Death and Taxes - The Blog

Ken Lay and Claims Priority

This law.com article discusses an attempt by the estate of Enron founder Kenneth Lay to wipe clean Mr. Lay's criminal record.  The estate's lawyers...

cited a 2004 ruling from the 5th U.S. Circuit Court of Appeals that found that a defendant's death pending appeal extinguished his entire case because he hadn't had a full opportunity to challenge the conviction and the government shouldn't be able to punish a dead defendant or his estate.

The last three words of the above passage -- "or his estate" -- don't really make sense to me from a probate perspective.  As the article notes, the government plans to try and collect $43.5 million from Mr. Lay's estate as part of the estate claims process.  And I can't see any reason why they shouldn't be entitled to do so. 

The bigger issue is that, as the article puts it, "[t]he government... would have to compete with other litigants, if any, also pursuing Lay's estate."  How does that work?

I talked a little about the claims process in Illinois in this article.  To update what I said there:

Section 18-10 [of the Illinois Probate Act] sets forth a classification system for claims, from first class through seventh class.  First class claims have the highest priority -- this class includes funeral and burial expenses, expenses of administration, and statutory custodial claims.  "Debts due the United States" are third class claims in Illinois.

Two concepts are at work here: (1) all claims of a given class must be paid before moving to the next class of claims and (2) if the amount of property available to pay claims of a given class cannot pay all such claims in full, then the claims will be paid on a pro rata basis.  To illustrate, if Mr. Lay were an Illinois resident with an estate of $200,000, and the first class claims total $200,000, then only those claims would be paid (claimants with second class or lower claims -- like the U.S. Government -- wouldn't get paid at all).  If we change the above hypothetical so that the estate contains $500,000, then all first class claims would be paid, and $300,000 would remain for second class claims (which are surviving spouse and child's awards, discussed here).  If those claims are also satisfied and money remains in the estate, then -- and only then -- could the government get paid as a third class claimant (after proving its case, of course).

Dealing with Tangible Personal Property

Distribution of someone's tangible personal property upon their death is tricky business, for a number of reasons:

1. Unless the decedent left specific instructions for each piece of property, their beneficiaries (usually the children) are going to be in direct competition for items of property.

2. While most Wills call for tangible personal property to be divided "in shares of substantially equal value," most families don't want to go to the expense of hiring an appraiser to value such property.  As a result, everyone guesses at approximate values, and these guesses may be incorrect.  Furthermore, "equal value" doesn't take into account sentimental value, or the fact that the items with the most sentimental value to the beneficiaries may be indivisible.  (For instance, if your father's prized possession was his cane, how do you and your three siblings decide who receives this item?)

3. It seems like every family (including my own, I've recently discovered) has at least one "looter."  By looter, I mean a family member who decides that he or she is entitled to some/most/all of the decedent's tangible personal property.  The typical looter will ransack the decedent's residence and walk off with lots of valuables -- often while the decedent's body is still warm.  When asked at a later date about what he or she took, the looter's memory usually becomes foggy ("I don't know").

How to deal with the above problems?  I think the keys are foresight and formality.  By foresight, I mean that the person named as executor in the Will (or the most responsible child, if there is no Will) needs to make sure that the residence -- and all tangible personal property in it -- is secured immediately upon the decedent's death.  (Three words: change the locks.)  In addition, appraisals should be performed -- there are costs involved, but I think appraisals save lots of money and aggravation in the long run.  Finally, a formal meeting should be convened at which the beneficiaries select the items they want.  At the end of that meeting, before anyone is allowed to leave with their property, each beneficiary should be required to sign a receipt and a release.

For a scary take on tangible personal property battles, you may want to take a look at yesterday's dear prudence column on Slate (here). 

Estate P.A.C.T.: A Service For Preparing Probate Property for Sale

It can be a royal pain for an estate representative to sell the decedent's house.  In many cases the house needs extensive cleaning and some repairs (often cosmetic) before it can be sold.  But where does the money for these services come from?  If the house is the major asset of the estate, then the representative will often wind up paying for services out of his or her pocket, and then getting reimbursement when the house is sold.  That's not always a good idea (and if your representative doesn't have a bunch of cash sitting around, it may not even be possible).

A Los Angeles-based realtor at Coldwell Banker, Lou Woolf, has a new service (called Estate P.A.C.T.) that could help in this area.  If you hire Mr. Woolf to sell your probate property, you gain access to a group of tradespeople who will (a) perform the necessary work on the house and (b) defer their fees until the house is sold.  (The fees are payable at the closing.)  Here is the press release.

Hopefully a Chicago-area realtor will institute a similar program -- I'm sure it would be a hit here.

The Longest Probate

When I give seminars, I always joke about how probate is no longer the long, drawn-out process depicted in Charles Dickens' Bleak House.  However, maybe I'm wrong -- this article discusses a dispute over a house owned by the Estate of Jose Manuel Polonio Rios, which has been in probate since 1925(!).

A Bit More on Disclaimers

As I discussed yesterday, disclaimers are a way of saying "thanks but no thanks" to a gift of property.  They are usually used in connection with gifts made at death, in one of two scenarios:

1. The tainted property scenario.  The situation in yesterday's post would qualify here -- if you are given property that may be subject to litigation or is otherwise encumbered, you may not want to accept it.

2. The estate or gift tax scenario.  This is a more common situation, where you either don't want to increase the size of your estate by accepting an inheritance or you want to (in a sense) steer an inheritance to someone who may need it more.  Let me give a couple of examples:

Ex. 1: Mildred Smith, a widow, dies at age 80.  Mrs. Smith is survived by her son, Kenneth, who is an investment banker.  Mrs. Smith's Will leaves all of her estate ($1.5 million) to Kenneth or, if he doesn't survive her, to Kenneth's three children.  Kenneth already has a net worth of $3 million, and he doesn't need any more property; however, his children are all in their mid-to-late 20's, and are trying to establish themselves.  If Kenneth accepts his gift under his mother's Will, and then passes it on to his three children, he will owe gift tax.  However, Kenneth instead disclaims his gift under his mother's Will -- the gift automatically passes to Kenneth's three children as if Kenneth predeceased his mother, and no gift tax is due.

Ex. 2: Bob Jones, a married man with three children (ages 22, 20 and 18), dies without a Will in 2005 (when the estate tax exemption is $1.5 million).  Under Illinois law, his $5 million estate will pass one-half to his wife and one-half to his three children, which isn't what Mr. Jones would have wanted; to add insult to injury, because a significant amount of his estate will pass to beneficiaries other than his wife (and therefore won't qualify for the marital deduction), an estate tax will be due.  Mr. Jones' children each disclaim all but $500,000 of their inheritance, thereby giving more of Mr. Jones' estate to his wife (their mother) and eliminating any estate tax due (since the sum total of their inheritances equals the amount of the estate tax exemption).

Using a disclaimer to deal with estate tax issues is sometimes described as "post-mortem estate planning" -- that is, you use a disclaimer to create the estate plan the decedent should have executed during his or her life.   This can work very well, so long as you don't run afoul of the many rules relating to disclaimers.  Essentially, we're talking about:

State property law.  In Illinois, the main rules are found in §2-7 of the Illinois Probate Act (the Disclaimer Under Nontestamentary Instrument Act, at 760 ILCS 25, is also relevant for trusts).  Section 2-7 discusses (among other things) (1) how the representative of a deceased or disabled person or a minor can disclaim on their behalf; (2) the form of the disclaimer; and (3) actions by the person seeking to disclaim that might bar such person from disclaiming property successfully.

Federal Tax law.  The key section of the Internal Revenue Code that discusses disclaimers is §2518.

A few final points:

• In my experience, the biggest impediment to a successful disclaimer is "grabby hands."  In Illinois, you can't disclaim property after you have accepted it.  So, for instance, if you are a surviving spouse, and immediately start making withdrawals from your deceased wife or husband's bank accounts after her or his death, you will probably be barred if you subsequently try to disclaim these accounts.
• While I talk above about "steering" property to other beneficiaries, this can't be done directly.  In other words, you can't direct where the disclaimed property should pass.
• Disclaiming inherited property in order to avoid creditors or to qualify for Medicaid is an increasingly complicated business, and may not be possible.

It may sound like self-interest, but I think the key to dealing with disclaimers is to talk with a probate attorney as soon as possible after a loved one passes away.

Disposing of Personal Property

Disposing of a decedent's personal property can be a tricky business, as this Lansing State Journal article points out.  The major difficulty comes from the fact that every estate planning document walks the fine line between specificity and flexibility:

• Specificity can solve a lot of problems in giving away your personal property.  You could, for instance, list and give away every piece of personal property you own (all of your furniture, every piece of clothing, every rug, every item in your kitchen, etc.).  Of course, you'd probably wind up with a 30-page Will.  Even worse, what happens if you list a piece of personal property in your Will, but then sell it or give it away to someone else?  That can lead to controversy among the beneficiaries (such as accusations of theft).


• Flexibility usually rules the day, but that results in a provision saying something like "I give my personal property in shares of substantially equal value to my children who survive me," without specifying particular pieces of property.  The problem then becomes, what if more than one child wants an item?  And how do you create a method of division that's orderly, and fair to all children?

I think the above article is a nice little introduction to this issue, but it's also important to focus a bit more closely on solutions.  The article talks about filing a memorandum with your Will, with instructions on how to divide personal property.  In Illinois, this seems like a bad idea, since such a memorandum would have to be executed in the same manner as a Will (with witnesses and a formal execution ceremony) in order to be effective. 

To my mind, the best plan for disposing of personal property would be something like this:

1. Set up a living trust during your life.  The living trust should have two key personal property-related provisions:

     a. A provision allowing you to execute a "personal property direction," giving away your property. This is a great way to leave personal property -- especially mementos -- to people other than your default beneficiaries.  For instance, if you want your children to receive most of your personal property, but your friend Ann has always loved your red shawl, then you can use the direction to leave the shawl to her.  And because a living trust isn't subject to the same formalities as a Will, you can change the direction as often as you wish (including after you sell or give away an item of personal property). 

    b. A default provision detailing where the rest of your personal property (i.e. that property not disposed of by a direction) should go.  Something like "I give my personal property in shares of substantially equal value to my children who survive me" is fine, but there should also be an "end date" provision, telling what happens if the beneficiaries don't agree on their shares within 60 (or 90 or 120) days after your death.  It's usually a good idea for the trustee to step in at that point and either (i) divide personal property as he or she sees fit or (ii) sell the personal property and divide the proceeds among the beneficiaries.

2. Transfer your personal property to your living trust via an assignment of personal property.

3. Complete a personal property direction as discussed above.

I prepare assigments of personal property and sample personal property directions for my estate planning clients upon request, at no extra charge.  I've found that my clients particularly like the sample directions, since these can be updated without the aid of an attorney.

The Case of the Grand Send-off

Ruth Morrow of Bedford, Iowa was a former bookkeeper.  A widow with no children, she left her $1 million estate to a number of charitable beneficiaries.

As I've discussed before, the administration of a probate estate follows a certain order -- debts and expenses are paid, and then (finally) distribution is made to the beneficiaries.  In Mrs. Morrow's estate, things got interesting at the "debts and expenses" stage, when...

"Two nieces, who inherited nothing, but were among the 83-year-old Morrow's few surviving relatives, decided on a grand send-off. They would buy a $51,000 solid-bronze casket, fly it to California, pay a local funeral director to escort it, and bury Aunt Ruth in a famous Hollywood Hills cemetery where Bette Davis, Lucille Ball, Telly Savalas, Liberace and other stars are buried. The price for the November funeral was $64,089.76. The average cost of an Iowa funeral is $8,514."

All heck broke loose when the nieces sought payment of the funeral bill -- the executor refused, and asked the probate court to decide whether the expense was justified.  (The charities, whose share of the estate will be reduced if the bill is paid, say it wasn't.)  Was Mrs. Morrow a spendthrift who wanted all of her money to pass to charity or a showbiz type who longed to be buried near Kojak  and Mr. Showmanship?  A judge will decide.

Independent Administration: Monitoring the Process

Last week I talked about how independent administration of a probate estate involves little judicial oversight.  This means the estate beneficiaries have to pick up the slack and make sure that the estate representative (executor or administrator) has done his or her job.

A beneficiary's last, best way of doing this is to thoroughly review the papers for the closing of the estate.  When an independent representative feels that the administration process is complete, he or she will send each beneficiary a "receipt and approval" document for signing.  A judge typically will not close a probate estate -- and discharge a representative from his or her duties -- until a receipt and approval from each beneficiary is on file with the court.

As its name suggests, the receipt and approval has two purposes:

1. The beneficiary acknowledges receipt of his or her full share of the estate; and
2. The beneficiary approves the fees charged by the estate's attorney (and by the representative, if any were charged -- many estate representatives don't charge a fee).

Of course, a beneficiary can't do either of these things without a little context.  For instance, a beneficiary can't know whether she's received her full share of estate assets unless and until she knows the value of all estate assets and the amount of all estate debts and expenses.  That's why an inventory and an accounting should be attached to the receipt and approval, enabling the beneficiary to determine how her share was computed.  Let's take an example:

Adam dies, leaving his assets in equal shares to his four children (Ben, Cathy, David and Edith).  Ben is the executor, and he tells the other three children that each of them is entitled to $150,000 from the estate. 

In order to determine whether this is correct, Edith needs to know:

-What assets were collected -- was anything forgotten?  The inventory should list each (probate) asset owned by Adam at his death.
-How the value of each asset was computed.  Stocks and bonds are easy (there's a market for them) -- so are bank accounts.  But real estate and tangible personal property is another story.  Did Ben correctly account for the value of these assets?
-What debts and expenses were paid from the estate? Were all of these debts and expenses proper?
-What records exist to support the fee taken by the estate's attorney?  (Time records, billing statements, etc.)

Edith might find that the $150,000 amount is justified -- maybe Adam owned $700,000 in assets at death and had $100,000 in debts and expenses (with the remaining $600,000 divided four ways).  In that case, Edith should sign the receipt and approval, and allow the estate to be closed.

But Edith also might come to believe that Ben failed to collect (or to correctly value) certain assets, or paid certain debts and expenses that shouldn't have been paid.  If that happens, Edith can refuse to sign the receipt and approval, and can try to have her concerns addressed informally (by having Ben and his attorney respond to them in private) or formally (by raising her concerns in court). 

More Thoughts on Intestacy

I often tell people that if they don't make a Will, the Illinois legislature will make one for them.  What I'm referring to is the intestacy statute I discussed yesterday -- it sets a bunch of defaults (and makes a bunch of assumptions) about who should receive your property at your death.  That can be a big problem, since many of the assumptions don't make a lot of sense.

Let's start with the nuclear family scenario: My informal poll of my married clients indicates that, if one spouse dies, all property should pass to the other spouse (who will then use it to care for himself or herself and the children).  But that's not what Illinois intestacy law says -- rather, it gives 1/2 of the decedent's probate estate to the spouse and the other 1/2 to the decedent's children, thereby creating a number of problems (and that's without even addressing the estate tax issues, which I'll save for another time):

• What if the spouse doesn't have enough money to live on?
• What if the decedent didn't want his children to receive equal shares of his property (for instance, if one child is a "bad seed" who should be disinherited, or one child has special needs that require more property)?
• What if the decedent does want his children to receive equal shares, but wants to control when the shares are received (because the children aren't responsible enough to receive the shares immediately)?

Similar questions can arise for a decedent without a spouse or children (e.g. What if you don't want your siblings to receive equal shares of your estate? What if you are estranged from one or both of your parents?).

The solution, of course, is to execute a Will (or a Will and living trust), so that you can control who receives your property at death and how they receive it (outright or in a trust).

An Intestacy Primer

I spoke a couple of days ago about why a Will is needed even if you have a living trust. One of the reasons I gave is that intestacy is worse than probate. In order to flesh out this idea, I thought I would discuss intestacy in a bit more detail.

Let’s start with some definitions: “intestacy” means “without a Will.” Dying intestate therefore means “dying without a Will,” and is the opposite of dying with a Will (sometimes described as “dying testate” – this is why a person who executes a Will is sometimes called a “testator”).

The Illinois statute governing intestacy can be found here, and applies to any probate property owned by a person at his or her death if the person didn’t have a valid Will. Under Illinois law, this property passes to the person’s closest heirs as determined by the statute. How is heirship determined? The intestacy statute is full of provisions that apply only in very specific situations (involving questions like whether you can inherit from someone whose death you caused, and how to treat "illegitimate" children). But for purposes of this simple explanation, let’s stick to the basics – here are the questions you would ask to determine the heirs of a “typical” man or woman who died intestate in Illinois (referred to in the rest of this post as “the decedent”).

1. Was the decedent married at the time of death?

2. Was the decedent survived by one or more descendants?

If the answer to either or both of these questions is “yes,” then we already have enough information to determine the identity of the decedent’s heirs.

If the answers were “yes” and “yes,” then the decedent’s surviving spouse receives one-half of the decedent’s probate property, and the descendants of the decedent receive the other half. 

If the answers were “yes” and “no,” then the decedent’s surviving spouse receives all of the decedent’s probate property.

If the answers were “no” and “yes,” then the descendants of the decedent receive all of the decedent’s probate property.

If the decedent had no surviving spouse or descendants, then we need additional information, and can follow up with three additional questions:

3. How many of the decedent’s parents survived him (neither, one, or both)?

4. How many of the decedent's siblings survived him?

5. How many of the decedent's siblings didn't survive him, but left children of their own who survived him?

At this point, an intestate decedent's estate will be divided into equal shares for the family members mentioned in questions 3-5.

If both parents survived the decedent, they each receive one share.  If only one parent survived the decedent, that parent receives two shares.

Each surviving sibling receives one share.

The surviving children of a sibling who didn't survive the decedent (collectively) receive one share.

Tomorrow I'll talk about why the above outcomes might not be optimal, as well as the method for dividing property between descendants (the concept of a "per stirpes" distribution).