than later, is called “Probate in Solemn Form.”
The person applying for probate of a will may file a Petition for Probate in Solemn Form, instead of relying on a Probate in Common Form, the less formal procedure which was discussed above.
Under a Probate in Solemn Form, the Clerk of Court issues a summons to all parties interested in the estate and schedules a hearing at which the petitioner presents the evidence necessary to probate the will (i.e., to certify its validity). This is in contrast to a Probate in Common Form, where there is no hearing at this point.
If any interested party wants to contest the validity of the will, he or she must either (a) file a will caveat before the hearing, or (b) present facts at the hearing (called “devasavit vel non”) pertinent to the validity of the will, after which the Clerk will transfer the matter to Superior Court, to be heard as a caveat proceeding.
If no interested party contests the validity of the will at the hearing before the Clerk, the probate in solemn form becomes binding, and no interested party who was properly served in the proceeding may file a subsequent contest or caveat of the probated will.
If someone has initially initiated a Probate in Common Form, he or she would not be barred from later applying for a Probate in Solemn Form.
Much of the time it is not necessary to go through a full estate administration for a decedent’s estate, due to one or more of the reasons discussed below, particularly if the estate is modest in size.
Estate administration is not needed for the transfer of non-probate assets, such as real property owned jointly with right of survivorship, life insurance or retirement accounts payable to a named beneficiary, bank accounts or securities accounts which are payable on death or transferred on death to a named beneficiary or beneficiaries, etc.
Also, assets titled in the name of a revocable trust will pass under the provisions of the trust agreement and do not go through a full court administration.
There is one exception to the above, which occasionally applies to bank accounts under a signature card which refers to NCGS Section 41-2.1, sometimes on old accounts which were opened years ago, which cannot generally be closed without the appointment of a personal representative for an estate.
Generally, a “small estate” is defined as personal property, less liens and encumbrances, totaling no more than $20,000 in value, except where the surviving spouse is the sole heir or devisee, in which the maximum amount is increased to $30,000. The facts may be established by affidavit.
An administration of small estates may be avoided if the Family Allowances available to the spouse and to minor family dependents equal or do not exceed the personal property in the decedent’s estate.
The Year’s Allowance for a surviving spouse in 2019 is $60,000 and the allowance for minor dependents is $5,000.
Minor dependents must be under 18 years of age to qualify for a Family Allowance.
In certain instances where the surviving spouse is the sole heir or devisee, the estate proceeding may be started as a summary administration.
Summary administration is not allowed if any property passes to the spouse in trust, or if the decedent’s will specifically states that summary administration may not be used.
In a summary administration, the attorney brings a copy of the Order of Summary Administration, for the clerk’s signature and certification, for each asset to be transferred to the spouse.
Please note that the liability for debts of the decedent continues under this procedure. The only way to cut off the claims of creditors is through regular administration with published notice to creditors, etc.
Notice to Creditors
When there is a full administration of a decedent’s estate, the executor or other personal representative is required to publish a notice to creditors weekly for four weeks in a newspaper of general circulation in the county in which the estate is being administered.
When pursuing an alternative to full administration, such notice is not required.
However, when pursuing an alternative, any person otherwise qualified to serve as personal representative may file a petition with the clerk of superior court to be appointed as limited personal representative to provide a notice to creditors without administration in certain circumstances, including:
(i) When a decedent has died testate (i.e., with a will) or intestate (i.e., without a will), leaving no property which is subject to probate and no real property devised to the executor;
(ii) When a decedent’s estate is being administered by collection by affidavit;
(iii) When a decedent’s estate is being administered under the Summary Administration provisions of the General Statutes
(iv) When a decedent’s estate consists only of a motor vehicle that may be transferred by procedure as described above; or
(v) When a decedent has left assets that may be treated as “assets of an estate for limited purposes” as described in NCGS 28A-15-10, such as a joint account with survivorship under NCGS 41-2.1 as described above, applicable occasionally to accounts with old signature cards.
Transfers of Motor Vehicles
If the estate consists of motor vehicles only, or if the estate consists of motor vehicles and other personal property valued at less than the applicable family allowances described above, it may be possible to avoid a full administration of the estate by using the family allowance procedure to transfer other assets to the spouse and children and by using the procedure in NCGS Section 20-77(b) to transfer title to the motor vehicles.
The Division of Motor Vehicles has issued a Form MVR-317, “Affidavit of Authority to Transfer Title, for transferring titles to motor vehicles out of the name of a deceased owner.
This procedure applies where the Clerk has not allotted the vehicle as part of a year’s allowance and (1) the decedent has died without a will and no personal representative has qualified or is expected to qualify, or (2) the decedent has died with a will and with a small estate which, in the opinion of the clerk, does not justify the expense of probate and administration
All of the heirs of the decedent must sign the affidavit before a notary public, and the parent of a minor child may sign on behalf of the child.
The clerk must also sign the affidavit after the heirs have signed.
Sales of Real Property Left to Heirs or Devisees
Unless real estate is willed directly to the decedent’s estate or the personal representative is expressly directed in the will to sell the real estate, title to real estate generally vests in the heirs or devisees the instant that the decedent dies, and it passes outside the administered estate.
However, the interests of the heirs or devisees in the property is subject to divestment if it is necessary for the personal representative of the estate to sell real property which belonged to the decedent on the date of death, to generate cash with which to pay creditors, administration expenses, etc.
In that case, the personal representative of the estate may file a special proceeding before the clerk of superior court for permission to bring the real property into the administered estate and to sell the same.
If granted, the personal representative may bring the property into the estate and sell the property as directed by the clerk of superior court.
Because of the possibility that the personal representative can do this, the title left to the heirs or devisees is subject to a “cloud on title” for two years after the decedent’s death or until the probate estate has been closed.
To enable the heirs or devisees to sell the real property sooner than that, while the estate is being administered, when it appears that it will not be necessary to bring the property into the estate and to sell the property to pay creditors, etc., the executor or other personal representative may join in the execution of a deed of sale by the heirs or devisees, essentially to indicate that the estate has sufficient assets, other than real estate, to satisfy the debts of the estate.
The heirs or devisees cannot sell the real property within two years after the date of death, without the executor’s joinder on the deed.
Unless someone qualifies as executor or administrator of the decedent’s estate, nobody would be authorized to sign the deed, so it would be necessary for someone to qualify as personal representative of the estate, it the heirs or devisees wanted to sell the property within two years after the date of death.
To protect himself or herself against possible personal liability for releasing the property as an asset with which to pay creditors, if necessary, the executor or other personal representative may insist on holding the proceeds of sale in escrow temporarily, until the estate has been closed or until two years has passed after the date of death.
North Carolina authorizes Health Care Powers of Attorney to be executed, authorizing someone to make medical decisions for you, if you become unable to make or communicate your own medical decisions.
We recommend that everyone have a Health Care Power of Attorney, which frequently designates a primary agent and also back-up agents, in case the primary agent cannot be reached or cannot make a decision for you.
The official form of Health Care Power of Attorney, as set out in the North Carolina General Statutes, is very thorough and comprehensive. It also contains some blank spaces, in which you may add to, limit or explain your Health Care Agent’s powers in further detail if you wish to do so.
That is, the official form may be modified to express your personal wishes, such as religious beliefs, whether or not you want to be an organ donor, or to express your funeral and burial wishes, or your desire to be cremated, if applicable.
A Health Care Power of Attorney must be signed in the presence of two witnesses and must be notarized.
The witnesses may not be your natural heirs (such as your spouse or children, or even siblings, aunts, uncles or first cousins) or people who are beneficiaries under your Will, or employees of your doctor or a hospital or other health facility, such as a retirement or a nursing home, where you are a resident.
Advance Directive, or Living Will
Another document which you may want to have is an Advance Directive or “Living Will,” which expresses your desire not to have the dying process prolonged if you are, in the opinion of your doctor, terminally ill and likely to die soon, or if you have completely lost your mental capacity, or are unconscious and unlikely to regain consciousness.
A Living Will can empower your doctor to make a decision not to put you on life support without input from your family, but if you want family or friends to be included in that decision, you can also require the doctor to get permission from your Health Care Agent.
A Living Will does not give anyone permission to cause you to die sooner than you would have died by natural causes, even if you are in great pain and want your life to be terminated.
A living will simply permits your health providers to allow you to die of natural causes, without putting you on life support to prolong the dying process, when you are terminally and incurably ill and likely to die in the near future, as determined by your attending physician.
A Living Will must be signed in the presence of two witnesses and must be notarized.
The witnesses may not be your natural heirs (such as your spouse or children, or even siblings, aunts, uncles or first cousins) or people who are beneficiaries under your Will, or employees of your doctor or a hospital or other health facility, such as a retirement or a nursing home, where you are a resident.
Combined Health Care Power of Attorney and Living Will
The Health Care Power of Attorney and Living Will may be combined into one document, provided that the combined document complies with all the requirements for both separate documents.
Authorization to Share Confidential Health Care Information
To move on to another legal document, please be aware that the HIPAA laws are intended to protect the health care privacy of patients from people who are not authorized by the patient to have that information.
Usually when a competent patient is admitted to a medical facility, he or she can give permission for the hospital to share his or her medical information with specific individuals. However, in case you are not able to give permission at the time of your admission, it is a good idea for you to have signed an Authorization to Share Confidential Health Information ahead of time, which can be used if necessary, when you are later admitted to a hospital or other health care facility.
Do Not Resuscitate Order (DNR) and Medical Orders for Scope of Treatment (MOST) Forms
In North Carolina a Do Not Resuscitate (DNR) Order is a medical order signed by a physician, which alerts medical personnel that a patient does not want cardiopulmonary resuscitation (CPR) in the event of medical emergency, such as a cardiac or respiratory arrest.
In North Carolina a physician may issue a DNR Order or a Medical Order for Scope of Treatment(MOST) Form, usually printed on brightly-colored paper, which are kept with the patient’s medical records.
The MOST form covers the DNR order, in addition to other end-of-life treatments, it informs medical personnel how to honor the wishes of the patient.
The patient (or his or her authorized health care agent) and attending physician must sign a MOST form.
These forms are prepared by the physician and not by the attorney for the patient.
The form does not replace a Living Will, but translates the patient’s wishes into a medical order, even if the patient is transferred from one medical facility to another.
Euthanasia or Assisted Suicide or Death
Causing someone to die sooner than they would if they died of natural causes is commonly called “Euthanasia,” or “assisted suicide/death,” which would be a crime under North Carolina law.
For about ten years only two states allowed assisted suicide – Oregon and Washington.
In recent years several other states or jurisdictions in the United States now allow assisted suicides – the most recent being New Jersey (effective 08/01/2019) and Maine (effective 01/01/2020) – and legislation has been proposed in many other states.
Even the states which permit assisted deaths recognize that the power to terminate someone’s life might be abused, and there are safeguards in those state laws: most apply only to persons who are residents of those states, and the patient must be found to be likely to die within a relatively short period of time, and to be of sound mind and not clinically depressed when they make the decision to proceed, as determined by medical opinion.
At the current time, no states permit an individual’s decision for Euthanasia or assisted death to be made by someone else, under an advance directive.
To the contrary, the individual must be competent and able to express his or her wishes at the time of his or her request, either verbally or non-verbally, as determined by medical or psychiatric examination.
It is suggested that you get an attorney to assist you in drafting Durable Powers of Attorney, Health Care Powers of Attorney, Advanced Directive (Living Will), and HIPAA Authorization to Release Confidential Health Care Information.
If you die without a Will and you are a resident of North Carolina, the assets owned by you personally on the date of death (i.e., not owned jointly with someone else who has survivorship rights), and not including assets payable to a named beneficiary at your death, will pass under the North Carolina Intestate Succession Act.
(If a person dies with a Will, he or she is said to have died “testate;” without a Will, he or she is said to have died “intestate”)
Many people assume that a married person’s estate will automatically pass to his or her spouse at death, if there is no will.
That can occasionally happen under the right fact situation, but in North Carolina, usually a decedent’s estate will not automatically pass to the surviving spouse.
It is important to know that many assets may be owned in a manner which will automatically pass ownership to a survivor upon someone’s death, instead of passing under the Intestate Succession Act.
This can happen with assets such as bank accounts or other assets owned by two or more persons jointly with right of survivorship, but the proper papers must be signed by the co-owners.
A person may also designate someone else as beneficiary in the event of the owner’s death, of assets such as retirement accounts or life insurance policies, or even bank or brokerage accounts which are owned strictly by one person during his or her lifetime, but payable to a named beneficiary upon the owner’s death.
The owner must sign the beneficiary designation forms for the appointment of beneficiaries to be effective.
Real estate conveyed during their marriage to a husband and wife in both names is usually owned by them “as tenants by the entirety,” a unique form of ownership which passes to the surviving spouse, free of the claims of creditors of the deceased spouse, upon the death of the other spouse.
A very common mistake is made nowadays when a couple acquires real estate in their joint names before their marriage; they may acquire the property as “tenants in common” which means that each of them would own a separate one-half ownership in the property without survivorship, or they may acquire title as “as joint tenants with right of survivorship.”
When they subsequently marry, their ownership is not automatically converted into a tenancy by the entirety, unless the property is re-deeded by both of them to themselves as tenants by the entirety.
Unless there is a new deed, they do not benefit from (1) survivorship, if they own separate one-half interests as tenants in common, or (2) the unique protection against creditor claims which they would have under a tenancy by the entirety.
The best practice would be for the new deed to recite that the purpose of the deed is to convert their ownership into a tenancy by the entirety.
The Intestate Succession Act, when applicable, is complicated, and leaves assets the way that the North Carolina General Assembly has determined – and not the way that you would likely want.
If you want your assets to pass as you intend, it would be better for you to have a will expressing your wishes, to insure that your assets will pass exactly as you want, instead of passing the way someone else has determined .
North Carolina law generally does not allow one spouse to disinherit the other spouse completely, or generally to leave the surviving spouse less that he or she would have received under the Intestate Succession Act.
If a surviving spouse would otherwise receive a smaller share under the will and other survivorship documents than under the Intestate Succession Act, the survivor can apply with the probate court for an elective share.
Please note that the Intestate Succession Act has slightly different inheritance provisions for real property (i.e., land and improvements – commonly called “real estate”) than for personal property (i.e., any property other than real estate – including furniture and household furnishings, motor vehicles, jewelry, tools, equipment and other “things” plus intangible property, such as money, bank and brokerage accounts stock in a corporation or ownership interests in partnerships and LLCs, etc.).
Unless a decedent leaves a Will, the North Carolina Intestate Succession Act determines the shares of heirs and the distribution of the decedent’s estate, as follows:
Decedent survived by spouse and two or more children
Spouse receives first $60,000 of personal property, one-third of personal property in excess of that $60,000, and one-third of real estate.
Children divide two-thirds of the personal property in excess of $60,000, and two-thirds of the real estate, and the shares of minor children are payable to a court-appointed guardian, to be used as approved by the Court until the child is age 18, at which time the assets are transferred into the child’s name, regardless of the maturity level of the child.
Decedent survived by spouse and one child
Spouse receives first $60,000 of personal property, one-half of personal property in excess of $60,000, plus one-half of real estate.
Child receives other one-half of the personal property in excess of $60,000, and one-half of the real estate. The share of a minor child is payable to a court-appointed guardian.
Decedent survived by spouse and no children
If Decedent is survived by one or more parents, Spouse receives first $100,000 of personal property, one-half of personal property in excess of $100,000, and one-half of real estate.
The then-living parent or parents of Decedent receive other one-half of the personal property in excess of $100,000, and one-half of the real estate, in equal shares.
Decedent not survived by spouse, but is survived by one or more children or lineal descendants of deceased children
All personal property and real estate to be divided equally by children, with the share of a minor child payable to a court-appointed guardian.
If any children are deceased and leave then-living children (i.e., Decedent’s grandchildren), the deceased children’s shares are equally divided among the Decedent’s grandchildren by those deceased children, and the share of any minor grandchild is payable to a court-appointed guardian.
Decedent not survived by spouse, children, or lineal descendants of deceased children, but is survived by one or both parents
The parents receive the entire estate, including real estate and personal property, to be divided equally between them if both are living, or all to the survivor, if only one of them is then living.
Decedent not survived by spouse, children or parents
The Decedent’s estate is distributed to the Decedent’s siblings equally and the descendants of deceased siblings.
The share of any minor beneficiary is distributed to a court-supervised guardian until the beneficiary reaches age 18.
Decedent not survived by spouse, children, parents or siblings
One-half the estate is distributed to the Decedent’s maternal grandparents or their descendants and the other one-half is distributed to the Decedent’s paternal grandparents and their descendants
The share of any minor beneficiary is distributed to a court-supervised guardian until the beneficiary reaches age 18.
Please be aware that the estate of a widow or widower under #5, 6 and 7 above will pass 100% to his or her family and nothing will go to the family of his or her spouse, if the spouse predeceased the Decedent.
For children to inherit under the Intestate Succession Act, they must be deemed legally to be children, under the following alternatives:
Legally adopted children are treated the same as biological children;
Stepchildren and foster children who have not been legally adopted are not treated as children;
Biological children who have been adopted by other adoptive parents will not receive a child’s share, with one exception: where children of one spouse are adopted by the other spouse, those children will be considered children of both spouses;
A child conceived before a parent’s death will receive a share if born within 10 months after death;
Illegitimate children born to a deceased father will not receive a share of his estate unless: (i) the child has been legitimated, (ii) the father acknowledged paternity; or (iii) the child was born within one year of the father’s death and paternity has been established through DNA testing.
All of the above can easily result in assets going to the wrong beneficiaries than the Decedent would have wanted. Two examples are as follows:
Unplanned Example A:
Fred and Ann were married for 30+ years and had no children.
Fred’s mother was in her nineties when Fred died without a will.
Under #5 above, Ann received Fred’s personal property up to $100,000 and one half of his personal property in excess of that amount, and she received one-half of Fred’s real estate.
The rest of Fred’s property went to his mother.
When she died a few years later, her estate went to her children, and nothing was left to Fred’s widow, Ann.
Unplanned Example B:
Bob, who is a farmer, was divorced from his first wife, and she deeded the farm property to him in the property settlement.
He remarried and had a wife and two minor children when he unexpectedly died in an accident.
He had a farm loan which had been covered by life insurance.
The property settlement with his former wife allowed her to keep the life insurance, and he did not get any more life insurance for his Widow.
When he died without a Will, his estate passed under #1 above, and the farm equipment went to his Widow, but the farm itself was left one-third to her and two-thirds to his children (in court-supervised guardianships).
His ex-wife collected the life insurance.
His Widow had to deal with the farm and the mortgage, and two-thirds of any farm profits went into the children’s guardianship accounts.
Not what Bob would have wanted.
A surviving spouse can also apply with the probate court to be allotted a spouse’s “Year’s Allowance,” as additional protection for the surviving spouse.
Persons will not inherit under the Intestate Succession Act unless they survive the Decedent by at least 120 hours.
Half relatives are treated the same as whole relatives
Relatives conceived before death will inherit as though actually delivered prior to death, as long as they are delivered within 10 months after the date of death.
Nonresidents and noncitizens are entitled to an intestate share of a Decedent’s estate, see Nonresident and Noncitizen Beneficiaries of Estates and Trusts
“Irrevocable” trusts in North Carolina often may be modified or even terminated under Article 4 of Chapter 36C of the North Carolina General Statutes.
Some terminology used in the article includes:
(a) The trust “Grantor” is the person who creates the Trust;
(b) The “Trustee” is the person or corporate fiduciary who manages the Trust; and
(c) The “Beneficiary” is the person or group of individuals or entities for whom the trust has been created.
Irrevocable Trusts are often used as a means of transferring wealth to loved ones while also reducing estate tax liability for the Grantor’s estate.
The Grantor not only gives the assets away, but he or she also gives up the right to amend or revoke the Trust, even if circumstances change.
If the Grantor reserved the right to make changes to the trust instrument, the gift would be considered incomplete for tax estate and gift tax purposes, which would defeat the principal tax objectives for the gift to the Trust.
Those prohibitions against changing or terminating irrevocable trusts have been softened in recent years by the terms of the Uniform Trust Code, which allow an irrevocable non-charitable trust agreement to be modified or terminated when appropriate, without the loss of the tax benefits, by two procedures: Modification or Termination by Consent and Modification or Termination by the Court.
We will also discuss a third method, called “Decanting,” in which a Trustee may be able to appoint trust assets to a new trust, often created by the Trustee, with more desirable terms and conditions than the old trust.
Modification or Termination by Consent
When the Trust’s Grantor and all the possible beneficiaries of a Trust unanimously agree to modifying or terminating an irrevocable trust with no charitable beneficiaries, the terms of the irrevocable trust instrument may be changed, or the Trust may be terminated, by consent.
This type of modification or termination does not require a court order and can be fairly easy to accomplish, regardless of the proposed changes.
Please note that all the beneficiaries must consent to the changes, and that everyone who might possibly receive trust benefits in the future – even if highly unlikely – is considered to be a beneficiary, and therefore must consent. Otherwise Modification by Consent is not available.
When a Trust is terminated by consent, the trust property is distributed as agreed by the beneficiaries, so it is important that there be a written consent, signed by the beneficiaries, which specifies how the trust assets are to be distributed.
The North Carolina General Statutes provide that a parent may give consent on behalf of his or her minor children, and that a lineal ancestor of an unborn beneficiary may represent the unborn beneficiary in giving consent, and there are other provisions for consent by representatives of missing or other beneficiaries, such as incapacitated ones.
Modification or Termination by the Court
If the Trust’s Grantor is deceased at the time of the proposed modification or termination, or if any beneficiary does not consent to the proposed modification or termination, then an irrevocable trust instrument may still be modified or terminated, but in that case, the irrevocable trust must be modified or terminated by a Superior Court judge, following certain procedures.
A Modification or Termination by the Court is not quite as simple as a Modification or Termination by Consent, but it can be accomplished fairly quickly if all the beneficiaries of the Trust agree.
A Petition must be filed with the Superior Court to allow the requested modification or termination. The Court has a little less latitude in modifying a trust by this method than is allowed for a Modification or Termination by Consent.
In a Modification or Termination by Consent, the Trust’s Grantor may permit a modification or termination, even if the modification or termination is inconsistent with a material purpose for which the original trust was written, but with a Modification or Termination by the Court, the rules are slightly different: A trust may not be terminated by the Court, unless the Court concludes that continuance of the trust is not necessary to achieve any material purpose of the trust.
A Modification by the Court, even with the consent of all the beneficiaries, generally may be done only if the Court concludes that the modification is consistent with a material purpose of the Trust.
Even then, there can be a narrow exception, if the Court concludes that the reason for the requested modification “substantially outweighs” the intended material purpose.
Also, if any beneficiaries refuse to consent to a Modification or Termination by the Court, it is still possible to obtain court approval, but in this case, the interests of all non-consenting beneficiaries must be “adequately protected.” Consequently, any non-consenting beneficiary should respond to the Petition and state the reasons for his or her refusal to consent.
In a Modification or Termination by the Court, minor children may be represented by a parent, and unborn beneficiaries may be represented by a lineal ancestor of the unborn beneficiary.
Missing or incapacitated beneficiaries, etc., may be represented by other individuals.
Upon a Termination by the Court, the Trustee shall distribute the trust property as ordered by the Court, in a manner consistent with the purposes of the Trust.
A third alternative, which results in overriding the terms of an irrevocable trust agreement is called “decanting.”
Decanting allows the Trustee of certain irrevocable trusts to “pour over” the assets of the original Trust into a new Trust, with more favorable terms.
Often, Court approval is not required, so decanting can be relatively inexpensive and easy to implement.
Decanting is allowed only if the original trust was created by an irrevocable trust instrument, which gives the Trustee the power to make discretionary distributions of trust assets to or for the benefit of one or more beneficiaries.
Also, the Trustee who exercises the decanting power must not be a beneficiary of the trust.
Decanting may be used to address unforeseen circumstances, such as how to care for a disabled beneficiary, or how to protect a beneficiary with creditor or marital problems.
However, there are limitations as to what the Trustee can do in transferring assets from an existing trust to a new trust: for example, no new beneficiaries may be added, who were not beneficiaries under the old trust instrument.
However, a result somewhat similar to naming a new beneficiary can be achieved in a different manner. Atrust beneficiary may be given a power of appointment in the new trust agreement, which would enable him or her to appoint trust assets to a person who is not named as a beneficiary in the original trust agreement.
For example, an irrevocable trust instrument may provide that trust income, and principal in the trustee’s discretion, may be distributed to the Grantor’s child for life, and after the child’s death, the trust assets are to be distributed to the Grantor’s grandchildren. In this example the child’s spouse would not be a beneficiary of the trust.
If the trust is decanted into a new trust, the spouse still cannot be named as a beneficiary, but the new trust instrument may give the child, who is the life beneficiary of the trust, a power of appointment over the trust assets, whereby the child would be able to appoint the trust assets on his or her death to a person who was not a beneficiary under the original trust instrument.
In that case, the child may choose to appoint the trust assets to his or her spouse, outright and free of trust, or in the alternative, to extend the term of the trust and to make the spouse an income beneficiary, and even to allow the Trustee to make additional distributions to the spouse in the Trustee’s discretion.
Continuing the trust for the spouse’s lifetime would give some protection for the Grantor’s grandchildren, if the spouse remarried, etc.
In any event, irrevocable trusts in North Carolina are generally no longer totally unchangeable.
All three statutory alternatives for changing the original terms of an irrevocable trust agreement which have become inappropriate will require professional assistance, but they can all result in modification of the terms of a trust or termination of a trust which no longer is appropriate.
A Power of Attorney is a legal document in which a person (the “Principal”) gives someone else (the “Agent”) the power to act on behalf of the Principal as set forth in the Power of Attorney, perhaps doing things such as writing and signing checks, or even signing deeds or tax returns. A Power of Attorney may also include the authority to do many other things, and not merely basic functions.
We highly recommend that all adults have properly-executed Durable Powers of Attorney as a precaution, in case the unexpected occurs.
If the Principal becomes incapacitated, the Agent’s authority under an ordinary agency agreement or an ordinary (non-durable) power of attorney is revoked as a matter of law, but if the Power of Attorney is “Durable,” i.e. if it includes “magic” words indicating the Principal’s intent that it remain in effect if the Principal becomes incapacitated, it will not be automatically revoked.
Until January 1, 2018, North Carolina law required a Durable Power of Attorney to be recorded in the office of the Register of Deeds in the event that the Principal became incapacitated, but that is no longer a legal requirement for documents executed after that date – except for real estate transactions, in which case the power of attorney must still be recorded.
Depending on the language in the instrument, a Durable Power of Attorney may be effective immediately, even if the Principal is capable of acting for himself or herself, or it may be “springing,” i.e. the Power of Attorney becomes active only upon the occurrence of a future event, such as when the Principal becomes legally incompetent.
A statutory Short-Form Power of Attorney form is set out in the North Carolina General Statutes which may be used, instead of a personally-drafted document.
Short-form powers of attorney have been allowed for many years, but a new statutory Short-Form Power of Attorney was adopted effective January 1, 2008, and it contains new language.
The new short-form document is generally more comprehensive than the old Short-Form Power of Attorney, and it may be further personalized by initialing certain additional powers which are not listed under the main list of powers. This option was not included under the old statutory form under the North Carolina General Statutes.
If you have an old statutory Short-Form Power of Attorney which was executed before January 1, 2018, it must still be recorded at the Register of Deeds office to be actively used if the Principal becomes incapacitated.
We recommend that you not use a Durable Power of Attorney with the old statutory short-form language if you can avoid doing so, because the language has been improved. That is, if you insist on having a statutory short-form power of attorney, you should at least use the new form.
Both the old and the new statutory Short-Form Powers of Attorney are limited in the scope of authority granted to the Agent to act on behalf of the Principal and we recommend that you have a longer, more detailed document which grants specific authority to perform certain types of transactions on your behalf which are not specifically covered in the statutory short-form documents.
Please note that a document which says something like “I authorize my Agent to do anything which I could do if I were present and acting for myself” does not grant the broad authority for which it seems to be intended, because certain powers must be explicitly specified, in order to be effective.
For example, a Power of Attorney often does not contain the language required by the IRS to authorize the Agent to sign a tax return for the Principal or to deal with the IRS concerning the Principal’s taxes, although it might include some language which on its face might seem sufficient.
Initialing a specific power titled “Taxes,” in the Power of Attorney, for example, will not be deemed to be sufficient by the IRS, which requires that a power of attorney describe the type of tax and form number to which it is applicable (e.g., “Personal Income Tax, Form 1040”), and also requires that the document specify the years to which it is applicable (e.g., years 2016 through 2022), provided that the applicable period may not extend forward for more than three calendar years after the year in which the power was signed.
IRS Form 2848, Power of Attorney, is not designed to be durable in the event of incompetency, and the Durable Power of Attorney should be broad enough in scope to permit the Agent to file a Form 2848 on behalf of the Principal.
The authority of the Agent to act on behalf of the Principal, not only with IRS matters, but in all respects, should be clear and unambiguous in a Durable Power of Attorney.
Example of a problem: A lady signed a Durable Power of Attorney several years ago. She now suffers from Alzheimer’s and does not have the legal capacity to sign new documents for herself. Her family wants to do long-term planning for her, which could include some structured family gifting, which would be permissible under the state Medicaid or Special Assistance laws. Unfortunately, the old power of attorney does not give her agent the power to make gifts.
We recommend that you not rely on the statutory Short-Form Power of Attorney, especially the old ones signed before 2018 – but even new documents signed on or after January 1, 2018 – on the mistaken assumption that the document will be comprehensive and will cover all of your needs.
To the contrary, we recommend that you consult with an attorney and have a power of attorney drafted, designed to meet your personal needs.
There are several different types of irrevocable trusts––mostly known by four-letter words––which we will describe very briefly (and superficially) below, and if you need to know more information about any of them, you will need to consult further with an estate planning professional.
1. Irrevocable Life Insurance Trust (ILIT)
If a life insurance policy is owned by the insured and is payable to named beneficiaries at death, the full death benefit is included in the taxable estate of the insured.
If a life insurance policy is owned from its inception by someone other than the insured, such as a trust, it will not be included in the taxable estate of the insured at the time of death.
If an existing policy is transferred to an irrevocable trust by the insured, instead of a brand-new policy owned from its inception by the trust, then the transferred policy will be taxable as part of the grantor’s taxable estate if the Grantor dies in less than three years after the transfer, but after three years, the policy will not be considered part of the grantor’s taxable estate.
Because the estate tax exemption for US citizens and residents is so high at the current time ($11.4 million in 2019, indexed for inflation), these trusts are not used as frequently as they have been in the past, when the estate tax exemption was much lower, but many irrevocable trusts which own life insurance policies remain in existence. They can still be useful tools for avoiding unnecessary estate tax when an insured has a large estate, and if the estate tax exemption is reduced in the future, they could become more important to many insureds.
If a contribution is made to an ILIT to pay premiums on a life insurance policy, certain procedures must be followed to qualify the contribution for the donor’s gift tax annual exclusion.
2. Qualified Personal Residence Trust (QPRT)
These trusts are not used as frequently as in the past because of the high estate tax exemption and also because the prevailing interest rates have been historically low for a number of years, but QPRTs have been used for many years to leverage taxpayers’ gift and estate tax exemptions, for both primary residences and vacation homes.
With a QPRT, a grantor gives away a residence, subject to the grantor’s right to continue using the residence for a term of years, after which the trust will terminate, and the residence will be turned over to the “remainder beneficiaries.”
For example, the trust grantor could give a vacation home to his or her children, subject to a 15-year retained possessory interest and subject to a reversionary interest in the grantor’s estate if the grantor dies before the end of the trust term. Depending on the applicable federal rate (AFR) of interest at the time of the transfer to the trust, and also depending the grantor’s actuarial life expectancy at that time, the gift of the “remainder” interest for a $500,000 vacation home might be $150,000 and the value of the grantor’s retained interests might be $350,000, for example.
In that case, if the grantor outlives the term of his or her retained possessory interest, he or she would have given away a $500,000 house for a taxable transfer valued at $150,000. Better yet, if the house appreciates in value to $650,000 after the gift, the grantor also would have avoided that $150,000 in future appreciation, without gift or estate tax consequences. The retained term should be shorter than the grantor’s life expectancy to obtain the anticipated gift and estate tax benefits.
An option, which appeals to some, is to name the spouse as a life beneficiary at the end of the grantor’s retained possessory term, but this must be done with caution.
Under most QPRT’s, if the grantor dies before the end of the trust term, the house will revert to the grantor at that time, so the owner, when he or she creates the QPRT, is essentially betting that he or she will outlive the term of the retained interest in the house.
If the grantor dies before the end of the trust term and the house reverts to his or her estate, the grantor’s estate would recover the $150,000 portion of his or her applicable gift tax exclusion used at the original transfer, so “losing the bet” would not be any worse that not having created the trust in the first place. One might look at it as “Heads you win, tails you do not lose.”
3. Charitable Remainder Unitrust (CRUT)
Not unlike the QPRT discussed above, this trust is a split-interest trust which is used to obtain some tax benefits for the trust’s grantor by a temporary interest retained by the grantor, followed by a “remainder” interest in a charity or charities selected by the grantor.
Suppose that the grantor owns $1,000,000 of stock in a company which is likely to be bought out by another company, and further suppose that the grantor has a very low cost-basis in the stock.
By creating a CRUT and transferring the stock to the CRUT prior to the buy-out, the grantor could avoid having to pay capital gains tax when the buy-out occurred. Since the CRUT would be a charitable trust, it would be exempt from capital gains taxes which could perhaps total as much as $200,000 on a $1 million sale of stock, as compared to the alternative of having immediate tax.
The trust would receive the proceeds of the stock sale when it occurred and would distribute a fixed percentage of the trust’s value to the grantor for life, based on the value of the trust assets, as recalculated annually.
If the investments went up in value during the year, the distributions would be increased accordingly, and if the trust assets went down in value, the distributions would go down by a similar percentage.
The actuarial value of the charitable payout on termination of the trust would be calculated up-front, at the time of the original stock transfer to the CRUT, which calculated amount would qualify for the income tax charitable deduction on the grantor’s personal income tax return, and also would not be subject to gift tax.
The grantor (and the grantor’s spouse, if applicable) would in effect receive taxable life distributions from the trust each year, but the capital gains would not be subject to capital gains tax so long as the trust continued to hold the undistributed gain.
Upon the death or deaths of the life beneficiaries of the trust, the trust would be terminated, and the remaining assets would be distributed to the charitable remainder beneficiary.
The trust would enable the grantor to retain a higher flow of distributions during the grantor’s lifetime than if the grantor had retained the assets and paid capital gains tax from the proceeds when the stock was sold, and the grantor would receive an income tax charitable deduction at the time of the initial gift to the trust.
The grantor’s spouse could be a life beneficiary of the trust, if the spouse survived the grantor. If both spouses were grantors of the original trust, the distributions could continue to the surviving grantor.
Drawbacks of a CRUT could include (1) lack of access to the trust assets if needed, as the grantor would receive only the prescribed distributions, (2) the cost of the trust’s administration would be higher than if there were no trust; and (3) since the trust assets would go to charity at the end of the trust term, those assets would not be available to go to the family at that time.
(Some families prefer to buy life insurance, using part of the extra cash flow resulting from tax savings at the creation of the trust, to pay insurance premiums, for a policy to replace the family wealth lost by the large charitable gift. That is, the life insurance death benefit could replace the family wealth which will go to charity on termination of the trust).
For someone with a big charitable inclination, however, a CRUT could be a good option.
4. Charitable Remainder Annuity (CRAT)
A CRAT would work in much the same manner as a CRUT, except that the distributions would be fixed during the trust term, instead of being adjusted each year to reflect appreciation or depreciation.
The distributions would remain fixed during the trust term.
5. Grantor Retained Annuity Trust (GRAT)
A GRAT is a trust whereby the grantor retains a fixed payout for a term of years, after which the trust would terminate and the assets would be distributed to non-charitable remainder beneficiaries, such as family members.
The grantor’s taxable gift would be reduced by the actuarial value of the annuity interest for the term of years retained by the trust’s grantor.
6. Grantor Retained Unitrust (GRUT)
A GRUT is similar to a GRAT, except that the distributions are adjusted annually, to reflect capital appreciation or depreciation from year to year, instead of fixed payments for the entire trust term.
Like a GRAT, the grantor’s taxable gift would be reduced by the actuarial value of the annuity interest for the term of years retained by the trust’s grantor.
For generation-skipping trusts (to grandchildren instead of children, etc.), a GRUT is a better tax vehicle than a GRAT.
7. Qualified Domestic Trust (QDOT)
A QDOT is used to qualify a gift to a non-citizen spouse for the estate of gift tax marital deduction.
A IDIT is a trust to which a grantor transfers assets but retains powers over the trust which, under the Internal Revenue Code requires the income of the trust to be taxable to the grantor because of too much retained control – hence called “defective.”
The so-called “defect” can be used to the advantage of the grantor, if the grantor gives assets (usually shares of stock) to originally fund the trust, then later sells a larger number of shares to the trust in exchange for a promissory note.
The sale is not deemed taxable because of the “defect.”
If the stock later increases in market value, appreciated shares can be transferred back to the grantor at their appreciated value, in payment for the promissory note. The remaining shares could be retained by the trust and/or distributed to the beneficiaries, without income tax or gift tax consequences.
In other words, future appreciation in the value of the stock could be transferred to the beneficiaries – without gift tax or income tax consequences.
9. “Bypass” Trust
A Bypass Trust is commonly used by one spouse to leave assets to his or her surviving spouse in a manner in which the surviving spouse can get the benefit of the trust assets, but the assets do not become part of the surviving spouse’s taxable estate – hence bypassing estate taxes upon the death of the survivor.
10. “Dynasty” Trust or GST Trust
This is a trust which can be created on behalf of more than one generation of beneficiaries, which can give each succeeding generation the benefit of distributions of income, etc., but which does not become subject to estate tax at the level of each generation.
If the assets grow steadily over several generations without being periodically subject to estate taxes, the trusts can grow to very large value – hence sometimes called “Dynasty” trusts.
Rather than holding everything in one big trust for several generations, the trust could authorize the trustee to split the trust periodically into smaller trusts, especially if individual members of succeeding generations have different needs and objectives. Also, the trust agreement could allow for principal distributions in addition to income distributions based on need, especially from smaller trusts after a split, if necessary.
All of the above are very technical and should be studied in detail with your professional tax advisor.
Want to make gifts for certain medical or educational expenses? Gifts may be made for these purposes, separate and apart from annual exclusion gifts for gift and GST tax purposes, but there is a separate set of rules which apply to these gifts.
Under Section 2503€ of the Internal Revenue Code, tuition payments made directly to an educational organization on behalf of an individual are not treated as taxable gifts for gift tax purposes. Also, certain qualifying medical expenses are not to be considered as taxable gifts, if paid directly to a medical provider.
The education expense exemption from gift tax is limited to tuition. “Tuition” means the amount of money required for enrollment, including tuition for part-time students. There is a “grey area” for boarding schools; which do not break out the enrollment fees between teaching-related fees and room and board – and charge only one fee for both. Some tax advisers recommend treating the entire payment as a tuition fee and claiming a gift tax exclusion for the entire amount; some may be more conservative and either not claim an exemption or only a partial exemption – but the IRS could challenge that in the future.
A school would not qualify for the gift tax exclusion unless it normally maintains a regular faculty and curriculum and has a regularly-enrolled body of students in attendance at the place where the activities are being performed, for presentation of formal instruction. We do not encourage someone to use this gift tax exclusion as a means of paying a parent to home-school.
The Treasury Regulations specify that “educational organization” includes primary, secondary, preparatory schools, high schools, colleges and universities. There is a “grey area” concerning nursery schools and preschools, depending on the facts. There have been Private Rulings finding a children’s day care center to be an educational organization because it had regular enrollment and instruction, a staff of teachers and assistants, planned educational activities, etc. Another day care center did not qualify for the gift tax exclusion because it was deemed to be more custodial than educational.
A martial arts school, a school for yoga and a wilderness camping and survival program for children with emotional and behavioral problems have all found to qualify.
The gift tax exclusion applies to payments for diagnosis, cure. Mitigation, treatment or prevention of disease, or for the purpose of any structure or function of the body, as well as for transportation, primarily for and essential to medical care.
Payments for medical insurance are covered.
The terms “medical care” includes long-term care, such as the cost of a nursing home or long-term care facility, if provided by a licensed health care provider.
If medical insurance later reimburses for the payment, then the initial payment will not qualify for the gift tax exclusion.
In case of both medical and tuition expenses, the payment must be made directly to the provider and may not be made by giving the done a cash gift with the understanding that the done will in turn make those payments.
If a US citizen or resident is married to a non-citizen, even if the non-citizen spouse has been a US resident for many years, the transfer of assets at the death of the US citizen or resident spouse to the non-citizen will not qualify for the estate tax marital deduction.
Due to the high estate and gift tax exemptions which are now in effect for the estates of US citizens and residents ($11.4 million in 2019, indexed for inflation), most people do not need to worry about those possible tax ramifications. But for people with large estates, they can be a problem.
If the surviving spouse is a US citizen, the decedent can transfer assets unlimited in value to the survivor without taxes at that time, claiming the estate tax marital deduction for assets transferred at death. Those assets would become part of the taxable estate of the surviving spouse and would presumably be subject to US estate tax at his or her death. On the other hand, if the surviving spouse is a non-citizen, there would be no marital deduction and estate taxes would be payable on those assets, unless certain other steps were taken as described below.
That is, an altogether different set of rules applies to transfers to non-citizen spouses than to spouses who are US citizens.
The reason for the two different sets of rules is this: the estate tax marital deduction is not intended to avoid estate taxes altogether on assets left to a surviving spouse. Instead, the marital deduction is supposed to postpone taxes until the second death between the spouses, at which time the transferred assets would presumably be subject to estate tax.
If the marital deduction were allowed for property left to a non-citizen spouse, the fear is that the surviving spouse might leave the US and establish residency elsewhere in a country without a treaty with the US to facilitate the collection of US estate tax at the death of the surviving spouse. In that case the estate of the surviving spouse might not pay any US estate tax at his or her death.
Because of the potential harshness of the rule denying the marital deduction for assets passing to a non-citizen spouse, based simply on the citizenship of the surviving spouse – and also because another alternative could be designed to insure that estate tax would eventually be collected on the assets left to the surviving spouse – Section 2056A of the Internal Revenue Code was adopted, which allows assets transferred to a Qualified Domestic Trust (QDOT) to qualify for the estate tax marital deduction under certain circumstances.
The QDOT must be created, and the assets transferred to the QDOT,before the estate tax filing deadline (nine months after the date of death, or if granted an extension, within 15 months), and the personal representative of the decedent’s estate must file the return in a timely manner and make a “QDOT election” on line 3 of Schedule M of the United States Estate Tax Return (Form 706). There are additional rules which apply to a QDOT, including the following:
The trustee, or at least one co-trustee must be a US citizen or a US corporate fiduciary. An individual US trustee may be required to post a bond or a letter of credit with the IRS, and the trust agreement must provide that no distributions other than income may be made from the trust unless the trustee has the right to withhold the Section 2056A estate tax (discussed below) at the time of the distributions. Also, a US corporate trustee is required if the assets transferred to the QDOT exceed $2 million in value on the date of death.
A QDOT can be clearly preferable to receiving no marital deduction whatsoever, if the deceased spouse has a taxable estate, but QDOTs are cumbersome, expensive to administer, and there are many negatives to go along with that tax benefit.
The rules applicable to QDOTs are complicated and strict, and they are designed to keep anything from “slipping through the cracks,” so to speak and escaping eventual estate taxes. If those rules are not strictly adhered to, the penalties are severe.
The IRS allows nothing to slip between the cracks!
The simplest and best way to deal with the marital deduction issue would be for the non-citizen spouse to obtain US citizenship while both spouses are living. Once the spouse has been granted US citizenship, he or she will be treated just the same as though he or she had been born a US citizen. The citizenship process often takes some time, and if the other spouse dies before US citizenship is granted, it may be best to have made provision for a QDOT for the non-citizen spouse in the estate planning documents for other spouse. If a QDOT is not created for the non-citizen spouse in those documents, he or she should at least leave assets to the surviving spouse, outright or in a trust which would have qualified for the estate tax marital deduction if the surviving spouse had been a US citizen.
If citizenship has not been granted to the non-citizen spouse before the decedent’s death, and if the decedent’s estate planning documents leave the assets to the surviving non-citizen spouse in a manner which would have qualified for the marital deduction if the surviving spouse had been a US citizen, then the surviving non-citizen spouse can irrevocably assign or transfer the assets to a QDOT, and if all the legal details are properly attended to, the QDOT property will qualify for the estate tax marital deduction.
There can be a number of reasons why a non-citizen fails to obtain US citizenship. Sometimes a non-citizen is reluctant to give up his or her native citizenship, and people often are not aware of the possibility that they may have dual citizenship in both their native country and in the United States, which would give them full rights as US citizens. The US allows dual citizenship, but some countries do not. Also a non-citizen spouse may not know that it makes any difference whether he or she has United States citizenship, and perhaps he or she does not want to go through the trouble and expense of obtaining US citizenship, in which case he or she never gets around to obtaining US citizenship before the death of his or her spouse.
A QDOT gives the surviving spouse a right to life income from the trust, but that spouse is only a beneficiary and is not the legal owner of the trust assets. When the surviving spouse dies, the remaining trust assets will be subject to US estate tax, and the trust assets will pass to the other beneficiaries under the QDOT trust agreement – often the couple’s children.
Because we do not want to get bogged down in too many technical details, we will proceed in question-and-answer format for some common questions which you might have:
Q&A #1: Who receives the trust’s income from the QDOT?
For the QDOT to qualify for the marital deduction, no distributions may be made to anyone, other than the surviving spouse.
Q&A #2: What income tax returns must be filed for the QDOT?
Like other trusts, a QDOT is required to file a fiduciary income tax return annually, listing all income, deductions and trust distributions. The trust beneficiary will receive a Schedule K-1 from the trust, showing items to be reported on his or her personal income tax return, arising out of the trust distributions to the beneficiary.
Q&A #3: If necessary, can the QDOT make distributions to the non-citizen spouse, other than income distributions?
If the governing instruments so provide, the trustee may make distributions of trust “principal” or “corpus” to the surviving spouse, but if that spouse is a non-citizen at the time of distribution, the distribution would be a “taxable event” and there would be estate tax consequences. If any such distributions are made, Tax Form 706-QDT must be filed by the QDOT by April 15, reporting any principal distributions made during the prior year, and paying estate tax under Section 2056A attributable thereto. This is a separate tax return from, and in addition to, the fiduciary income tax return for the QDOT.
Q&A #4: If the surviving spouse becomes a US citizen, (a) can the trust be terminated? and (b) would additional estate tax be payable on termination?
As a general rule, a QDOT can be terminatedif the trust instrument so permits. But, if the QDOT was initially funded by the assignment of the non-citizen spouse’s interest in a trust which did not allow distributions of trust principal to the surviving spouse, the QDOT requirements would be simply “wrapped around” the terms of the prior trust, and the assets could not be distributed to the surviving spouse, even if he or she later became a citizen. Outright transfers which were assigned to the QDOT, on the other hand, could be distributed to the surviving spouse on termination.
As to the tax consequences on termination: The 2056A estate tax, which would otherwise be required for principal distributions which are categorized as “taxable events,” does not apply under two circumstances if the surviving spouse has become a citizen: (a) if the surviving spouse was a US resident at all times from the date of death until the date on which the surviving spouse became a citizen, or if no “taxable event” occurred prior to the surviving spouse’s becoming a citizen, regardless of residence; or (b) if the surviving spouse cannot comply with (a) above and other technical requirements are met, an election may be made to keep the Section 2056A estate tax from applying.
Q&A # 5: If the QDOT was originally funded by irrevocable assignment from the surviving non-citizen spouse to the QDOT of an interest in another trust, which trust terms will apply to the QDOT?
As briefly alluded to under #3 and #4 above, the interest in a trust on behalf of a non-citizen surviving spouse which would have qualified for the estate tax marital deduction, if the surviving spouse had been a US citizen, can be assigned to a QDOT, in which case the original trust terms would essentially be retained, but the original trust would be “wrapped” in a QDOT. For example, if the trustee of the original trust were a non-citizen or a non-US corporate fiduciary, then the QDOT rules would require a US trustee or corporate trustee to be appointed and a trustee power would have to be added, which authorizes the withholding of additional estate tax upon taxable events as described in #4 above, but the trust terms generally would otherwise remain the same.
If assets from several sources are used to qualify for the estate marital deduction, it may be necessary to have more than one QDOT, because of the different dispositive provisions which would apply to the assets from each source.
Q&A # 6: Can lifetime gift planning help reduce the complications of a QDOT at death of the first spouse?
Yes. Lifetime gifts may be made to the non-citizen spouse up to the annual gift tax exclusion for gifts to non-citizen spouses ($155,000 in 2019, and indexed for inflation), which would reduce the size of the decedent’s taxable estate, and would reduce the amount needed to qualify for the marital deduction at the decedent spouse’s death.
Q&A # 7: May a decedent’s estate elect both QDOT treatment and DSUE portability on the estate tax return of the deceased spouse?
A deceased spouse unused estate tax exclusion amount (DSUE) may be preserved for the surviving spouse’s later use, to the extent it has not been used on the decedent’s estate tax return, if certain technicalities have been met. This is commonly called “portability” of the DSUE amount.
If the estate elects QDOT treatment and also portability of the DSUE amount, then the estate reports a preliminary DSUE, which is subject to reduction if distributions of trust principal are later made as taxable events, or if a tax treaty later modifies the applicable DSUE amount. The DSUE amount is finally determined upon the death of the surviving spouse or other termination of the QDOT. This requires careful planning, both when the original estate tax return is filed and later, during the QDOT administration.
Q&A #8: Can the surviving spouse’s life interest in a charitable remainder trust be transferred to a QDOT, and if so, would there be any tax benefits from doing so?
Yes. At the death of the deceased spouse who was the grantor of a charitable remainder trust and who names a US citizen spouse as successor life beneficiary, followed by the charitable remainder beneficiary, the actuarial value of the surviving spouse’s life interest would qualify for the estate tax marital deduction and the actuarial value of the charitable interest would qualify for the estate tax charitable deduction. But if the surviving spouse is a noncitizen, there would be no estate tax marital deduction, which would require the using part of the decedent’s $11.4 estate tax exclusion (in 2019, indexed for inflation) to avoid estate tax on the amount left to the spouse. If, however, the spouse’s life interest was left to the QDOT it would qualify for the estate tax marital deduction, thereby preserving more of the decedent’s estate tax exclusion for beneficiaries other than the spouse.
Q&A # 9: Can there be estate tax payable on a QDOT, both as Section 2056A tax on the deceased spouse’s estate and for federal estate tax on the estate of the surviving spouse?
Yes, The death of the surviving non-citizen spouse can be a taxable event for the decedent’s estate under Section 2056A, as well as an asset of the surviving spouse’s taxable estate for regular estate tax purposes, if (a) the QDOT is also a QTIP trust, (b) the QDOT is an “estate trust,” payable to the surviving spouse’s estate, (c) the QDOT is a “power of appointment trust” because the surviving spouse had a power of appointment over the trust assets, (d) the trust estate holds a “non-assignable asset” over an asset such as an IRA or retirement benefit, or (e) the surviving spouse created the QDOT and retained certain powers described in Sections 2035, 2036, 2037, 2038 or 2042 of the Internal Revenue Code. Also, credits may be available for estate taxes paid under Section 2056A for up to 10 years after the decedent’s date of death, under certain circumstances.
Q&A # 10: Responsibilities and Potential Liability of Trustees.
The trustee or trustees of a QDOT is/are required to comply with the QDOT requirements and may be held personally responsible for their failure to comply.
QDOTs can involve millions of dollars and require compliance with a lot of complicated IRS rules, which necessarily will require legal advice and representation from a qualified attorney or law firm, about the advisability of setting up and administering a QDOT trust.
We hope that this information will be useful if at least one spouse is a non-citizen spouse.