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A. Preparation of a Will for both husband and wife and other related documents (trusts,

guardian designations, and powers of attorney)

B. Estate and gift tax planning

C. Income tax planning for each estate and for family members, now and later

D. Life insurance and employee benefit planning

E. Other considerations (e.g., family business, buy-sell agreements, living will)

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A. Minimize state and federal taxes on your estate

B. Minimize the probate and administrative costs connected with your estate

C. Assure distribution of your estate so your spouse, children, charity, etc., are provided for as you wish

D. Assure that there is liquidity in the estate adequate to pay expenses associated with settling your estate

E. Avoid confusion and litigation during an estate’s administration by setting forth clear and binding instructions

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A. A will is a legal document that you make which provides for the settlement of the probate estate after your death.

1. The probate estate is all property that you own and that does not pass pursuant to an agreement, contract, or by operation of law.

a) If the you have an ownership interest in any life insurance policies, employee benefit plans, joint tenancy with right of survivorship properties, or trusts, these items are considered part of your estate for federal estate and gift tax purposes (i.e., subject to transfer tax at death or earlier, if given away), but are not part of your probate estate since ownership of this property is not transferred by Will but, for example, by a beneficiary designation, or automatically by law.

2. If you are married, your estate consists of one-half of the community property of you and your spouse plus any separate property you may own.

a) Community property is all property acquired by either spouse during the marriage except for that acquired by one of them by gift or by devise or descent (i.e., inherited).
b) Separate property is all property acquired before marriage (or while unmarried) and any property acquired by gift or by devise or descent (i.e., inherited).
c) Unless altered by a pre-marital or marital agreement, all income from separate property is community property.
d) If community property and separate property are commingled, it will all be presumed community property.

B. In a Will you, the Testator, may determine:

1. To whom the property should be distributed (family, friends, and charities).

2. How the estate should be distributed (i.e., outright or in trust, etc.).

3. Who will supervise the distribution process and take charge of paying debts and taxes and transferring the property (Independent Executor).

4. Other important matters (such as when and under what circumstances the Estate shall be distributed).

C. With a Will the Testator can plan so as to minimize estate and income taxes, and thereby increase the property passing to the beneficiaries (and decrease the property passing to Uncle Sam).

D. With a Will the Testator can be certain that his or her property will pass according to his or her plan (and not the plan provided by Texas law for persons who die without Wills).

E. With a Will the Testator can make special provisions for family needs, such as trusts for loved ones that can be protected from their spouses and their creditors, or for minors or those unable to handle property. You can also make special gifts to family members, friends or charities.

F. A duly executed Will must be signed by the Testator. The Testator must be 18 years old (or married, or in the armed forces.) The will must be signed by the Testator and two attesting witnesses who sign in the Testator’s presence. A witness should not be a beneficiary.

G. Texas recognizes holographic (handwritten, unwitnessed) wills if they are “wholly in the handwriting of the Testator” and signed by the Testator. Holographic wills often lead to confusion and litigation and should generally be avoided.

H. Competency - did the Testator have sufficient capacity to:

1. Understand the nature of the act he or she was doing? (i.e., he or she was writing a will)

2. Know the nature and character of his or her property?

3. Know the natural objects of his or her bounty?

4. Understand the disposition he or she was making?

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A. The State of Texas has written a Will for those without one! This “Will” is sometimes referred to as the Statutes of Descent and Distribution or the Intestacy Laws.

1. If the Decedent was married and had children when he or she died, his or her property will be distributed by the probate court pursuant to Texas law as follows:

a) His or her one-half (½) of the community property passes:
(i) to his or her spouse, if the deceased spouse is not survived by descendants or all of those descendants are also descendants of the surviving spouse; or
(ii) to his or her descendants if the deceased spouse had descendants who were not also the descendants of the surviving spouse. In the second case, the surviving spouse keeps only the surviving spouse’s one-half (½) of the community property and the other one-half (½) passes to the descendants; typically, the children of the Decedent, the stepchildren of the surviving spouse.
b) Only one-third (1/3) of the Decedent’s separate property personalty (cash, securities, personal effects), if he or she had any, will pass to his or her spouse and only a life estate (a right to use during lifetime but no right to dispose) in one-third (1/3) of the Decedent’s separate property real estate will pass to his or her spouse. The remainder of his or her separate property will pass to his or her children. Very few Texas residents who have been married a long time have any separate property due to commingling.
c) Thus, the spouse may receive very little of the deceased spouse’s property, especially if there are children of a prior marriage, and may have financial difficulties because of this.

2. If the Decedent is single when he or she dies, his or her property will be distributed by the probate court pursuant to Texas law as follows:

a) If the Decedent has any children (or grandchildren), all of his or her property will pass equally to his or her surviving children, or all to the survivor of them if only one of them survives him; provided that, a deceased child’s share passes to his or her surviving children.
b) If the Decedent has no children (or grandchildren), his or her property will pass as follows:
(1) One-half (½) to his or her mother and one-half (½) to his or her father, if they both survive him; or

(2) One-half (½) to his or her surviving parent, if only one parent survives him, and the other one-half (½) equally to his or her brothers and sisters (or their descendants); or

(3) If neither parent survives him, equally to his or her brothers and sisters (or their descendants).


B. If the Decedent dies without a Will, the court will appoint someone to handle the estate (time-consuming, cumbersome and expensive).

1. The person appointed (Administrator) is entitled to receive compensation for so acting (expensive).

2. The Administrator must seek prior permission from the court before entering into transactions with the Estate property, including routine transactions like paying utility bills and distributing money to the spouse and children for their support (cumbersome).

3. Generally an attorney must be retained to advise the Administrator and to prepare the many documents required (expensive).

4. The Administrator must account to the court for each and every receipt and disbursement and must file an accounting, each year while handling the estate, which is usually prepared by the attorney (time-consuming, cumbersome and expensive).

C. If the Decedent dies without a Will and any minor (under age 18) is entitled to property from the estate, a Guardianship for the minor’s Estate may need to be created in the Probate Court (expensive, time-consuming and cumbersome). This is true even if the minor is the Decedent’s child and the spouse (who is the minor’s parent) survives. Further, if the minor is the Decedent’s child and the spouse predeceased the Decedent, in addition to appointing a Guardian of the minor’s estate, the court will appoint a person called a Guardian of the Person to take care of the child (could be a friend, relative or stranger) based upon what the court thinks is best.

1. The Guardian of the Estate is entitled to compensation for being in charge of the minor’s property (expensive).

2. The Guardian must seek prior permission from the probate court for each transaction involving the minor’s property, including such routine transactions as paying for school expenses and buying food and clothing for the minor (cumbersome).

3. Generally, an attorney must be retained to advise the Guardian and to prepare the many documents that are required to be filed with the court (expensive).

4. The Guardian must account to the court for each and every receipt and disbursement and must file an annual accounting report, which is usually prepared by the attorney (time consuming, cumbersome and expensive).

5. No matter how immature or ill equipped to handle the property, when the minor reaches age 18, all of the property must be turned over to him or her.

6. All of the foregoing is true even if the minor’s own parent is appointed as Guardian of his or her Estate.

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A. A Will can provide for an Independent Executor (trustworthy person) to administer the Estate free from court supervision (minimal expense). If such person is a family member, compensation is usually not necessary, as determined by the provisions of the Will.

B. A Will can provide for the spouse in a manner, which will insure financial security and reduce taxes.

C. A Will can provide a trust for any child or grandchild or other loved one entitled to property under the Will, which can protect the property from attachment by the beneficiary’s creditors or spouse and can prevent commingling.

1. In the Will the Testator can appoint a Trustee (trustworthy person) to manage the property for such child or grandchild or incompetent person, free from court supervision (minimal expense). The Trustee can be the child’s own parent or a relative. If necessary, a bank can be appointed Trustee; however, banks are entitled to fees for so acting (may be inefficient for a small estate, but can be useful if neutrality is important).

2. A Will can provide for distributions from the trust of income and principal (if income is insufficient) to the child or incompetent person during the term of the trust pursuant to a definite distribution standard such as health, support, maintenance or education.

3. When the child reaches the age that the Testator has specified, he or she can be appointed sole trustee for his or her trust to manage and distribute as he or she determines.

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A. If the marital status has changed.

B. If the Testator has moved from one state to another.

C. If the size of the estate has changed significantly, for example, by the receipt of a large gift or inheritance.

D. If someone in the family dies or a new family member is born.

E. If the executor and/or trustee has died or moved away.

F. If the tax laws have changed significantly.

G. If the Testator has changed his or her mind about the persons who should be beneficiaries, executors, trustees or guardians or about the manner in which he or she wants to dispose of his or her property.

H. If the Testator has started a new business or made changes in the structure of an existing business.

I. You should review your estate plan in your will frequently to ensure it meets your needs.

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A. The Federal Estate and Gift Tax is a tax imposed on the transfer of property - either during lifetime or at death. The tax is assessed against and paid by the person making the transfer (or his or her estate). The beneficiary of the gift does not pay the transfer tax, and the gift itself is not included in the beneficiary’s income tax return. Of course, if the gifted property produces any income for the beneficiary, that income is taxed to the beneficiary.

B. Due to the Economic Recovery Tax Act of 1981 (ERTA), all property which is given to a spouse who is a U. S. citizen, either by gift during lifetime or by Will upon death, passes to the spouse tax-free because it qualifies for what is termed the unlimited marital deduction. This property can be given to the spouse outright or in one of several types of trusts, the most common of which is the qualified terminal interest property (or “QTIP”) trust.

C. ERTA also increased the exemption equivalent amount (now called the applicable exclusion amount, which is the amount of property that can be transferred to anyone without paying a transfer tax). This amount is now $1,000,000 for the year 2003. Until a person transfers more than the applicable exclusion amount, no estate or gift tax will be paid.

D. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), includes significant estate and gift tax relief. A few of the major changes are summarized here. The Bill gradually increases the amount that is exempt from estate tax from the current $1,000,000 to $3.5 million, between 2003 and 2009. For 2010 the estate tax is repealed. However, for 2011, the repeal is repealed and we go back to 2003 where the applicable exclusion amount will remain at $1 million. Below is a table showing the increase in applicable exclusion amount and reduction in the maximum estate tax rate.


Estate Exemption

Top Estate Rate


$1 million



$1.5 million



$1.5 million



$2 million



$2 million



$2 million



$3.5 million



Estate Tax repealed

35% (Gift tax)


$1 million


E. In the Will the Testator can shelter the applicable exclusion amount in a bypass trust for the benefit of the spouse and avoid taxation of the property in a bypass trust on the spouse’s death (saves estate tax of $345,800 on $1,000,000).

F. The annual gift tax exclusion is now $11,000. Each donor can give up to $11,000 of property each year to each person he or she wants to without incurring any gift tax (assuming a present interest gift, such as an outright gift). Spouses who split gifts can give $22,000 a year to each person. The Taxpayer Relief Act of 1997 now provides that the annual exclusion for gifts will be indexed annually for inflation, beginning in 1999, but only at such time as when the additions will equal $1,000. Thus, it just increased from $10,000 to $11,000 in 2002.

G. Impact of Recent Tax Laws on Estate Planning and Administration

1. Income tax rates for estates, trusts and individuals have been modified.

2. All trusts, and estates after 2 years from death, must be on a calendar year for income tax purposes.

3. Trusts and estates must now make estimated payments.

4. The new “Kiddie Tax” taxes the excess of $1,400 of unearned income of a child under the age of 14 at his or her parents’ marginal rate.

5. The generation-skipping transfer tax, designed to tax property in each generation even if the gift itself skips a generation, has been made “simpler.” In fact it is a very complex portion of the Internal Revenue Code and baffles most practitioners, not to mention laymen.

6. Trust income tax brackets have been squeezed such that any taxable income over $8,450 is taxed 39.6%.

7. The Taxpayer Relief Act of 1997 provides that the $750,000 ceiling on special use valuation of farm and business assets, the $1,000,000 generation-skipping transfer tax exemption, and the $1,000,000 ceiling on the value of a closely-held business eligible for the special low interest rate (discussed below), will be indexed annually for inflation, beginning in 1999.

8. The Taxpayer Relief Act of 1997 repealed the Excess Accumulation and Distribution Taxes. The 15% excise tax on excess accumulations in and excess distributions from IRAs and retirement plans is repealed, effective December 31, 1996.

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A. Universal (or Durable) Power of Attorney

1. This is a document, which empowers another person (agent or attorney-in-fact) to act for the principal on his or her behalf. For example, the attorney-in-fact can sell property for the principal, sign contracts for the principal, cash certificates of deposit for the principal, transfer bank accounts, i.e., do anything for the principal that he or she could do for himself or herself.

2. A person can execute this document now to be effective immediately or only in the event he or she becomes disabled or unable to act for any reason. Because a properly drawn durable power of attorney is effective even after the principal becomes incompetent, the opening of a guardianship for the incompetent person may be avoided.


. The person appointed should be someone trustworthy, such as the spouse or child, because the powers are so broad.

4. Note that in some instances a bank, a stock transfer agent or a title company does not accept a power of attorney. The more specifically it is drafted with respect to a particular transaction, the more likely it is to be accepted.

5. Recent Legislation

a) In 1993 the Texas Legislature enacted the Durable Power of Attorney Act which provides for a statutory form in which you can designate your agents to act on your behalf under such a durable power of attorney and you can elect whether the power of attorney will become effective upon signing or if it will be a “springing” power of attorney that will become effective upon your incapacity. The statutory durable power of attorney that we have attached hereto for your use is finding much more favor with financial institutions than the previous attorney-drafted powers of attorneys.
b) However, a statutory durable power of attorney is not as good as an attorney-drafted power of attorney with respect to providing for estate planning that could be done by your agent in the event of your incapacity. Consequently, signing both types of documents often warrants a “belt and suspenders” approach. In this way you can use the statutory form to deal with third parties such as banks, savings and loans and brokerage houses and use the attorney-drafted, more expansive form to deal with your estate planning opportunities that may not be apparent at the time of an incapacity but could arise subsequent to an incapacity.

6. Medical Power of Attorney, formerly Durable Power of Attorney for Health Care. Texas law now permits an adult to designate an agent in a durable power of attorney for health care to make decisions on behalf of the adult. Certain persons, notably the principal’s health care provider, may not act as the agent or as one of the two witnesses to execution of the power of attorney. Also, the power of attorney is not automatically revoked upon the appointment of a guardian. The probate court, however, must give consideration to the preferences of the principal in determining whether or not to revoke the authority of the agent during the guardianship. The Act includes an acceptable form for a durable power of attorney for health care. The power of attorney becomes effective upon certification by the attending physician that the principal lacks capacity to make health care decisions. However, treatment may not be given or withheld if the principal objects. Also, the act requires the principal’s attending physician to attempt to make reasonable efforts to inform the principal of the treatment or its withdrawal.
Further, the agent is directed to make decisions in accordance with his or her understanding of the principal’s wishes, including religious and moral beliefs or, in the absence of such knowledge, in accordance with the agent’s assessment of the principal’s best interests. The agent cannot consent to commitment in a mental facility, electro-convulsive treatment, psychosurgery, abortion, or the omission of care intended for the principal’s comfort. The power of attorney, once executed, is effective indefinitely unless revoked in accordance with the terms of the Act. The principal’s health care or residential care provider and employees (unless a relative) are excluded from acting as agent under a durable power of attorney for health care.

B. Homestead Laws

1. At the death of a spouse, the homestead, whether it is the separate property of the deceased or community property, is not partitioned among the beneficiaries of the decedent’s Estate, as long as the surviving spouse or the guardian of the deceased’s minor children uses and occupies it as a residence.

2. The homestead right can be waived by an agreement in writing and signed by both spouses, for example, in a prenuptial or postnuptial agreement.

C. Lifetime Trusts (Living Trusts) - Revocable Management Trusts and Irrevocable Trusts

1. A revocable management trust is an arrangement whereby a person (the grantor) transfers property to a Trustee who will hold and manage the property for the benefit of the beneficiary, usually the person himself or herself.

2. The grantor can modify the terms of the revocable management trust, and, usually, the trust itself can be terminated.

3. For federal income and estate tax purposes, the property placed in such trusts usually is treated as being owned outright by the grantor. Thus, the creation of a revocable trust is not a method of avoiding income or estate tax.

4. Revocable management trusts are useful for management and investment. They may avoid the necessity of a guardianship in the event of disability. They are useful in the case of out of state real estate because probate proceedings in those states may be avoided.

5. Living trusts incorporate all of the benefits of the revocable management trust described above and usually employ all of the estate planning techniques needed to minimize the estate tax liabilities and by their very nature, minimize or do away with probate costs connected with an estate. They can do all of the things that a will can do with minor exceptions regarding some income tax provisions that an estate has that a living trust does not have. Upon the death of each spouse, his or her respective share of the trust becomes irrevocable. More on living trusts below.6. Irrevocable trusts, by their very name, cannot be changed. Often they are useful in insurance planning to attempt to avoid taxation of the proceeds of an insurance policy in the estate of either spouse. Generally the purpose of such trusts is to save income and/or estate taxes.

D. Special Trusts for Children

1. Although the recent changes in the Internal Revenue Code relating to the income taxation of trusts have had a significant impact on estate planning, there are still some useful trusts for the benefit of people other than the grantor.

2. “2503(c)” trusts are permitted under that section of the Internal Revenue Code for children under the age of 21. Income and principal can be distributed at the Trustee’s discretion.

3. A “Crummey” trust is a popular form of trust used to accumulate substantial property over time, with no gift tax consequences, to be used for a child’s college education or to provide “start-up” funds to a child upon his or her reaching a specified age.

E. Beneficiary Designations for Life Insurance Policies and Employee Benefit Plans

1. It is vitally important to coordinate any life insurance policies and employee benefit plans with the overall dispositive scheme of the estate.

2. If the beneficiaries of a life insurance policy or of an employee benefit plan are different from the beneficiaries under the Will, careful consideration needs to be given to the allocation of death taxes among the beneficiaries and special provisions should be included in the will specifying which properties and gifts are to bear such taxes.

F. Characterization of your bank accounts and investment accounts

1. It is also vitally important to ensure that all of your bank accounts and investment accounts are “tenants in common” and not joint tenants with right of survivorship.

2. If your accounts are not specifically established or converted to tenants in common accounts, as between a husband and wife, or as between a single parent and a child, your will or living trust will not govern those funds and they can totally circumvent the estate planning that you are trying to accomplish through your will or living trust. Many people do not know whether their accounts are tenants in common or joint tenants with right of survivorship. You should determine what they are and have them converted to tenants in common accounts.

G. Uniform Transfer to Minors Act

1. Under the Texas Uniform Transfer to Minors Act property can be given to a custodian for the benefit of a person under the age of 21. The custodian acts much like a Trustee, with the statute serving as the trust agreement.

2. The relationship terminates when the child reaches 21 whether or not the child is sufficiently mature to handle the property on his or her own. Contrast this with trusts, which can be set up for much longer periods. Consequently, transfers under the Uniform Transfer to Minors Act are generally relatively small.

H. Living Will

1. Under the Natural Death Act, a person can control certain decisions relating to life-sustaining procedures in the event of a terminal condition. The living will is also called a Directive to Physicians.

2. The 1999 legislature made significant changes to the Act, which greatly expanded its original scope. For example, it is now possible to designate another person to make the decision to remove life-sustaining equipment. In addition, the Directive to Physicians does not have to be in the form set out in the statute. Also new is the possibility of indicating a patient’s desires by a non-written communication in the presence of the attending physician and two disinterested witnesses. Further, you can provide for the cessation or initiation of life-sustaining equipment under 2 conditions:

(1) if you need life support and a doctor certifies that you have less than 6 months to live, do you want to die soon and peacefully without life-support or do you want to be kept alive as long as possible and
(2) if you have an irreversible condition, no matter how long you have to live (I call this the Christopher Reeve situation), do you want to die soon and peacefully without life-support or do you want to be kept alive as long as possible.

I. Prenuptial and Postnuptial Agreements

1. Unless otherwise agreed upon in writing all income received during marriage is community property.

2. Under recent changes in Texas law, spouses, or those about to be married, can agree that the income from a spouse’s separate property will be the separate property of that spouse.

3. These agreements are also useful to identify the property that each spouse brings to the marriage. Careful record keeping is essential to preserving the separate character of such property.

4. These agreements can also cover any number of other areas, such as homestead rights, guardianship priority, the character of compensation earned by each spouse, income taxes, etc.

5. Precautions should be taken to ensure that each spouse is fully informed as to the legal consequences of such an agreement. Independent counsel is essential. The burden of proof is on the spouse attempting to rely on the validity of the agreement.

J. Declaration of Appointment of Guardian for Children in the Event of Death

1. In 1995 the Texas Legislature enacted a new statute whereby you can sign a Declaration of Appointment of Guardian for your children in the event of your death, which is witnessed by two (2) people who are at least fourteen (14) and is notarized by a notary and this will effectuate an appointment of guardian for any of your minor children. This does not need to be a part of your will and, indeed, is a separate document from your will.

K. Appointment of Agent to Control Disposition of Remains

1. Texas law now provides for you to designate someone in a writing signed by you and acknowledged before a notary as to whom you desire to have as your agent to make the arrangements for the disposition of your remains, including the right to make special directions.

2. This appointment becomes effective only upon death and can be revoked by you. It further authorizes the cemetery organization or crematory or funeral director, etcetera to rely on the representations of your agent in making the arrangements for the disposition of your remains.

3. This is relatively important in that many people attempt to make a provision in their will for the disposition of their remains, and while it is legally effective under this statute, the will is often times in a safe deposit box and not easily accessible and the arrangements for the disposition of your remains needs to be done relatively quickly after your death.

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A. The Revocable Grantor Trust, popularly known as the Living Trust is fast becoming the vehicle of choice for Americans who want to maximize available advantages for structuring their Estate.

B. With a Living Trust, the title to your property is transferred to the trust, so that your beneficiaries can easily receive your assets, and will not have to go through Probate Court proceedings. Probate is completely eliminated.

C. A Living Trust is a private document, the size and distribution of your estate remains confidential and not a matter of public record.

D. A Living Trust prevents a will contest. In Probate Court, anyone can easily contest a will. Since your are dead, you can’t tell a jury why you disinherited someone. With a Living Trust your wishes are carried out without interference.

E. A Living Trust avoids joint tenancy problems. Joint Tenancy, is a method of avoiding Probate, where upon the death of one co-owner, the survivor becomes the full owner of the property. If you place your child on your property as a Joint Tenant with you:

1. As an owner, your child has the power to interfere with your decision to sell or refinance the property.

2. If your child should go through a divorce, the other spouse can claim an interest in the property.

3. If your child should owe taxes, the tax collector may take your property to satisfy their tax obligation.

4. If your child should be found liable in any lawsuit, your property may be sold to pay the judgment.

F. With a Living Trust, probate is entirely avoided and there is no exposure of your assets to the debts or liabilities of your child.

G. A Living Trust avoids a Guardianship. If you ever become incapacitated, the Probate Court will appoint a Guardian to manage your property, and your estate will be required to pay attorney fees, court fees and costs for the Guardianship each year. With a Living Trust, your Trustee can manage your property if you are unable to handle your affairs, and there are no court fees or involvement.

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A. The family limited partnership (“FLP”) and Charitable Family Limited Partnership (“CFLP”) are sophisticated estate planning devices. By transferring income-producing capital assets (e.g., rental property or securities) into an FLP, the value of the assets can be discounted up to forty percent or more based on factors such as the lack of marketability of or minority interest in the partnership shares. Gifting fractionalized FLP interests in the assets can be an effective way to make maximum use of an individual’s $1,000,000 federal transfer tax applicable exclusion amount during life.

B. In a limited partnership, personal liability for acts of the partnership can be imposed on the general but not the limited partners. The general partners have management control over the partnership while the limited partners do not.

C. The Internal Revenue Code recognizes the validity of FLPs where certain requirements are met, including that limited partners receive a legitimate ownership interest in their shares and that general partners receive reasonable compensation for their services.

D. Consider the following example: A husband and wife own rental property and publicly traded stock with a fair market value of $3 million and a income tax basis of $500,000. Their other assets total $2 million. They have three children. Their business appraiser determines that the value of the rental property and stock portfolio in the FLP they have created would be discounted by 40 percent. The couple transfers the property into the FLP and gifts small limited partnership interests in the FLP to their children, as limited partners, not exceeding $22,000 per child. The parents are general partners and therefore retain total control over the investment and distributions from the Family Limited Partnership.

$3,000,000     net value of rental property after application of 40%

          x60%    discount

$2,100,000    current fair market value of FLP

   LESS       $   100,000     current fair market value of gifts to children ($60,000/.6)

$2,000,000     Remaining value of FLP in parents’ estate

             Estate Tax Results if parents both died in 2003

            (assuming no appreciation of couple’s property)


  With no FLP-(Bypass Trust used):

$5,000,000 - net value of estate at 2nd spouse’s death

-1,360,000 - federal estate tax

$3,640,000 - net to children

  With FLP:

$4,000,000 - net value of estate at 2nd spouse’s death

-    870,000 - federal estate tax

$4,130,000 - net to children (including undiscounted value of FLP)

Thus a $490,000 reduction in estate tax is achieved with an FLP in this scenario.

E. In addition to estate tax advantages, an FLP can result in income tax advantages during the parents’ lives. The income attributable to the FLP shares of the over age 14 children will be taxed in the children’s rather than the parents’ bracket.

F. The estate tax savings described above can be totally eliminated if the FLP is a CFLP. Additionally, significant income taxes can be eliminated if any of the rental property or stocks are sold in a CFLP. For instance, if all of the property in the Family Limited Partnership was sold before death and all of the gain was long-term capital gain, an income tax of $500,000 would result. If a CFLP were used the tax liability would only be $10,000.

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A. On January 11, 2001, the Service issued new IRA distribution rules in REG-13047700 and REG-13048100. These new rules completely replace the former methods for determining IRA minimum distributions. They will have great impact on everyone with an IRA and all professional advisors who have clients with IRAs. The rules for IRA distributions are currently based on 1987 proposed regulations. These regulations have produced a very complex system. A virtually infinite number of combinations are possible for an IRA owner and his or her designated beneficiary. There are calculation methods based on the decision to recalculate one or both expectancies, and the minimum distribution requirement varies with the age of both the owner and the designated beneficiary. This existing complexity leads to confusion, uncertainty and a lack of compliance. When a system becomes very complex, the potential for CPAs and account owners to make errors in calculating distributions is obvious. Thus, the Service has issued a new set of rules that completely replace and greatly simplify the existing IRA Distribution Rules. The new rules will be optional for the year 2001 and mandatory for the year 2002.

B. There are several specific goals for the new rules. First, a simple uniform table is used for all employees. Regardless of the age of a designated beneficiary, IRA owners will use the same table. The age of the beneficiary will not make any difference, except for a spouse who
is more than 10 years younger than the account owner. Second, there will be no decision to recalculate or not recalculate life expectancy. With the 1987 proposed regulation method, the potential for recalculating or not recalculating for both the owner and the designated beneficiary created possible four different options. Even with sophisticated software, it was difficult to make rational comparisons of the benefits and detriments of the different options.  Thus, the new single table uses recalculation for the account owner to calculate the minimum distribution. Third, it is now possible to change the beneficiary at any time. Under the current rules, changing a beneficiary can lead to larger distributions, but never smaller distributions, even if the new beneficiary has a longer life expectancy. The new system will allow complete freedom to select designated beneficiaries, with no impact on the minimum distribution requirement. Fourth, the beneficiary will be determined by the end of the year following the death of the owner. This provision allows for disclaimers and cashing out of some beneficiaries. The “Stretch IRA” may then be available for the remaining beneficiaries. Fifth, the distributions at death will generally be permitted over the remaining expectancy of the owner or the expectancy of a designated beneficiary, whichever period of time is greater. This new method will generally reduce required distributions for the vast majority of IRA owners and beneficiaries.

C. Under the previous Minimum Distribution Rules, if your spouse was not the beneficiary of your IRA, you were required to use the minimum distribution table known as “MDIB”. This table shows the expectancy of an account owner and a designated beneficiary 10 years younger than the account owner. It is in effect the largest expectancy or denominator that may be used in a fraction to determine the minimum distribution and produces the lowest possible minimum distributions. The Service chose to apply this concept not just for IRA owners with non-spouses as designated beneficiaries, but rather for all IRA owners.  Regardless of the beneficiary, the MDIB table may now be used. However, there is one favorable exception - a spouse 10 years younger than the owner will entitle the IRA owner to the use of a calculated lower minimum distribution amount. The new distribution rules are set forth in the proposed regulations under Sec. 1.401(a)(9)-5 Required Minimum Distributions From Defined Contribution Plans. In this Article, all references to regulations will be taken from the proposed regulations in REG-13047700 and REG-13048100.

D. Under Sec. 1.401(a)(9)-5, Par. A-3(a), the determination requires first a calculation of “the account balance as of the last valuation date in the calendar year immediately preceding that distribution.” This end of year balance is then multiplied times a fraction. The numerator of the
fraction is one and the denominator for IRA owners is the “applicable distribution period (determined under A-4 of this section).” This distribution is of course limited to the “vested account balance” as of the date for the distribution.

E. For example, Jane IRA was born October 15, 1931. She becomes 70 ½ on April 15, 2002 and her required beginning date (RBD) is therefore April 1, 2003. If the value of the IRA on December 31, 2001 is $25,300, then based on her age of 71 during calendar year 2002, her minimum distribution may be calculated. The distribution is $25,300 times one divided by her expectancy under the table in Par. A-4(a)(2), or 25.3 years. Thus the calculation is $25,300 times one divided by 25.3 or $1,000. This minimum distribution amount must be paid by April 1, 2003. Thereafter, minimum distributions must be paid by the end of each year. In each succeeding year, the life expectancy calculated under Par. A-4(a)(2) will decrease and the percent of the year end balance to be distributed will then increase.

F. Unlike the 1987 proposed regulations, the recalculation-MDIB method in the new rules will mean that IRAs are never exhausted. Even at ages over 115, the divisor will be 1.8. Thus, it is nearly certain that all IRAs will have a residuum that may be distributed to a designated beneficiary. The lower level of required distributions will enable the IRAs of most individuals to increase in value during the period for distributions. That is, unless the person lives well into their mid to late 90’s, the value when they pass away will exceed the value at age 70.

G. There are three major goals that the Service reached with this new system. First, it eliminates the use of different tables for different individuals - the same MDIB table is used for virtually all IRA owners. Second, it eliminates the use of the designated beneficiary’s age to calculate the withdrawal. Therefore, changing the beneficiary to a different person, a trust or a charity will have no impact on the withdrawal schedule. Third, it eliminates the very confusing decision whether to select recalculation or no recalculation.

H. Mortality Tables, Penalties, Excess Distributions, and Multiple IRAs The mortality tables are determined based on tables V and VI of Reg. Sec. 1.72-9. These tables were effective July 1, 1986 and are based on 1983 actuarial data. While the tables are somewhat dated, the decision was made not to change to newer tables. The current tables are not based on the entire population, but rather on a selected group that purchased annuities. In addition, using the MDIB table results in a lower payout. However, under Reg. Sec. 1.401(a)(9)-5, Par. A-6(b) the Service may update the tables at a future time if that is deemed appropriate.

I. Another suggestion by commentators was that future minimum distribution requirements should be reduced if a person exceeds the minimum distribution for a given year. However, in Reg. Sec. 1.401(a)(9)-5, Par. A-2, the Service stated “No credit will be given in subsequent calendar years for such excess distribution.” The excess distribution does reduce the end of year value for calculating future distributions, but it was deemed too complex to allow any carry forwards of excess distributions.

J. If an IRA owner does not take the required minimum distribution, then under Reg. Sec. 54.4974-2, Par. A-1, there is an excise tax of 50% of the required minimum distribution. This is consistent with the prior 50% excise tax rule.

K. What if the individual has more than one IRA? Under Reg. Sec. 1.408- 8, Par. A-9, if there are two or more IRAs, the minimum distribution will be calculated separately for each IRA. However, the total distribution may be taken from any one of the individual IRAs. If the IRA owner also has a 403(b) plan or a Roth IRA, those distribution requirements must be calculated separately and withdrawn from those respective plans.

L. Designated Beneficiaries is another area that was simplified. There are specific rules that will apply to four types of designated beneficiaries. These beneficiaries could include the surviving spouse, a non-spouse individual, a trust or a charity. For nearly all married couples, the surviving spouse will be the designated beneficiary. Under Reg. Sec. 1.408-8, Par. A-5(a), a surviving spouse “may elect in the manner described in Par. (b) of this A-5 to treat the spouse’s entire interest as a beneficiary in an individual’s IRA (or the remaining part of such interest if distribution thereof has commenced to the spouse) as the spouse’s own IRA.” The election is made by the surviving spouse redesignating the account in the name of the surviving spouse as IRA owner. If a spouse is the designated beneficiary and decides not to roll the IRA over into his or her own IRA, then there is a distribution to the spouse by using the age of the spouse in the year after the IRA owner’s death. For subsequent years, “the applicable distribution period is reduced by one for each calendar year.” In effect, this means the spouse would have a distribution schedule following the former “no recalculation” method. See Reg. Sec. 1.401(a)(9)-5 Par. A-5(c)(2). For a non-spouse designated beneficiary, a similar payout method will be used. The expectancy will be the age in the year following the year of the IRA owner’s death. Once again, the applicable distribution period will be reduced by one for each calendar year. For example, a child age 50 the year after the death of the IRA owner has an applicable distribution period of 33.1. The distribution at age 50 would be the end of year IRA value for the prior year times 1/33.1. The next year, the fraction will be 1/32.1. Each following year, the denominator will be reduced by one until the fraction eventually becomes 1/1 and the entire balance is distributed to the beneficiary.

M. If there is no designated beneficiary, then the distribution method will again follow the “reduced by one for each calendar year” method. However, it will use the life expectancy of the IRA owner as of the year of his or her death as the applicable distribution period. See Reg. Sec. 1.401(a)(9)-5 Par. A-5(c)(3). If a class is designated as a beneficiary, such as the donor’s children, then under Reg. Sec. 1.401(a)(9)-5 Par. A-7(a), the designated beneficiary with the shortest life expectancy will be used for the calculation. All of the beneficiaries of the class will receive the same distribution, based upon the age of the oldest beneficiary the year after the demise of the IRA owner. However, if a basis for separate shares can be established, then each child will be able to use his or her own life expectancy.

N. In some circumstances, a trust will be the designated beneficiary of a plan. Can the formula use the ages of the trust recipients to calculate distributions for a stretch IRA? This is permissible under Reg. Sec. 1.401(a)(9)-4 Par. A-5(b) if the trust meets several requirements. The trust must be a valid trust under state law, must be irrevocable upon the death of the IRA owner, the beneficiaries must be identifiable and the appropriate documentation must be given to the plan administrator.

O. A new requirement mandates reporting of minimum IRA distributions by trustees and custodians. Under Reg. Sec. 1.408-8, Par. A-10, the trustee of an IRA must report the required distribution. The IRS will issue the forms and instructions for such reporting at a later date.

P. Planning Strategies

1. These proposed regulations are a wonderful and commendable effort at simplification of tax law. Nearly all individuals will use the new MDIB schedule. IRA owners may now change beneficiaries with no consequence to minimum distribution schedules. Given the lower rates of withdrawal required, it is also virtually certain that most individuals will have an increase in the IRA principal at the time they pass away.

2. Since the distributions start at about 4%, most IRA owners will earn 6% to 9% and thus accumulate excess income during their 70’s. Only in later years when the payouts increase will all income and some of the IRA principal be distributed. For example, an IRA owner earning 7% will not start to invade principal until age 85. For an 8% earnings rate, the invasion starts at age 87. A person earning 9% will not start to invade principal until age 89. Thus, the vast majority of individuals will have from 40% to 80% more value in their IRA when they pass away then they do at age 70 ½. Many persons with $100,000 at age 70 ½ will pass away at age 90 with over $150,000 in their IRA.

3. This new set of rules may be used during the year 2001 and thus allows several charitable planning options. An individual may now designate a charity for a percentage of his or her IRA. When the person passes away the charity will receive that percentage in cash and the children may then use the balance for Stretch IRAs.

4. Alternatively, individuals may choose to select a charitable trust for a surviving spouse or a charitable trust for children for part or all of their IRA. Since the trust is tax exempt, upon the demise of the IRA owner, the distribution may be made to the charitable trust and any balance of the IRA can still be used for Stretch IRAs for children or other family members. The major advantage of the CRT for children is the opportunity to pay out mostly capital gain, even though the trust is funded with an IRA.

IRA Distribution Table
Prop. Reg. Sec. 1.401(a)(9)-5, Par.


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