Typical California estate planning package

A California estate planning attorney typically provides the client with the following documents:

1. A fee letter outlining the attorney's responsibilities, setting the basis for the fee, describing conflicts involved in the representation, and providing for approval of the fee and for waiver of the conflicts.
2. A revocable living trust.
3. A pour-over will for each client.
4. A Durable Power of Attorney for Property for each client.
5. A Durable Power of Attorney for Health Care for each client.
6. A Declaration Under California Natural Death Act.
7. A letter of instruction explaining how the trust is to be operated and funded.
8. Deeds and other transfer documents for the property initially transferred to the trust.

Overview

Both the revocable living trust and joint tenancy avoid probate.
A trust is more flexible than joint tenancy and easily divides the settlor's property among a group of beneficiaries. A joint tenancy is less flexible, cannot include postdeath trusts for tax planning, and works best with two or three joint tenants.

If a settlor creates a revocable living trust, the settlor retains control and flexibility, and has not made a taxable gift to anyone. The settlor generally can revoke the gift without telling any beneficiary. He or she usually controls the property absolutely as the originally-designated trustee. The settlor's designation of a particular beneficiary does not create the danger that the trust property might be levied upon by creditors of the beneficiary, because the beneficiary has no current right to ownership or possession of the trust property.

Purpose of will

In recent years, the historical function of wills, as the principal estate planning document, has been increasingly supplanted with what are commonly known as will substitutes. Will substitutes include inter vivos trusts, pay-on-death contracts, multi-party accounts, and joint tenancy arrangements. Wills are frequently associated with probate; a characterization that is often true. In contrast, will substitutes usually provide for the nonprobate transfer of property, and relief from the delay and expense associated with probate.

Pour-over wills

With the increasing use of the revocable trust in modern estate planning has come the development of the pour-over will. Basically, a pour-over will includes a devise to the trustee of an existing trust for the benefit of the beneficiaries named in the trust. Such transfers do not violate the law of wills despite the testator's ability to amend the trust and thereby change the disposition of property at his or her death without complying with will formalities. The pour-over will receives specific statutory recognition under Prob C § 6300. Under Prob C § 6300, a devise, the validity of which is determinable by the laws of California, may be made by a will to the trustee of a trust established or to be established (1) by the testator, (2) the testator and some other person or (3) some other person (including a funded or unfunded life insurance trust, even though the settlor has reserved any or all rights of ownership of the insurance contracts). The trust must be identified in the testator's will and its terms must be set forth in a written instrument (other than a will) executed before or concurrently with the execution of the testator's will or in the valid last will of a person who has predeceased the testator (regardless of the existence, size, or character of the trust property).

There are many different types of trusts which will be tailored to each client's needs. The following are examples of some of these types of trusts:

Revocable Living Trust

Today, the vast majority of estate plans drafted in California feature a revocable living trust. The trust need not be written, but it almost always is. It must be written if it is to deal effectively with real property. A California trust is presumed to be revocable, and a well-drafted trust will contain provisions clearly defining the settlor's powers of revocation. It is called a "living trust" because the settlor transfers property to it and makes it effective while the settlor is living. A "testamentary trust," on the other hand, is contained in a decedent's will and is effective upon the decedent's death, at the conclusion of probate.

The features that make the revocable living trust especially useful as a practical estate planning tool are:

1. It is flexible;
2. The trustee can manage the trust estate during the settlor's lifetime or transfer the trust estate at the settlor's death without submitting the document for validation by the probate court; and
3. The settlor can be trustee of the settlor's own trust without causing a merger of the legal and equitable interests.

Compared to conservatorship

When a settlor becomes incapacitated, the successor trustee of the revocable living trust can, in most cases, efficiently and privately manage the settlor's affairs for life. When the trust works well, this is one time when the trust assists the client more than anyone else: It conserves the client's assets for the client's actual care. The trustee is not burdened by the strictures of the probate system, and can administer the client's affairs efficiently.

Grantor

A grantor trust is a trust which is taxed to the creator (grantor) of the trust under 26 U.S.C.A. §§ 671 to 677, or a beneficiary of the trust under 26 U.S.C.A. § 678. It does not matter which of these provisions makes the trust a grantor trust, any grantor trust will meet the exception, so long as the deemed owner is a United States citizen or resident.

Spendthrift trust

Spendthrift trusts protect the income and principal of the trust from a beneficiary's creditors. If the trust instrument provides that a beneficiary's interest in income is not subject to voluntary or involuntary transfer, the beneficiary's income interest in the trust may not be transferred and is not subject to enforcement of a money judgment until paid to the beneficiary. Likewise, if the trust prohibits transfers of principal of the trust, the beneficiary's interest in principal is not subject to creditor claims until actually paid to the beneficiary. The amount allowed to a spendthrift trust beneficiary free from creditors' claims varies according to the beneficiary's station in life, taking into account cost of living, medical expenses, reasonable entertainment and other reasonably necessary expenses, but allowance will not be made for extravagant entertainment or for unbridled luxuries.

Trust for support

A "trust for support" instructs the trustee to pay for the education and necessary support costs of the beneficiary from the trust property, and has some characteristics of a spendthrift trust. If the trust instrument provides that the trustee must pay income, principal, or both for a beneficiary's education or support, and the payments are necessary for the beneficiary's education or support, the beneficiary's interest in the income or principal may not be transferred, and is not subject to the enforcement of a money judgment until paid to the beneficiary.

Discretionary trust

A "discretionary trust" also may be used to keep trust property from the reach of a beneficiary's creditors. A discretionary trust grants the trustee discretion to choose which costs of the beneficiary to pay. A beneficiary cannot compel payment out of a discretionary trust, and neither can a creditor of the beneficiary. The discretionary trust differs from the spendthrift trust in a significant way. If a trustee is aware of the transfer of a beneficiary's interest, or was served with process in a proceeding under CCP § 709.010 by a judgment creditor seeking to reach the beneficiary's interest, the trustee may be liable for payments to or for the benefit of the beneficiary to the extent that the payments impair the rights of the transferee or the creditor. With a spendthrift trust or a trust for support, this limitation would not apply.

Charitable Trusts

A charitable trust is a fiduciary relationship with respect to property arising as a result of a manifestation of intent to create it, and subjecting the person holding the property to equitable duties to deal with the property for a charitable purpose. A charitable trust splits the interests in a trust between one or more noncharitable beneficiaries and one or more qualified charities. The charity's interest may consist of an immediate right to receive a specified payment for a term of years or for the life expectancy of one or more named individuals. Such trusts are called "charitable lead trusts" ("CLTs"). Alternatively, the charity's interest may consist of the right to receive the balance remaining in the trust at termination of a lead interest held by one or more noncharitable beneficiaries. Such trusts are called "charitable remainder trusts" ("CRTs"). A donor may create a charitable trust during the donor's lifetime, in which case it is a living or inter vivos trust. A donor may also create a charitable trust at the time of and incident to the donor's death, in which case it is a testamentary trust.

Charitable remainder trust

Generally, a charitable remainder trust ("CRT") is a trust providing for a specified distribution at least annually to one or more beneficiaries, at least one of whom is not a charity, for life or for a term of years, with an irrevocable remainder interest to be held for the benefit of or to be paid over to a charity. Trusts meeting the specific requirements of 26 USCA § 644 qualify as CRTs and generally are exempt from income taxes. Regulations restrict the use of charitable remainder trusts that borrow from third parties to meet their annuity or unitrust obligations. The regulations treat the trust as having sold a pro rata share of its appreciated assets in any year it which it distributes an annuity or unitrust amount and the distribution is not characterized in the hands of the recipient as ordinary income, capital gains, or tax-exempt income.

Special Needs Trusts

Special needs trusts can be viewed through two different lenses. The first focuses on the source of the trust funds. The trust funds are either sourced in the beneficiary's own assets or sourced in assets from others. The second focus is on the type of government benefits which the beneficiary is receiving currently or is expected to receive at some future date. Special needs trusts established for a disabled individual and funded with assets owned by someone other than the beneficiary will not disqualify the beneficiary from government benefits if properly drafted. These trusts are not required to contain "payback" provisions. The types of government benefits which the beneficiary is receiving currently or is expected to receive sometime in the future will influence the types of trust provisions which are to be included in the special needs trust. Generally, these benefits include SSI/SSP, Social Security Disability, Medi-Cal, and occasionally Veterans Administration benefits.

Objectives of estate planning for family businesses.

The estate planning process generally involves the identification of assets belonging to the client, the determination of the value of those assets, the determination of the manner in which title to those assets is held by the client, and the implementation of an estate plan for the client. The implementation of the estate plan will incorporate both appropriate income, gift, estate, and generation-skipping tax planning and the client's dispositive goals. However, this process becomes much more complicated where a major asset of the client's estate is an interest held by the client in a business entity. Typically, the business interest will have been created, developed, and operated by the client (and perhaps one or more members of the client's family). On occasion, however, the estate planner may be dealing with interests which were received by the client, either by gift from older generation family members or following the death of older generation family members. The objective of the estate planner will be to:

1. Gather, analyze, and understand all relevant facts relating to the finances and operation of the business;
2. Determine which of various planning techniques discussed in this chapter are available and are appropriate to apply to the client;
3. Assist the client in determining:
   • whether the business can or should be continued by one or more of the client's heirs following the client's death, identifying those heirs most suited to successfully continue the operation of the business; or
   • whether the business should be sold to preserve maximum value for the family, identifying potential buyers for the business and developing mechanisms to structure the sale of the business at an appropriate price; and
4. Implement an estate plan which will affect an orderly disposition of the business interest, whether by sale or by devise, to the appropriate heirs.

Five Types of Trusts Which Are Eligible to Hold S Corporation Stock

There are five types of trusts which are eligible to hold S corporation stock: grantor trusts (trusts under which net income and capital gains are taxed to the grantor under 26 U.S.C.A. §§ 671 to 677 or to an individual other than the grantor under 26 U.S.C.A. § 678); qualified subchapter S trusts; trusts which receive assets from a deceased shareholder's estate (however, any such trust may continue to hold the S corporation stock only for limited period of time); special S corporation voting trusts; and new electing small business trusts.

A subchapter S corporation ("S corporation") is an entity which is a corporation, for state law purposes, and which makes a special election to be taxed under Subchapter S of the Code (a subchapter S election). A California corporation which makes a subchapter S election for federal income tax purposes is treated as an S corporation for California income tax purposes as well, unless a special affirmative election is made to treat the corporation as a C corporation for state income tax purposes. An S corporation is not treated as a separate entity for federal income tax purposes, but is subject to income tax in a manner which is substantially similar to the income taxation of partnerships. For a period of time, California did not recognize S corporations as such but, rather, imposed state income tax on S corporations in the same manner as it imposed income tax on C corporations. Starting in 1987, California changed the manner in which it imposed state income tax on S corporations which did not make an affirmative election to be treated as C corporations for state income tax purposes. Generally, all items of income, gain, loss, deduction, and credit attributable to the operation of the S corporation's business are reportable by and taxable to its shareholders, subject to certain at risk limitations. However, the S corporation must also pay a tax at the corporate level in an amount equal to the greater of the minimum franchise tax, determined under Rev. & Tax Code § 23151 ($800), or 8.84% of its net income. Prior to 1997, an S corporation was limited to a maximum of 35 shareholders; however, the Small Business Job Protection Act of 1996 increased the permitted number of shareholders of an S corporation from 35 to 75 for taxable years beginning on and after January 1, 1997. S corporation shareholders are generally limited to individuals who are United States citizens or residents, with husbands and wives counting as a single shareholder.

For more information on S and C Corporations, see the Business Law Section.

Durable powers of attorney for property

A durable power of attorney is a principal's designation of an agent (or attorney-in-fact) to act for the principal regardless of the principal's subsequent incapacity. The power of attorney can spring into effect when the principal becomes incapacitated or can be effective immediately and last beyond the principal's incapacity. If a principal creates a power of attorney but does not include the statutory language required to qualify it as a durable power of attorney, the agent's powers terminate when the principal loses the capacity to contract. Powers of attorney generally terminate at the principal's death and, therefore, cannot be used effectively as postdeath planning devices.