Estate Plans May Need Update (Fisher Law Office)

Living Trusts Are Useful Devices

Wills are the standard estate plan. They are relatively simple, readily updated, and relatively inexpensive. Living trusts are less commonly used. They are more complex, less readily updated, and more expensive. For many people, wills are the planning vehicle of choice. For others, trusts are preferable.

Why would more complex and expensive plans be appropriate in some circumstances? A historical analysis helps put both into perspective.

Wills require probate. Trusts do not. Trusts, to avoid probate, require pre-death funding (that is, conveying all of ones assets to the trust). Wills do not require this extra step. Are these differences significant?

Until the late 1970's, Michigan probate proceedings (and those in many other states) were always supervised by the probate court. Heirs were usually determined, and the will was usually admitted, after formal hearings. Real estate could not be sold without a hearing, in many cases. Accountings of the executor were reviewed by the probate court. A final order of assignment was required on completion of the estate.

Therefore the administrative load imposed by all this required judicial activity was considerable, and probate was also blamed for all of the complexities that can attend the conclusion of a decedent's affairs. William Dacey wrote a controversial book, "How To Avoid Probate," which was quite popular in the middle 1960's. The thrust of Dacey's book was that if one established a living trust and conveyed all his or her property to the trustee, probate proceedings could usually be avoided. That much was true, but the "do-it-yourself" format of the book led many people into matters beyond their depth of knowledge, and titles to real estate and other assets became clouded and tax situations became confused. Also, the readers would sometimes purchase additional assets and leave them outside the trust, and probate would be required anyway.

However, the movement was not to be stopped, and it culminated in a successful drive by the American Association of Retired Persons (AARP) to reform the probate laws of all states on a broad scale. The result of this drive was the Revised Probate Code which, in the 1970's, spawned a new concept: "independent probate." The Commissioners on Uniform State Laws adopted it and recommended it to the states, and Michigan adopted it with some modifications in 1978. Under this concept, there was to be no probate judge involvement in a probate proceeding unless someone requested it--for example, to construe a will, to determine whether someone had the mental capacity to make a will, or otherwise to resolve or prevent likely disputes. Otherwise, the probate court's involvement was to be merely administrative, and was handled by the register of probate: issuing letters of authority--the documents empowering the executor to act--at the beginning of the proceeding, reviewing the inventory of assets to determine court fees, ascertaining that death taxes had been paid or were not due, and issuing a certificate when the administration was concluded.

With independent probate, the distinction between living trust administration and will administration became quite narrow.

If we think of the functions of the administration of a decedent's estate as (1) marshaling the assets--that is, finding out what the assets are; (2) determining creditors and paying claims and expenses; (3) determining and paying estate and other death taxes; (4) liquidation of assets as necessary for distribution; and (5) distribution of assets; we can see that all 5 of these functions must be dealt with in both living trust administrations and in will administrations, even after the adoption of the Revised Probate Code in 1978.

After that time, the difference between will and trust administration post-death was principally that in the case of the trust, the marshaling of assets had to be done twice--once at the time the trust was set up and the assets were conveyed to it--and again when death ensued--to be sure that everything that was assumed to be in the trust was indeed in the trust. Another difference was that there was no statutory requirement for notification of creditors post-death, in the case of a living trust administration. However, there was no permissive provision for notification of creditors in the living trust setting, either. Therefore, in the case of a decedent who had possible unknown creditors, such as a businessman or professional, it was then necessary to open a probate estate anyway, just to publish creditors' notice, and bar claims. (Consistent with the Revised Probate Code's Independent probate concept, the probate court was not involved in that activity). But formal probate court involvement, on a routine basis, was no longer necessary in either case.

In the late 1990's, the Commissioners on Uniform State Laws proposed another probate code revision, to remedy some perceived difficulties under the Revised Probate Code. The result was the Estate Settlement Act, of some 250 pages. Again, Michigan followed suit and enacted that statute, with some modifications, calling it the Estates and Protected Individuals Code. It became effective April 1, 2000.

The concept of independent probate was continued under the new scheme, renamed "informal" rather than "independent," but the new statute added complexities to living trust administration, especially post death. Now, notice to creditors (including publication) is required in every case. Specific, detailed requirements for accountings by the trustee are imposed. And by the time the dust had settled, what little difference there had been between will administration and trust administration diminished further, except that if probate was to be avoided, marshaling of the assets still had to be done twice. And if a living trust is not funded before death, probate will be required to get the assets to it, anyway. Funded living trust administration does offer one other advantage, still: privacy. Wills must be filed with the probate court, but trusts usually are not.

Therefore, as of today, there is no reason to choose living trusts over wills, as a routine matter, insofar as complexity of administration is concerned. And the expense of administration is quite comparable in each.

If "probate" is not the cause for complexity in administration, what is? We have all heard horror stories, but what are the facts behind them?

First, we must remember that every estate that passes to more than one person is fragmented--that is, it is divided among the beneficiaries. A $200,000 estate passing to 4 people cannot be expected to generate more than $50,000 each. This "beneficiary surprise" creates a "phantom" reduction in the estate, from the survivors' point of view.

Second, if the estate is within the federal estate tax bracket (currently, $675,000), a federal estate tax return most be filed and likely federal estate tax must be paid, which begins at the 37% rate(!). As there is no discount for prepayment of the tax, there is usually no benefit to filing the return early, and it is not due until 9 months after death. Once filed, the return may be selected for audit, or at least further inquiry, and therefore the assets of the estate cannot safely be distributed until after the tax return is cleared, as the executor or trustee is personally liable for those taxes. A "closing letter" is issued by the Internal Revenue Service when the return is accepted, or when all issues are agreed or otherwise determined. That frequently takes from 1 to 2 years. Therefore, federal estate taxes can complicate and delay administrations.

Second, liquidity may be a problem. If the estate owes significant debts, or if there are specific and large distributions of money of definite amount specified in the will or trust, or if taxes are significant (and if there are taxes they are usually significant), assets may need to be sold. Liquid assets can often be sold promptly, but in depressed securities markets one may not wish the executor or trustee to sell precipitously, and some assets such as real estate, closely-held business ventures, or unusual items of personal property such as art collections or antiques, cannot be sold quickly. Obviously, therefore, the illiquidity of some estates may complicate and delay the administration.

Third, valuation problems can complicate and delay administration, whether will or trust. A classic example of a valuation problem of major proportions would be the ownership of farmland at the intersection of an interstate highway and a local road. The farmland value may be measured in dollars an acre, but the shopping center value is more likely valued in dollars per square foot. Since estate taxes may be payable on the date of death value of this property, until the estate is satisfied with the valuation by the Internal Revenue Service, or the Service is satisfied by the valuation by the estate, or until some other final determination is made as to value, the estate will remain open.

Fourth, beneficiary disagreements obviously can complicate administration. Typically, these can arise over whether assets should be distributed to one or another of them, or should be sold. If agreement cannot be reached promptly, the probate court may be asked to intervene, and make the determination, so the case can be closed. These proceedings take time, and cause expense.

Fifth, unusual dispositive schemes can lead to disputes which similarly delay conclusion. A man with a wife and 5 children who gives his entire estate to a caregiver, or to charity, may have spawned a contest to his will. That kind of contest usually involves formal probate court proceedings, and delay and expense can be expected to ensue.

Sixth, disagreements as to the meaning of documents can result in probate court intervention. If the beneficiaries cannot agree with the executor as to what the will or trust means, the court may be the only recourse. Again, delay and expense can result.

This list, though not exhaustive, is illustrative of some of the major reasons for complications and unusual expense in estate administration. However, these complications can occur equally readily in will administration or trust administration. Indeed, most of these complications can occur where there is no will, or where all assets are joint.

What, therefore, is the current role of the living trust? If probate avoidance does not necessarily reduce complexity, then that is not a valid reason. Then what is?

Trusts are useful in 3 settings: where there are young potential beneficiaries to whom distribution should not be made outright, where there are otherwise incapacitated beneficiaries (including potentially the trust settlor, in the future) who should not or can not handle their own affairs, and where significant estate tax considerations require them. Also, privacy is accorded living trust administrations more than will administrations, and that can be a proper factor in decisions also..

The first two categories are therefore beneficiary driven. If an estate plan makes distribution outright to beneficiaries who are minors or otherwise under a disability, a guardian must be appointed by the probate court for each such beneficiary. The guardianship proceeding in probate court is an "old probate" type proceeding: everything goes before the judge for determination, and this consumes time and money, and is best therefore avoided. Trusts can avoid this complexity.

The third category is tax driven. By the judicious use of trusts, estates can be split horizontally, among beneficiaries, or vertically, along a timeline, in accordance with detailed laws and regulations, to maximize exemptions and deductions, and minimize estate taxes.

The fourth consideration is personal. The will filed in probate court is theoretically a public document, but it usually is not really made public (that is, made the subject of media exposure) except in the case of celebrities. Living trusts are usually not filed with the court, and therefore those proceedings can be more private, unless probate court involvement on a formal basis is requested for some reason by the trustee or a beneficiary.

Can trusts be set up under a will? Certainly, they can, and before the 1960's most trusts were set up under wills. With the rough equivalence today between will administration and trust administration, there is little reason not to set them up under wills, except one: privacy. As mentioned earlier, living trusts typically are not filed with the court, whereas wills are required to be. However, a trust set up under a will does not require the pre-funding marshaling of assets, as will trusts are not funded until after death, by distribution from the estate.

Therefore, in proper circumstances, a living trust may be an appropriate guardianship avoidance or tax-reduction device. And it may also help to safeguard privacy.

This general discussion is not intended as advice, which properly can be given only in individual consultation between attorney and client.

Vance A. Fisher
May 9, 2001

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