This year, new tax legislation—perhaps the most significant in over 30 years—went into effect. The new legislation markedly alters the tax laws for both individuals and businesses, including some of the estate, gift, and generation-skipping transfer tax provisions.
The new law did not eliminate the estate, gift, or generation-skipping transfer (GST) taxes, nor did it dramatically alter how these taxes work: the 40% rate, marital deduction, portability, annual exclusion, and lifetime exemption are still around. But the new law did increase some of the exemption and exclusion amounts.
Most significantly, the new law doubled the lifetime exemption, i.e., the amount each of us can transfer during our lives or upon our deaths before we have to pay estate or gift tax. The GST tax exemption amount also doubled. For 2018, the exemption amounts will be around $11.2 million.* However, unfortunately, the increased exemption amounts are temporary. They will revert back to their current levels in 2025—unless a change in the political tides reduces them sooner or makes them permanent.
The large but temporary exemption amounts have a couple of important implications:
- Individuals and couples who are likely to die with more than $5 million may benefit considerably from making substantial gifts before the exemption amounts revert. Techniques like GRATs, IDGTs, SLATs, FLPs and similar are helpful in leveraging exemption, i.e., transferring as much value as possible with the exemption available.
- Some estate planning documents need to be updated. Certain funding formulas in estates of less than $11 million may result in the surviving spouse not having sufficient access to funds. Those formulas may also result in state death taxes being incurred on the first spouse’s death (rather than deferred for the surviving spouse’s lifetime) or unnecessary capital gains tax.
In addition to the changes in the lifetime and GST tax exemptions, the new law creates a deduction for certain qualified business income, increases certain limits on charitable contributions, and expands the uses of 529 plans, among other changes.
This year also brings some new inflation-adjusted figures to familiar provisions of the tax code. For example, the gift tax annual exclusion amount for 2018 is $15,000 (up from $14,000 in 2017). Other inflation-adjusted amounts are available
All of these changes make 2018 a good year to evaluate whether your estate plan reflects your wishes and accomplishes your tax objectives. Please feel free to contact us to schedule a time to for such an evaluation.
*The official number has not yet been released by the IRS.
In Thorsen v. Richmond Society for the Prevention of Cruelty to Animals, the Virginia Supreme Court established that attorneys who draft wills are liable to the intended beneficiaries of their services. The opinion is available here. This case is notable for two reasons: (i) it marks a change in what some, or perhaps many, attorneys believed to be the law on the rights of third-party beneficiaries of the attorney-client relationship in Virginia, and (ii) at least some attorneys are thinking about how to adapt.
Ms. Dumville hired Mr. Thorsen, an attorney, to draft a will. Ms. Dumville intended her assets to go to her mother, if her mother survived her. If her mother predeceased her, Ms. Dumville intended her assets to go to the Richmond Society for the Prevention of Cruelty to Animals, a charity. Mr. Thorsen understood Ms. Dumville’s wishes and prepared the will. Ms. Dumville signed it.
Ms. Dumville’s mother predeceased Ms. Dumville.
Due to a scrivener’s error, the will left only some of Ms. Dumville’s property (Ms. Dumville’s personal property, which was significantly less than all of her property) to the RSPCA. The rest ended up in the hands of Ms. Dumville’s heirs-at-law.
Mr. Thorsen fell on his sword and tried to correct the error. He was unsuccessful.
The RSPCA sued Mr. Thorsen in the Circuit Court for the City of Richmond. Mr. Thorsen lost. He appealed to the Virginia Supreme Court. He lost in a 6-1 decision. Justice McClanahan dissented.
Two of the issues the court considered are particularly interesting.
Some Injured Third-Party Beneficiaries Can Sue Attorneys
The majority answers the question of whether a third-party beneficiary has a cause of action for breach of contract against an attorney in the affirmative. The opinion acknowledges the general common law rule in Virginia that strangers to a contract do not have rights under the contract. However, the majority also notes an exception to the rule allows third party beneficiaries to enforce certain contracts. An injured third-party beneficiary may enforce the contract that creates (or should create) the beneficiary’s interest if the beneficiary was “clearly and definitely” the intended beneficiary of the contract. The majority applies this exception to reach a contract between an attorney and a client to draw a will for the benefit of a particular beneficiary.
The majority seems to be extending the third-party beneficiary doctrine to this case for public policy reasons. Without this extension of the third-party beneficiary exception, the innocent beneficiary bears the burden of the attorney’s error.
As to the legal basis for this extension of the third-party beneficiary doctrine, the majority looks to the law of other states and the court’s decision in Copenhaver v. Rogers. 238 Va. 361. The extent to which the court’s decision in Copenhaver grounds the Thorsen decision is a point of disagreement between the majority and the dissent.
The majority opinion addresses the important issue of when a beneficiary is “clearly and definitely” an intended beneficiary of the contract between the lawyer and the client. The determination seems to be about the client’s intent and the attorney’s assent to the representation.
Drawing from Copenhaver, the majority gives the following examples: (1) where a client who tells his lawyer “he really does not care what happens to his money except that he wants the government to get as little of it as possible,” the beneficiaries will not be beneficiaries of the contract between the lawyer and the client; (2) where a client tells his lawyer “that his one overriding intent is to ensure that each of his grandchildren receive one million dollars at his death and that unless the lawyer agrees to take all steps necessary to ensure that each grandchild receives the specified amount, the client will take his legal business elsewhere” the grandchildren may be intended beneficiaries of the contract between the lawyer and the client, as long as the lawyer agrees to comply with the client’s directives. (P. 9)
What does the majority actually consider in upholding the determination that the RSPCA was “clearly and definitely” an intended beneficiary of the contract between Ms. Dumville and Mr. Thorsen? The key considerations seem to be the client’s intent and whether the attorney assented to draft the document. The opinion considers Ms. Dumville’s intent and Mr. Thorsen’s separately. As to Ms. Dumville, an overriding purpose of the contract was to benefit the RSPCA was key. However, as to Mr. Thorsen, the majority said, “the agreement to comply with specific directives is implied when the client contracts with the attorney to perform a specific service which the attorney then undertakes to perform. We cannot separate the obligations of the client’s intent from the agreement because, without the intent and the assent to take on those specific directives, there would be no retention agreement.” (P. 24)
The majority gives us the following additional examples where a third party may be a “clearly and definitely” intended beneficiary:
- A woman retains an attorney to create a will for the benefit of her biological son, leaves a specific bequest to her new husband of her wedding ring, and bequeaths the residue of her estate to her son. About this hypothetical, the majority says, “although there may have been multiple purposes to the will, the son was a ‘clearly and definitely intended beneficiary’ of the contract and not an incidental beneficiary.” (PP. 14-15)
- A couple with a new baby retains an attorney to draft their wills. Each spouse names the other as the primary beneficiary of his/her will, and the child (or a trust for him/her) is the contingent beneficiary. As to this set of facts, the majority says, “[a]n overriding purpose in entering into the contract with the attorney to draft such a will at this time is generally to account for the possibility that both parents might perish, perhaps in a common accident, and to provide for the child’s long-term care. Although the surviving spouse remains the primary beneficiary of the will, and the child takes only as a contingent beneficiary, this does not alter the fact that the child is a ‘clearly and definitely intended beneficiary’ of the contract to draft the will.” (P. 16)
A residuary or contingent beneficiary can be a “clearly and definitely” intended beneficiary. The class of the beneficiary is a factor to be considered, but whether a residuary or contingent beneficiary is “clearly and definitely” an intended beneficiary is a fact-intensive inquiry. (PP. 14-17)
The examples in the opinion and the majority’s analysis of the Thorsen case suggest to me that third-party beneficiaries will exist in almost all estate planning engagements. The only example the majority gives of a case where a beneficiary is not “clearly and definitely” and intended beneficiary is where the client does not care who receives his money, as long as the government gets as little as possible. In order for me to prepare an estate plan for a client, the client has to select some beneficiaries (as I am not in the business of selecting beneficiaries for my clients). Once the client selects some beneficiaries, it is difficult to see which of those beneficiaries will not be “clearly and definitely” intended beneficiaries under Thorsen. Perhaps there is something that makes only some chosen beneficiaries “clearly and definitely” intended beneficiaries in the statement that “one of the primary purposes for the establishment of the attorney-client relationship [must be] to benefit the nonclient;” however, I am not sure where to draw the line and am inclined toward caution. (P. 12)
The Third-Party Beneficiary May Sue Many Years After the Will is Signed
The majority determined that the statute of limitations on the third-party beneficiary’s right of action begins to run when the beneficiary is injured (i.e., at or after the testator’s death). This is a departure from the general rule that such limitations periods begin to run at the time of the breach. The rationale underlying the rule in this case seems to be in that the RSPCA “was unable to bring suit in the years following the execution of the will: lacking a vested interest and possessing only a bare expectancy, it had no standing to sue. Not even slight harm or damage accrued to the RSPCA until the testator’s death.” (P. 20) Query whether death will always be the time at which the limitations period begins as to third party beneficiaries in cases like Thorsen or whether “vesting” is really significant.
Thorsen changes who can make a claim against the estate planning attorney for breach of the attorney-client contract and when. In changing those things, Thorsen may affect the frequency of particular types of claims against estate planning attorneys. For example, post-Thorsen, we might see more claims that the estate planning attorney’s error caused a beneficiary to get less than he or she otherwise would have. In Thorsen, a beneficiary received less due to a scrivener’s error. Errors that alter beneficial interests are not always so straightforward. Misunderstandings of default rules (like the rule against perpetuities, elective share, or tax apportionment), inappropriate tax planning, failures to include special needs trust provisions, improper execution, and unreasonable delays could also result in different beneficiaries taking or different allocations among beneficiaries.
The implications of Thorsen may not be limited to estate planning. As Justice McClanahan notes in her dissent, the court may intend to abolish the requirement of privity in all legal malpractice actions. (P. 32, FN 6) It is easy to imagine facts similar to those in Thorsen in estate administration, family law, and other contexts.
Implications for the Attorney-Client Relationship
The majority acknowledges the need for the injured beneficiary to have recourse against a negligent attorney, and Justice McClanahan points out countervailing public policies, chief among which is preserving the sanctity of the attorney-client relationship. (P. 28) While I agree with the majority that the injured beneficiary should have recourse (and am quite comfortable being liable for any negligent acts I might commit), I think Justice McClanahan makes important points about the effects the majority’s decision may have on the attorney-client relationship. The idea that it is not only the client who matters does not fit well into how I have previously thought of my client relationships. The prospect, reasonable or not, of being a defendant in many dissatisfied beneficiaries’ lawsuits—because I am here rather than because I was actually negligent—also concerns me.
Attorneys in other states are already dealing with potential liability to third-party beneficiaries, and perhaps we should not expect major changes in the estate planning field in Virginia in response to Thorsen. However, I think we may see some changes. In particular, we may see Virginia attorneys attempt to limit their liability or reduce their potential negligence.
Some attorneys may seek to limit their liability to third party beneficiaries in their engagement or other agreements with clients. It is an open question whether this will be effective in Virginia.
As to minimizing potential negligence, we might see attorneys practice more defensively. Attorneys may write more warning and confirmatory letters, have another attorney in the office review their estate planning documents, have an another attorney or a paralegal attend some client meetings, include estate tax planning provisions in more documents (increasing length and complexity), expend the resources necessary to be able to produce documents more quickly, implement more extensive practice management solutions, insist more strongly on clients signing documents in their offices, ask (and require answers to) more questions, and similar. These measures would very likely raise the costs of estate planning services, though the measures may ultimately be beneficial for clients.
In their efforts to minimize potential negligence, attorneys may also become more reluctant to take on or continue in cases they perceive as more likely to result in a claim by an intended third-party beneficiary. That perceived likelihood might result from the atypical nature or complexity of a client’s wishes, the litigious nature of a beneficiary, the client’s lack of comprehension of the limitations on the feasibility of his or her estate planning objectives, or other concerns.
Thorsen may not be the final word on attorney liability to third party beneficiaries. Virginia courts will continue to define the contours of these rules, and we may see a response from the legislature. As long as Thorsen is the law, however, I think we will see estate planning attorneys (and possibly other attorneys) thinking more about—and altering—how they practice.
What happens when a resident of another state dies owning Virginia real estate?
When a person dies owning real estate in more than one state, ancillary probate may be necessary to transfer some of the real estate.
Let’s say Henry passes away. At the time of his death, Henry was a resident of a state other than Virginia. Let’s call that other state “Home State.” Henry’s wife, Wendy, probated Henry’s will and qualified as the executor of Henry’s estate in Home State. At the time of his death, Henry owned a piece of real estate in Virginia. That real estate was Henry’s only Virginia asset. Wendy wants to be able to sell the Virginia real estate. What does she need to do?
Wendy needs to probate Henry’s will in Virginia. She needs to obtain an authenticated copy of the will probated in Home State and a certificate of probate from the relevant court in Home State. She may also need her certificate of qualification from the same court and possibly other documentation or information. Let’s say Wendy obtains the necessary documents from the appropriate court in Home State. She (or her lawyer) makes an appointment with the clerk of the appropriate Virginia circuit court to probate the will in that court. If the will meets Virginia’s execution requirements or is self-proving under the laws of Home State, the will is effective as to Henry’s Virginia real estate. Note: The probate of the will in Virginia (or any state other than Home State) is called “ancillary probate.” The probate in Home State is sometimes called “domiciliary probate.”
The effect of the probate of the will in Virginia is generally (but not always) to vest title to the real estate in the beneficiaries under the will. The Virginia case Broaddus v. Broaddus, 144 Va. 727 (1925) is the basis for that rule. Once title is vested in them, the beneficiaries can sell the real estate, if they wish to do so. Let’s assume that under Henry’s will, all of Henry’s property passes to Wendy. Assuming Henry’s will is effective to vest title to his Virginia real estate in the beneficiaries of his will, Wendy, in her capacity as the sole beneficiary under the will, would be able to sell the real estate upon the admission of the will to probate in Virginia.
Alternatively, a foreign executor can, under certain circumstances, convey the Virginia real estate without qualifying in Virginia. Once the will is probated in the Virginia circuit court for the property’s jurisdiction, the foreign executor will be able to sell the real estate if the following requirements are met: (i) the executor qualified under the laws of the state where the will was probated, (ii) the will is valid and executed according to Virginia law, (iii) the will gives the executor the power to convey the real estate. So, assuming Henry’s will and Wendy met the foregoing requirements, Wendy could sell the Virginia real estate in her capacity as the executor of Henry’s estate. This rule, which is perhaps unusual, is in Section 64.2-524 of the Virginia Code. In many other states, Wendy would be required to qualify as an ancillary administrator before she would be able to sell the real estate. (Note: While qualification as an ancillary administrator may not be required, it is possible and may be advisable under certain circumstances. A qualified lawyer can advise.)
Although Wendy does not have to qualify as a personal representative in Virginia, she does have to comply with certain Virginia probate requirements. At the time of probating Henry’s will, Wendy will need to pay certain fees to the clerk and the applicable probate tax. Once Wendy probates Henry’s will in Virginia, she needs to send Notices of Probate to the appropriate people and file an Affidavit of Notice. Whether Wendy sells the Virginia real estate as the beneficiary or the foreign executor, she does not have to file inventories or accounts in Virginia.
Charitable trusts are often appealing to donors who wish to give significant sums to charity. These kinds of trusts afford tax benefits for donors and allow donors to retain certain benefits for themselves or their family members. For small donations, however, charitable trusts are not typically feasible: they involve setup and administration costs in the thousands of dollars. Charities can set up pooled income funds (among other arrangements) to provide similar tax and retained benefits for donors making smaller contributions.
A pooled income fund is a sort of shared charitable trust. It is set up and maintained by a public charity. It does not involve setup costs for the donor. Once established, pooled income funds operate basically as follows:
- A donor contributes a sum of money or property other than tax-exempt securities, subject to any minimum contributions or other limitations imposed by the charity, to the fund.
- The donor chooses a beneficiary or beneficiaries to receive income distributions from the fund for the beneficiary’s lifetime. The donor can be the beneficiary.
- The donor gets a tax deduction for the present value of the portion of the contribution that is going to the charity (i.e., the remainder interest). A donor who gives appreciated property can avoid paying capital gains tax, which is one of the most appealing aspects of pooled income funds for donors.
- The trustees of the fund add the donor’s contribution to the contributions of the other donors. The trustees invest all of the funds together. Often, a charity will sell and reinvest the non-cash assets the donor contributed.
- The trustees make the required income distributions to the beneficiaries, which is the beneficiary’s proportion of the income of the entire fund (i.e., the “pooled income”).
- The donor can make additional contributions to the fund, subject to any additional limitations imposed by the charity.
- At the death(s) of the beneficiary or beneficiaries, the trustees pay the remaining funds to the charity.
For the charity, the appeal of establishing a pooled income fund is in making smaller donations appealing to and feasible for donors. The donor who has appreciated assets but wants to retain income, as well as the donor who wants the benefits of a charitable remainder trust without the up-front costs, may find pooled income funds particularly appealing. Also, donors may find that a pooled income fund that is less than 3 years old can provide them with a larger charitable deduction than can an older fund, because of the way the tax code and regulations require the remainder value to be calculated.
Like any legal arrangement, pooled income funds are not appropriate for all public charities. Pooled income funds require maintenance, may compete with other giving vehicles that charity offers, and may not draw donors at the rate the charity hopes. For the right public charity, a pooled income fund can be a valuable source of funds and donors.
If you would like to discuss whether a pooled income fund might be right for your organization, please feel free to contact our office.
Unitrusts and the Big Problem They Address
Some trusts have different income beneficiaries and remainder beneficiaries. Such a trust might provide, for example, that the surviving spouse receives all of the income while he/she is alive, and the children receive what’s left upon the surviving spouse’s death. The interests of the income beneficiaries (the spouse in the example) and the remainder beneficiaries (the children) in these kinds of trusts conflict as to investments: the income beneficiaries want the trust to produce as much income as possible (even at the expense of growth), while the remainder beneficiaries want the trust to grow as much as possible (even at the expense of income). The trustee of such a trust—who, like any trustee, has a duty to act impartially as to the beneficiaries—is in the difficult position of having to decide how to invest the trust property. The trustee and beneficiaries in this situation have a few options. One option is to convert the trust to a unitrust.
A unitrust is a trust that instead of paying all of its income to the income beneficiary annually, pays a percentage of its net asset value annually. In a unitrust, the interests of the income beneficiaries and the remainder beneficiaries are aligned: everyone wants the value of the trust to increase.
The Conversion Process
Virginia law provides a mechanism for converting a trust that pays its income (let’s call this kind of trust an income trust) to a unitrust.
In Virginia, the percentage that the trustee pays to the income beneficiaries has to be a “reasonable current return” and between 3% and 5% of the net assets. In determining the percentage, the trustee is directed to take into account the grantor’s intentions, the beneficiaries’ needs, economic conditions, projected current earnings and appreciation, and projected inflation.
Virginia law requires the trustee to follow a specific procedure to convert an income trust to a unitrust. The procedure depends on who the trustee is: there is one set of steps for “interested trustees” and another set of steps for other trustees. The process is similar for both types of trustees, but the interested trustee has to appoint an independent person to make certain decisions. The adoption of a written policy and notice to the beneficiaries are required in either case. The trustee, for a variety of reasons, may prefer to accomplish the conversion through an agreement with the beneficiaries rather than by notifying them and allowing them time to object.
Unitrust conversions are one way to align the interests of a trust’s income and remainder beneficiaries. However, not all income trusts and portfolios are good candidates for unitrust conversions. The trust’s portfolio and terms will significantly affect whether a unitrust conversion makes sense. Your financial, tax, or legal adviser can help you begin to assess whether a unitrust conversion might make sense for your trust.
Our estate planning process is a collaboration between us and our clients. The process itself is something we work with each client to define, so it varies from client to client. The time it takes to get from contacting us to a complete estate plan also varies from client-to client. Some clients wish to have their estate plans signed within a few weeks of contacting us, and we work to accommodate those clients. Many clients prefer to go through the process at a more leisurely pace.
All of that said, our estate planning process typically consists of the following phases: (1) information sharing, (2) designing the plan, (3) reviewing and revising the documents, and (4) signing and follow-up.
(1) Information Sharing
Let’s say you call or email one of our attorneys and say something like, “Hi, I think I need an estate plan. Can you help me?” The attorney would typically ask you if you have a few minutes to talk by phone about estate planning and whether we’re the right law firm to help you with your estate plan. If, at the end of that phone call, it seems like we would work well together, we’d schedule a meeting to talk about the details of your estate plan. If we’re planning the estates of you and your spouse, we would need both of you to participate in this meeting. We would also send a questionnaire for you to fill out and send back or bring to the meeting. The questionnaire asks you to fill in information about yourself, your family, and your assets. The questionnaire is extensive, but we ask that you just fill in just the information you have readily available. For someone who is unfamiliar with estate planning, we might also send some optional reading material.
(2) Designing the Plan
During our meeting, we would discuss how, exactly, your estate plan will work. We’d talk about things like who should manage your finances if you’re unable to do so yourself, whether you’d ever want anyone to “pull the plug” if you’re ill, who should receive your property when you pass away, how those people receive the property, and more. This meeting typically lasts between 45 minutes and 2 hours. Additional meetings, phone calls, and emails may be necessary, depending on your goals.
(3) Reviewing and Revising the Drafts
Once we’re all on the same page about how your estate plan should work, we would draft your estate planning documents. We’d send the draft documents to you (and your spouse, if we’re working with both of you) by mail and/or email to review at your convenience. We’d be available to discuss questions and changes as you go through the documents.
(4) Signing and Follow-Up
Once the documents are acceptable to you, we would arrange for you to sign them. We prefer to have our clients sign estate planning documents in our office, as we like to ensure the documents are executed correctly and to serve as the witnesses. Proper execution and credible, locatable witnesses can be helpful if any questions or challenges arise over your estate plan. We typically keep electronic copies of our clients’ estate planning documents and send the originals to the client.
Depending on the type of estate plan you signed and the nature of your assets, we may recommend some follow-up work. For example, if your estate plan included a revocable trust, the trust would need to be funded. We assist clients with as much or as little of the process of funding their trusts as they wish.
As time passes, laws, wishes, and circumstances change. These changes sometimes necessitate changes in estate plans. We suggest our clients assess their estate plans after significant life changes (births, deaths, marriages, divorces, significant changes in wealth, etc.) and at least every few years. We can assist with the assessment and any necessary updates.
If you would like to speak to us about estate planning, please feel free to contact one of our attorneys.
You might think that any lawyer with law degree (a J.D.), a license to practice law, and no disciplinary complaints can make you a good estate plan or advise you well regarding an estate or trust. Those things are important, but they might not be enough.
Choosing “Something Else”
Previously, we distinguished English per stirpes from the other distribution methods. In the scenario in Part 1, in which all of Henry and Wendy’s children die before them, the allocation methods other than English per stirpes all produced the same result. In this post,
Many parents wish for their property to pass to their children when they die. If the children die before the parents, the parents often want the property to go to their grandchildren instead. This sounds simple enough, but there are a few different ways property can be allocated among surviving children and grandchildren.