Mark A. Bregman, Estates and Trusts Lawyer

 

New Perils of Arizona Beneficiary Deeds

I first wrote about using an Arizona beneficiary deed to avoid probate on November 13, 2012.

A recent decision of the Ninth Circuit Bankruptcy Appellate Panel reveals a major shortcoming that should affect the popularity of beneficiary deeds.  In Jones v. Mullen, BAP No. AZ-12-1644-DPaKu, the panel decided that the debtor’s interest in real property acquired because of the death of his grandmother 3 days after the debtor filed a Chapter 7 bankruptcy petition was property of the bankruptcy estate.  The bankruptcy trustee was allowed to sell the debtor’s post-petition acquired interest in the real property.  The debtor’s creditors benefitted from the decedent’s beneficiary deed rather than the intended grantee, the decedent’s grandson.

Beneficiary deeds have become so popular and widely available on the internet, many people create beneficiary deeds without consulting a lawyer or otherwise gaining an appreciation for some of the more common pitfalls.  Leaving property outright to an intended beneficiary heads the list of problems that can be avoided with planning.  This mistake could be made in a Will or a trust as well as a beneficiary deed, but most trusts and many Wills are prepared by lawyers who have the opportunity to counsel their clients and discover whether or not special circumstances exist which suggest adoption of a different plan.

Bankruptcy laws can disrupt an estate plan and cause a detrimental unintended consequence.  A well constructed estate plan considers potential obstacles such as unforeseen bankruptcy filings and poor timing and “plans” for such possibilities in ways that a beneficiary deed form cannot.

Interestingly, in Jones, the decision did not rely on the 180 day clawback rule of §541(a)(5) for inheritances, but rather reconfirmed a 24 year old case, Neuton v. B. Danning (In re Neuton), 922 F.2d 1379 (9th Cir. 1990), decided using §541(a)(1).  The controlling law in the Ninth Circuit is that a contingent interest becomes property of the bankruptcy estate upon the filing of a petition, subject to divestiture and valuation issues.  Here, when the contingency occurred, Grandma’s death, during the pendency of the bankruptcy case, the debtor was left with no recourse and the interest was sold for the benefit of the bankruptcy estate and the debtor’s creditors.

The Ninth Circuit consists of California, Oregon, Washington, Nevada, Hawaii, Alaska, Montana, Idaho and Arizona.  The result could be different in other states that don’t have the same precedent.

The Jones case is a perfect example of the old adage “that for the want of a nail, the horse was lost.”  Although a beneficiary deed may be inexpensive to create and avoids probate, it also contains none of the protections many folks want for their descendants.  If any adverse conditions exist on the date of death, the decedent’s estate plan will be frustrated.

This is just one example of how beneficiary deeds may be innocently misused.  Failure to adequately identify who takes the property if the originally named beneficiary fails to survive the grantor is another common mistake that can be avoided with careful planning and competent drafting.

In the proper circumstances, a beneficiary deed can be a time and money saving alternative to probate, but unforeseen consequences can assure that the simple idea is not a good one.  Before using a beneficiary deed, make sure you have identified not only the benefits you desire, but the risks and pitfalls not often discussed.  I can help you analyze whether a beneficiary deed is a good solution for you.  For this or any other estate planning concern, call me today.

The 6 Potentially Fatal Flaws of Joint Tenancy

Last week I mentioned joint tenancy bank accounts as being a simple, but potentially dangerous way to provide for a transition of bank accounts.  It is a commonly used technique because it is simple and is the favored way for bankers and investment advisors to administrative your accounts with the least amount of effort for them.

It is another example of my “broken clock” philosophy.  It is right twice a day.  When it works it is very simple and economical, but when it fails, it falls with a loud “thud” and can be very expensive, especially when you are aware of the other almost as simple and cost effective methods you could use.

About 12 years ago, I wrote a brief explanation of these problems from the perspective of the wealth transfer system.  Those 6 reasons remain valuable today, but I have rearranged the order of importance to take into consideration the different considerations which I believe almost everyone will face based on today’s different challenges.

In summary, using joint tenancy, may expose your assets to the liabilities of your joint tenant, accounts may be at risk because the joint tenant has control over the account without a corresponding fiduciary duty, you may unwittingly incur the costs of an unwanted probate proceeding, you may suffer an adverse income tax result, you may suffer an adverse estate tax result, your property may not pass to your descendants as you intended, and you may have created an avoidable risk from accidental creditors.

Here are the 6 tragic adverse, but avoidable, consequences you and your family may suffer if you rely on joint tenancy:

1. Joint tenancy accounts with adult child or caretaker subjects you to expensive and potentially devastating results and the loss of the asset.  Joint tenancy property is fair game for creditors of your joint tenant.  Although you may have an opportunity to prove the property was placed into joint tenancy for convenience and that the property really does not belong to the debtor, you are exposed to litigation and the expense and uncertainty that are litigation’s natural results.  You are also susceptible to the joint tenant misusing the property or not sharing the property with his or her siblings as you intended.

2. Joint tenancy will avoid probate for the first spouse, but not the second.  In fact it assures that there will be a public probate proceeding when the surviving spouse dies.

3. If the asset is real property or an investment account, joint tenancy will also cause the estate to lose the double step-up in basis afforded to community property assets.  This is a significant loss resulting in additional capital gains taxes if the asset is sold by the surviving spouse

4. A joint tenant has no control over what happens to the property after death.  A surviving joint tenant can sell or transfer the property, or can pass it to the survivor’s choice of heirs, including subsequent spouses.  Joint tenancy deprives you from assuring that your property stays in your bloodline.  Without any further planning, property owned by a surviving joint tenant will pass automatically to the heirs of the survivor.  If the survivor’s heirs are not the same as the decedent’s this could lead to an unintended result

5. No creditor protection is available when property passes by joint tenancy.  Creditors come in many shapes and sizes these days.  Jury verdicts in even the most common accidents easily exceed insurance limits.  Aging survivors are more susceptible to lapses of concentration while driving or otherwise.  Why unnecessarily expose all of the survivor’s assets to creditors when a trust can provide creditor protection to your spouse or your descendants?  This is valuable protection that can not be purchased at any price if you miss the planning opportunity of placing your accounts into a trust that will be irrevocable when the first spouse dies.

6. No estate tax protection for post-death appreciation is available if joint tenancy is used.  Although the asset will pass to your spouse estate tax free; upon the death of the survivor, the entire estate is exposed to estate taxes and the estate tax exemption available to the first decedent is lost unless you have planned for a credit shelter trust or file an estate tax return and claim the “portability” carryover exemption.  If your combined estate, including life insurance is likely to exceed $5,000,000 (or $1,000,000 if the law is not changed before the end of 2012), then you have unnecessarily benefitted the government at the expense of your descendants.  This could be a mistake that could cost you 55% of the value of your estate in excess of $1,000,000.

     I encourage you to take the time to consider whether joint tenancy is a viable strategy for you.  You may be the broken clock that is right twice a day, by why take that risk relying on a do-it-yourself approach to a complicated issue.  Call me to help you sort through what plan is best for you.

What Do the New Estate Tax Laws Mean to You?

By now you have probably heard that on December 17, 2010, Congress increased the estate tax exemption to 5 million dollars. You may also have heard the new term “portability” thrown about; read that the estate, gift, and GST taxes have once again been “reunified” at the 5 million dollar level; and that this is a 2 year fix indexed for inflation with a return to the $1 million level in 2014.

What has gotten much less publicity is the 3.8% surtax added on investment income for couples with AGI greater than $250,000 which is part of the Health Care bill and effective in 2013.

What does this mean for you?

1. You may now need a Life Insurance Trust. I have always held that life insurance and Irrevocable Life Insurance Trusts (ILITs) are a valuable tool, and I am even more convinced of this now. In fact, ILITs are even more desirable than before if you have wealth you intend to use primarily to create a legacy for your descendants.

Decision making no longer needs to be driven by the estate tax rules. And if you are thinking of waiting you have to consider that you don’t know if you will be medically qualified for life insurance a year or 2 years from now. It’s best to act now, and we can design trusts that will shield the proceeds from taxation in your estate while giving you access to the accumulated cash surrender value if circumstances change.

Life insurance remains the single best strategy for a healthy person to create a large legacy that eliminates the stress of a volatile investment strategy. And now policy premiums can be paid in advance and avoid the complexities of Crummey letters and hanging powers, and existing policies with large cash values can be transferred to ILITs to avoid potential taxation.

2. As much as I believe in ILITs, they are not your only option for Legacy Planning: Family partnerships, GRATs and other strategies can also be structured and more economically implemented to take advantage of the temporary uptick in the exemption amounts.

3. It is open season on outright gifts and gifts to dynastic trusts now that you have the opportunity to make tax free gifts up to 5 times larger than in the past. The multiplier effect for 2 or more generations will be astonishing!

4. The 3.8% surtax also makes pushing investment assets down to lower generation members in lower tax brackets an important income tax plan for multi-generation families.

5. Achieving creditor protection using spousal limited access trusts and lifetime QTIP trusts has become a tantalizing opportunity.

6. Portability, however, is a trap for the unwary, as is the increased federal exemption that may destroy your existing estate plan if you have a blended family or other targeted planning in place. Formula gifts to charity may disappear from your plan unless you make changes.

Your legacy is important, and now is the time to consider changes to your plan and to implement those changes you have considered–but avoided–until now.

If “getting it right” is important to you (as it should be); then planning right now is indispensable. To learn more about these Legacy Planning techniques — or any other estate and tax strategies –call me today.

The New Reality of Single Member Limited Liability Companies (SMLLCs)

If you’re looking for a way to protect your assets from creditors and lawsuits you should consider creating a Limited Liability Company (LLC).  An LLC is a business entity that combines the benefits of a business partnership and a corporation and protects your assets while still allowing you to retain control over them.  Desirable characteristics of LLC include that it can be formed by a single member, does not have to have a business purpose, and does not require a separate tax return or annual filings to maintain its existence.  LLCs can be a wonderful tool… but not all LLCs are created equal.

Arizona asset protection enjoys a competitive advantage over the laws of many other states because the drafters of the Arizona LLC law omitted creditor friendly portions of the Uniform Laws that allowed creditors to foreclose their charging order liens to realize on the underlying assets owned by the LLC.  This puts Arizona LLCs among the country’s elite LLCs for asset protection.  This enhanced protection is commonly known as the “charging order as the exclusive remedy,” and until recently was thought to be absolute in states like Arizona.  However, this enhanced protection is now being eroded by developing case law, and even in an LLC-friendly state such as Arizona the yellow flag of caution must be out for a Single Member LLC (SMLLC) as protection of its assets from its member’s creditors.

The Battle Between Creditors and SMLLCs

In the 2003 Colorado bankruptcy case Ashley Albright, the Court allowed a bankruptcy trustee to stand in the shoes of the debtor and control the assets of the debtor’s SMLLC.  First thought to be an aberration limited to its facts, in fact that decision was correctly decided and a warning to all SMLLCs.  The true lesson of that case is stay out of bankruptcy court if you expect to protect the assets in a SMLLC because the bankruptcy trustee steps into the place of the debtor and can control the assets inside the SMLLC if there are no other members to protect.

Then in 2005, in an Arizona bankruptcy case case, In re Ehmann, a decision since vacated when the parties settled, Judge Haines articulated a theory that if a limited partner had a passive role in the governance of a family limited partnership, the bankruptcy trustee could under some circumstances succeed to the interest of the debtor limited partner, formulating a theory about the impact of the executory nature of the limited partnership interest.  While not particularly interesting because it broke no new intellectual ground –the bankruptcy trustee always had that bundle of rights, the case is interesting and instructive because the general partner governed the limited partnership to the detriment of the bankruptcy trustee giving rise to a right to dissolve the partnership and reach the underlying assets, the case is nevertheless instructive.  The case is important because it is the vanguard case signaling that the remedy of judicial dissolution can be used by creditors in a variety of circumstances where no other remedies exist.

The next important case is the recently published Florida Olmstead case where the Florida Supreme Court failed to decide the question certified to it by the Federal District Court about the remedies available against a SMLLC, but rather held that a charging order was not the exclusive remedy against a single member limited liability company because single member limited liability companies lacked other members whose interests needed to be protected.

The Florida Supreme Court refused to interpret the state statute and instead chose to fashion a remedy designed to protect creditors against artificial barriers in collection procedures.

It has been suggested elsewhere that a strict reading of exclusive remedy statutes (such as the one in  Arizona) invites judicial activism to shape remedies as did the Florida Supreme Court which has now given it’s imprimatur to the creditor friendly theory.

Arizona-Specific SMLLCs

Although SMLLCs are good asset protection entities protecting a member’s other assets from claims by creditors of the SMLLC (commonly called inside out protection), even that protection is limited if the member has signed a guarantee or can be held directly responsible as the actor giving rise to the claim.

The importance of the omission in Arizona law of the right to foreclose the charging order means a judgment creditor is entitled to a lien against a member’s interest in an LLC, but the creditor is only entitled to receive distributions that would otherwise be made to the member.  If the LLC makes no distributions, then the creditor receives nothing except the satisfaction of making life difficult for the debtor.  In states that follow the Uniform Laws or have their version of the charging order statute, the creditor may foreclose its lien on the member’s interest and force its way into the governance of the LLC; this is not the case in Arizona.

In single member limited liability companies, this means the creditor may have an absolute right to distributions from the SMLLC, but the debtor retains control over the assets of the SMLLC and the timing of distributions.  This is a most undesirable result from the point of view of the debtor.

What Does This Mean For You?

The battle will continue over the distinction between economic rights and governance rights in SMLLCs. How much deference to a plain reading of the statute can asset protectors expect from judges in cases with difficult fact patterns will continue to present a quandary to most.  Practitioners have long argued peppercorn theories of additional members, but the modern genre of reverse piercing and judicial dissolution arguments in an increasingly hostile judicial environment require you to stand up and take notice rather than relying only on statutory constructions.  It will be increasingly important that documents are well drafted in a state with favorable laws and that the ownership and governance provisions of your operating agreements be given particularly attention to achieve your specific goals.  Most importantly specific facts must be analyzed because beginning with the best structure is the key to long term success.

If you think a custom crafted LLC will benefit you, give me a call.