INCAPACITY OUTLINE
CHARITABLE GIVING ADVICE:
WHO, WHEN, HOW, WHAT & WHY
OR
CLT, CRT, 401K, IRA, LI, TCJA & HFAC
10 COMMON MISTAKES AND TRAPS
Presented By:
PATRICK J. PACHECO[1]
Cadence Bank, N.A.
Written By:
PATRICK J. PACHECO
Cadence Bank, N.A.
&
SARAH PATEL PACHECO
Crain Caton & James P.C.
INDEX
INTRODUCTION. 1
I. MISTAKE 1: FAILING TO PROPERLY EVALUATE THE PROPOSED ENGAGMENT. 1
A. The Engagement 1
1. Evaluate Potential Engagement 1
(i) Consider Potential Conflicts of Interest 1
(ii) Assess Legal Competency 1
(iii) Assess Litigation Risks 2
B. Engagement/Fee Agreements 2
II. MISTAKE 2: FAILING TO PROPERLY ASSESS CLIENT CAPACITY. 3
A. Applicable Standards Of Capacity 3
1. Mental or Transactional Capacity 3
2. Testamentary Capacity 4
3. Warning Signs 5
4. Effect of Determination of Lack of Capacity 5
B. Evaluating Capacity to Engage in Underlying Transaction. 6
1. When Presumption of Capacity Exists 6
2. When Presumption of Incapacity Exists 6
III. MISTAKE 3: FAILING TO ‘KNOW YOUR CLIENT’ 7
A. Gathering Basic Information. 7
B. The Client Interview. 7
C. Counsel Your Client 8
IV. MISTAKE 4: FAILING TO CREATE A FULLY INTEGRATED ESTATE PLAN 9
A. Coordination of Estate Planning Vehicles 9
B. Asset Coordination 10
C. Coordination of Non-Probate Assets 10
1. Titling of Accounts. 10
2. Coordination of Beneficiary Designations 10
V. MISTAKE 5: FAILING TO GIVE FULL CONSIDERATION TO TAX PLANNING 11
A. The Scope of Transfer Tax Planning. 11
1. Applicable Credit Amount and the Bypass Trust. 12
2. Marital Deduction Planning. 12
3. GST Planning. 13
B. The Economic Growth and Tax Relief Reconciliation Act of 2001 13
1. Increases in the GST Exemption and Applicable Credit Amounts 13
a. Planning Considerations 13
(i). Formula Gifts May Yield Unwanted Results 13
(ii). ‘Active’ GST Plans are Complicated by Equalization Of GST Exemption and Applicable Exclusion (Estate Tax Exemption) Amounts. 14
2. Automatic GST Allocations--IRC § 2632(c). 14
a. The GST Trust. 14
b. Planning Considerations. 14
VI. MISTAKE 6: FAILING TO GIVE FULL CONSIDERATION TO THE SELECTION OF FIDUCIARIES 15
A. Selection of Fiduciaries 15
B. Appointment of Successor Agents. 15
C. Appoint Agents Who Do Not Have Potential Conflicts Of Interest. 16
VII. MISTAKE 7: FAILING TO GIVE FULL CONSIDERATION TO THE CONTROL AND PROTECTION OF FIDUCIARIES 16
A. Include Comprehensive Fiduciary Provisions 16
B. Draft Clear Distributions Standards 16
1. Marital Gifts 16
2. Non-Marital Gifts 17
C. Consider Including Powers of Appointment 17
D. Consider Trustee Removal Powers 17
E. Consider Trust Protectors and Advisors 17
F. Provide for Reasonable Accountability 21
G. Plan for Capacity Disputes 21
1. Include a Definition of Incapacity 21
(a). Grantor’s or Trustee’s Incapacity 22
(b). Beneficiary’s Incapacity 22
2. Include Notice Provisions 22
3. Include a Procedure to Avoid Disputes Based on Capacity 23
H. Include Indemnity/Exoneration Provisions 23
1. Indemnity of Third Parties 23
2. Indemnity of Physician and Healthcare Workers 23
3. Indemnity of An Agent 24
I. Consider the Benefit of a No Contest Clause 24
J. Consider Including An Arbitration Clause 25
K. Utilize Debt and Tax Allocation Clauses 25
L. Include Attorney Fee and Expenses Allocation Clause 25
VIII. MISTAKE 8: FAILING TO PLAN FOR FLEXIBILTY 26
A. Address Power To Modify or Revoke 26
1. Agent 26
2. Guardian 26
3. Others 26
B. Ability to Make Future Gifts 27
C. Consider Including Powers of Appointment 27
D. Consider Trust Protectors and Advisors 27
IX. MISTAKE 9: FAILING TO PLAN FOR POSSIBLE CAPACITY CHALLENGES 27
A. Gather Evidence of Client’s Capacity 27
1. Non-Medical Evidence 28
2. Medical Evaluations 28
(a) Documentation 29
(ii) Selecting the Physician 29
B. Drafting Considerations 29
1. Simplicity Versus Complexity 29
2. Identify Family Members – Included and Excluded 30
3. Identify Assets - Generally 30
C. Accommodations for Visually Challenged Clients 30
D. Fully Funded Management Trusts. 30
E. The Execution Ceremony 31
1. Location, Location, Location 31
2. Persons Present at Execution 31
3. Selecting Witnesses and Notary Public 31
F. Memos to File 32
G. Storage of Documents 32
H. File Maintenance 33
I. Provide a ‘Defense’ Fund. 33
1. Lifetime Gifts 33
2. Life Insurance 33
3. Funded Trust 33
4. Right of Survivorship Accounts 33
5. Saving Bonds 33
X. MISTAKE 10: FAILING TO PAY ATTENTION TO THE DETAILS 33
CONCLUSION 34
INTRODUCTION
This article focuses on 10 common mistakes and traps that permeate estate planning advice in general and charitable planning advice specifically. The article is not designed to be a technical tax article, but rather a pragmatic look at those areas where awareness and focus can be the key to eliminating potential problems.
I note that while charitable planning very often is based in noble goals and an underlying belief in stewardship, every charitable gift essentially is a disinheritance event as to “normally” expected beneficiaries of the donor. As a result, it is not unheard of for families to question why mom or dad made a large gift, what level of influence was exerted and why the giving technique was so complicated or why it didn’t work out like it was supposed to work out. Based on this view, it appears that equal or possibly increased care be taken up front to avoid questions or appearances of poor advice or excess pressure leading to a decision that is not favored by those who believe their inheritance was taken,
All references are to the Texas Estates Code unless otherwise specifically cited.
I. MISTAKE 1: FAILING TO PROPERLY EVALUATE THE PROPOSED ENGAGMENT.
A. Evaluate Potential Engagement.
It is rumored that Abraham Lincoln gave the following advice to a new lawyer upon passing the bar, “Young man, it’s more important to know what cases not to take than it is to know the law.” Jay G. Foonberg, How to Start and Build a Law Practice (3d. 1991) at 135. Unfortunately, neither President Lincoln nor anyone else can advise an attorney which clients, or cases, should be taken. Rather, it is a product of the attorney’s legal education, practical experience, intuition, and sometimes moral and ethical beliefs. Each case must be evaluated based on the facts and circumstances of that particular proposed representation. A few suggestions regarding evaluating a proposed engagement follow.
1. Consider Potential Conflicts of Interest.
The Texas Disciplinary Rules of Professional Conduct provide that an attorney should not represent individuals who have material conflicts of interest. See Tex. R. Disciplinary P. 1.06, reprinted in Tex. Gov’t Code Ann., tit. 2, subtit. G app. (Vernon 2014). Potential or alleged conflicts of interest are generally raised when an attorney represents both a husband and a wife, or other joint clients, in the broader estate-planning or more focused charitable planning context.
While potential conflicts of interest do not prohibit all joint representations, it is necessary to evaluate the potential conflicts and the nature, implications and possible consequences of the joint representation before agreeing to the joint engagement. When one client has questionable capacity, additional attention should be given to potential conflicts of interest. Even if the client has capacity to execute estate-planning documents, he or she may not arguably have capacity to waive potential conflicts of interest.
Furthermore, if the advisor represents one or more of the intended beneficiaries, the other client may face claims of undue influence or utilizing their attorney to encourage the client with questionable capacity to execute estate-planning documents. In such a case, both clients may benefit from retaining separate attorneys. Another potential conflict scenario leading to claim of even conspiracy arise when an attorney meets with their clients and the development officer who referred client to attorney. Remember, the relationship of the client, beneficiary and advisor will be later viewed objectively, and a client’s advisors should make efforts to reduce (if not avoid) the perception that any conflicts existed or there was even the opportunity for influence.
2. Assess Your Legal Competency.
Rule 1.01 of the Texas Disciplinary Rules of Professional Conduct provides that an attorney may not accept or continue the representation, which the attorney knows or should know, is beyond his or her legal competence. When determining whether a matter is beyond an attorney’s competence, the practice area of the underlying representation is not the only issue. Relevant factors include the complexity of the particular case, the lawyer’s experience in addressing the facts of that particular case, the time the lawyer is available to address the issues, and the attorney’s experience in handling issues raised by such representation.
Furthermore, while a lawyer may be technically competent to handle the proposed engagement, the lawyer may determine that the proposed client’s needs could be better served by referring the potential client to another attorney who has dealt with the specific issues and complexities that may be raised during the representation. An attorney does not violate the Rules of Ethics, however, if he or she associates with another attorney for purposes of gaining additional knowledge or expertise with regard to the client’s specific issues, provided, the client’s representation can be carried out in a competent manner upon receiving such additional advice. See Tex. R. Disciplinary P. 1.01(a), reprinted in Tex. Gov’t Code Ann., tit. 2, subtit. G app. (Vernon 2014).
Many charitable giving techniques are highly sophisticated, and all have some type of tax ramifications. If you are not well versed in the area, do yourself and your client a favor—refer on or associate someone with relevant expertise.
3. Assess Litigation Risks.
Some cases involve greater litigation risks than others. Warning signs of a future potential challenge may include:
Unusual disposition of estate—maybe all to charity?
Disparate wealth between spouses;
Excluding spouse as beneficiary;
Marital problems;
Second, Third, etc., marriages;
Children from prior marriages;
Estranged children or family members;
Unequal treatment of children;
Non-traditional relationships;
Re-involvement by a previously estranged family member;
Beneficiaries with drug, alcohol or other dependencies;
Elderly client or clients;
Ill clients or those who have suffered a significant medical episode;
Client’s formation of a recent relationship with an intended beneficiary;
Client’s formation of a recent relationship with a representative of the intended charitable beneficiary such as a charities development officer;
Nonstandard involvement by an intended beneficiary; and
Existing or anticipated family conflict.
While the preceding is not intended to be a complete list, these situations are often a precursor to future litigation. While every estate plan, with or without charitable aspects, inherently requires that the lawyer, on some level, become a witness to the proposed estate planning representation, some representations are more complex than others. An attorney is not under an ethical obligation to accept every requested engagement. It is appropriate for an attorney to consider whether the proposed engagement will result in him or her becoming an unwilling witness in, or party to, future litigation.
Furthermore, in all estate planning situations, but particularly in engagements that have a higher risk of being challenged, the advisor should take additional steps to protect the client’s objectives. For example, third parties may appear to be influencing the potential client and attempt to advise the attorney how the proposed client wishes to leave his or her property. If the potential client is not willing to meet without these third parties present, the lawyer should strongly consider declining the engagement. To do otherwise, may place the lawyer in a situation of being a party to an alleged conspiracy scheme or interference claims with the third parties.
B. Engagement/Fee Agreements.
As with any representation, a well drafted engagement or fee agreement can both provide protection to the attorney and be beneficial to the client. The agreement should set out the scope of the engagement as well as the method of calculating and collecting fees. If entering into a joint representation of, for example, a husband and wife, the fee agreement should also discuss potential conflicts of interest and the expected course of action in the event of an actual future conflict. In the husband and wife situation, for example:
“You have elected to jointly hire our firm. By agreeing to a joint representation rather than engaging separate independent counsel, you have each foregone the potential benefits of having your own lawyer advocate on your behalf in an effort to minimize expenses and facilitate the development of a coordinated estate plan. As we discussed, many couples have reasonable differences of opinion with regard to one or more aspects of their estate plan, however we, in representing both of you, cannot advocate on behalf of just one of you over the other. Rather, we will balance both views, advise both of you regarding the positives and negatives associated with each view, and attempt to resolve disagreements before they rise to the level of an actual conflict of interest. We do not currently have knowledge of any existing conflict between you, or any knowledge of any facts that may result in a future conflict. If any conflict or potential conflict does arise, however, you agree to make us aware of the conflict immediately. If we are unable to resolve the conflict, we will withdraw from representation of you jointly and each of you, individually.”
In addition, it may also be appropriate to confirm certain unusual or unique facts provided by the client. Finally, if the client’s documents may be subject to future challenge, the engagement agreement can provide a means for the attorney to be paid for his or her time relating to protecting the client’s privileges, testifying, and related involvement in future litigation. An attorney should not, however, charge more that his standard hourly rate for such matters to avoid the implication that he or she may gain a financial advantage in the event of litigation.
II. MISTAKE 2: FAILING TO PROPERLY ASSESS CLIENT (LEGAL OR PRACTICAL) CAPACITY.
A. Applicable Standards of Capacity.
A client’s capacity is a prerequisite to a successful estate and/or charitable giving plan. Thus, an advisor should understand the required level of capacity to enter into the contemplated transactions. To date, Texas courts have not adopted a single, bright-line test to determine whether an individual has capacity to engage in certain transactions. Rather, the applicable standard of capacity or incapacity is dependent on the specific facts or transactions contemplated by the individual. Thus, an individual may have capacity to engage in certain transactions, but not others. In any estate planning engagement, the advisors involved should be able to recognize and understand the varying levels of capacity. The most frequently encountered standards of capacity required in estate planning and probate transactions are discussed below.
1. Mental or Transactional Capacity.
In Texas, a person has “mental capacity” to contract if, at the time of contracting, he “appreciated the effect of what [he] was doing and understood the nature and consequences of [his] acts and the business [he] was transacting.” Mandell & Wright v. Thomas, 441 S.W.2d 841, 845 (Tex. 1969); see also Bach v. Hudson, 596 S.W.2d 673, 675-76 (Tex.Civ.App.--Corpus Christi 1980, no writ); Board of Regents of the Univ. of Tex. v. Yarbrough, 470 S.W.2d 86, 90 (Tex.Civ.App.--Waco 1971, writ ref’d n.r.e.). The requisite mental capacity depends on the contemplated transaction. A client may have sufficient capacity to enter into certain contracts, agreements, etc., but not others. Mental capacity, or a lack thereof, may be shown by circumstantial evidence, including:
a person’s outward conduct, “manifesting an inward and causing condition;”
any pre-existing external circumstances tending to produce a special mental condition; and
the prior or subsequent existence of a mental condition from which a person’s mental capacity (or incapacity) at the time in question may be inferred.
See Bach, 596 S.W.2d at 676.
The question of whether a person, at the time of contracting, knows or understands the nature and consequences of his actions is generally an issue of fact for the jury. See Fox v. Lewis, 344 S.W.2d 731, 739 (Tex.Civ.App.--Austin 1961, writ ref’d n.r.e.). However, allegations that a person is merely nervous, appears tense or anxious, or has personal problems, is not sufficient to raise a fact issue as to whether a person lacked capacity. See Schmaltz v. Walder, 566 S.W.2d 81, 83 (Tex.Civ.App.--Corpus Christi 1978, writ ref’d n.r.e.); Mandell & Wright v. Thomas, 441 S.W.2d 841, 845 (Tex. 1969). Rather, relevant evidence may include “evidence of prior actions, conduct, utterances, and transactions of a person whose mental capacity is in question.” Bach, 596 S.W.2d at 677 (citing Miguez v. Miguez, 221 S.W.2d 293, 295-96 (Tex.Civ.App.--Beaumont 1949, no writ); Carr v. Radkey, 393 S.W.2d 806 (Tex. 1965); Buhidar v. Abernathy, 541 S.W.2d 648, 651 (Tex.Civ.App.--Corpus Christi 1976, writ ref’d n. r. e.)).
2. Testamentary Capacity.
Section 251.001 of the Texas Estates Code mandates that the test for testamentary capacity includes the requirement that the testator be of “sound mind.” Tex. Est. Code Ann. § 251.001. Sound mind is referred to both commonly and in Texas case law as testamentary capacity even though Section 251.001 does impose other requirements. The sound mind element of testamentary capacity means that at the time the testator signs the will, he or she has sufficient mental capacity to:
understand the business in which he or she is engaged;
know the general nature and extent of his or her property;
understand the effect of the act of making a will;
know the persons to whom he or she wishes to give their property to and the persons dependent upon him or her for support; and
collect in his or her mind the elements of business to be transacted in executing the will and hold them long enough to perceive their obvious relationship to each other and to form a reasonable judgment about them.
See Tieken v. Midwestern State Univ., 912 S.W.2d 878 (Tex.App.—Fort Worth 1995, no writ) (emphasis added) (citing Prather v. McClelland, 13 S.W. 543, 546 (Tex. 1890)); see also McNaley v. Sealy, 122 S.W.2d 330 (Tex.Civ.App.—Austin 1938, writ dism’d); Horton v. Horton, 965 S.W.2d 78, 85 (Tex.App.—Fort Worth 1998, no writ) (courts generally limit evidence regarding testator’s capacity to time period surrounding will execution).
It is generally accepted that less mental capacity is required to make a valid will than to make a valid contract. See Rudersdorf v. Bowers, 112 S.W.2d 784 (Tex.Civ.App.—Galveston 1937, writ dism’d w.o.j.); Hamill v. Brashear, 513 S.W.2d 602 (Tex.Civ.App.—Amarillo 1974, writ ref’d n.r.e.). The tests regarding capacity to contract are generally not applied in determining the question of testamentary capacity. See Venner v. Layton, 244 S.W.2d 852 (Tex.Civ.App.—Dallas 1951, writ ref’d n.r.e.). There remains some authority, however, suggesting otherwise. A few Texas courts have held that the legal standards for determining the existence of mental capacity for purposes of executing a will are substantially the same as the mental capacity for executing a contract. Bach v. Hudson, 596 S.W.2d 673 (Tex.Civ.App.—Corpus Christi 1980) (discussed supra).
The issue of whether a person has testamentary capacity is usually a question of fact. See Smith v. Welch, 285 S.W.2d 823 (Tex.Civ.App.—Texarkana 1955, writ ref’d n.r.e.). No particular standard is prescribed. See Farmer v. Dodson, 326 S.W.2d 57 (Tex.Civ.App.—Dallas 1959); see also Brown v. Mitchell, 12 S.W. 606 (Tex. 1889); Garrison v. Blanton, 48 Tex. 299 (1877); Wilson v. Estate of Wilson, 593 S.W.2d 789 (Tex.Civ.App.—Dallas 1979); Anderson v. Clingingsmith, 369 S.W.2d 634 (Tex.Civ. App.—Fort Worth 1963, writ ref’d n.r.e.); Nowlin v. Trottman, 348 S.W.2d 169 (Tex.Civ.App.—Amarillo 1961, writ ref’d n.r.e.); Green v. Dickson, 208 S.W.2d 119 (Tex.Civ.App.—Galveston 1948, writ ref’d n.r.e.).
It is notable that although lack of testamentary capacity may appear to imply lack of intelligent mental power, it is not necessary for a person to be highly intelligent to dispose of his or her property by will. See Bell v. Bell, 237 S.W.2d 688 (Tex.Civ.App.—Amarillo 1951, no writ); Lowery v. Saunders, 666 S.W.2d 226 (Tex.Civ.App.—San Antonio 1984, writ ref’d n.r.e.). Rather, lack of education or proof of illiteracy has little, if any, bearing on mental capacity to make a will. Oliver v. Williams, 381 S.W.2d 703 (Tex.Civ.App.—Corpus Christi 1964, no writ).
3. Warning Signs.
It is wise for all estate planning advisors to be aware of potential warning signs during the initial telephone call or meeting with a potential client. These warning signs may indicate incapacity or another disability that could affect either the representation or basis for the representation. Unfortunately, there is not a definitive list of warning signs. A listing of some potential warning signs that might require future inquiry, the cancellation of a contract, or even the notification of a court under the State Bar Disciplinary Rules is included below. See Tex. R. Disciplinary P. 1.02(a) and 1.02(g), reprinted in Tex. Gov’t. Code Ann., tit. 2, subtit G. app. (Vernon 2004). Potential warning signs may include:
Memory problems evidenced by excessive reliance on third parties to provide basic information;
Tendency to avoid answering questions that relate to memory recall;
Covering, i.e. answers a question with responses like: everyone knows that, or glib answers;
Repeated conversations regarding the same issues or concerns that have been previously responded to;
Unusual reliance on another person for their basic daily needs such as food, shelter, clothing, and communication needs;
Obsessive/compulsive behavior;
Victim-like behavior, such as the inability to ever perceive the contribution of one’s own actions to the current situation;
Significant mood swings in short periods making rational decisions difficult;
Unreasonable suspicions, such as that a family member is an enemy, stealing money, or is trying to kill without any factual or logical basis;
Manic/depressive behavior, such as behaving extremely jubilant for no reason at a serious time, or becoming suddenly depressed, sad and tearful;
Obsession for revenge;
Substance abuse disorders to the degree that communication is limited to days when the client has not abused the substance to the degree they are incoherent;
Mental retardation, to the degree that the person possesses a certain level of understanding, but not necessarily the ability to contract;
Major depression to the degree there are changes in appetite, sleep patterns, energy, concentration, and possibly feelings of hopelessness and suicidal thoughts;
Schizophrenia or schizophrenia affective disorders which, when not controlled, result in delusions, disorganized speech, and possibly hallucinations;
Amnesic disorders that are difficult to address such as fluctuating dementia and dementia of Alzheimer’s type; and
Psychopharmacological disorders such that the client is non-compliant with medications, over-medicates, or abuses both prescribed and over-the-counter medications.
Attorneys are often placed in a difficult position when trying to ascertain the capacity of a client. An attorney may witness some or many of these traits yet are hesitant to “play doctor.” Additionally, the questions involved in attempting to “test” the potential clients can prove to be both insulting and embarrassing to the potential client. See discussion infra. Thus, handling the issue becomes one of instinct and is based on the specific facts at each case. It is, however, often difficult to determine whether the person may lack capacity or is just eccentric.
4. Effect of Determination of Lack of Capacity.
If it is determined that a contract was “executed by a person who does not have the mental capacity to contract, the contract is voidable; and if such person signed a contract without sufficient mental capacity to understand the nature and consequences thereof, the contract is not binding and may be set aside.” See Schmaltz v. Walder, 566 S.W.2d 81, 83 (Tex.Civ.App.--Corpus Christi 1978, writ ref’d n.r.e.). A determination that a will was executed at a time the testator lacked capacity will result in its failure to be admitted to probate. See discussion supra.
B. Evaluating Capacity to Engage in Underlying Transaction.
It is advisable to personally meet a potential estate-planning client before agreeing to the proposed representation. This face-to-face meeting is particularly important when capacity may be an issue or the decisions of the client may be challenged. Although not doctors, attorneys are under ethical obligations to at least make a good faith effort to determine if the client has the requisite capacity to retain counsel. Also, when the prospective client is or has been subject to a guardianship proceeding, an adjudication of incapacity can have a significant impact on a person’s ability to engage in the underlying transaction.
1. When Presumption of Capacity Exists.
Generally, mental capacity is determined at the time the document at issue is executed or the person enters into a transaction. Therefore, unless a person has been adjudicated to be incapacitated when the attorney is retained, the trust was created, the will was executed, etc., the law presumes sufficient mental capacity to enter into the transaction. See Estate of Galland v. Rosenberg, 630 S.W.2d 294, 297 (Tex.Civ.App.--Houston [14th Dist.] 1981, writ ref’d n.r.e.). The presumption of capacity may, however, be overcome with relevant and credible evidence. See discussion supra.
2. When Presumption of Incapacity Exists.
An adjudication of the testator’s incapacity prior to the execution of a will is typically admissible on the issue of the testator’s mental capacity. See Haile v. Holtzclaw, 414 S.W.2d 916 (Tex. 1967). When the adjudication remains in effect on the date the will was executed, the testator will generally be presumed to lack testamentary capacity. See Bogel v. White, 168 S.W.2d 309 (Tex.Civ.App.—Galveston 1942, writ ref’d). This presumption may be overcome by evidence of testamentary capacity. Id. at 311.
On the other hand, an adjudication that a person was totally or partially incapacitated entered after the date of the will is generally not admissible as evidence on the question of testamentary capacity. See Carr v. Radkey, 393 S.W.2d 806 (Tex. 1965). For example, in Stephen v. Coleman, the testator signed his will three days before being adjudicated incompetent. The subsequent adjudication did not raise any presumption of lack of testamentary capacity. See Stephen v. Coleman, 533 S.W.2d 444 (Tex.Civ.App.—Fort Worth 1976, writ ref’d n.r.e.).
The determination of incapacity does not, however, automatically result in a person lacking sufficient capacity to execute any document or instrument or enter into any transaction. Each of these proposed actions must be determined based on the particular facts, circumstances, time frame, and abilities of the person subject to a guardianship. For example, under the current guardianship laws, persons under temporary guardianship are presumed to have capacity. See Tex. Est. Code Ann. § 1251.001. Furthermore, a ward subject to a permanent guardianship is presumed to retain all rights not expressly granted to his or her guardian. See Tex. Est. Code Ann. § 1151.001.
3. Consider Practical Capacity and the Process.
Assuming no conflicts exist, legal capacity is not an issue and there is no apparent litigation risk then you are safe to proceed---right? The answer is a definite maybe. Whether you’re the advisor is an attorney, CPA, development officer or fill another role where you are giving advice that will be reasonably relied on the authors personal belief is that you must make and objective assessment based on subjective knowledge of your client regarding their ability to truly understand the full effect of any charitable strategy or even substantial gift they are contemplating.
This is the art of advising as opposed to the science. It is the place where we as advisors need to check ourselves and our clients to insure the decision-making process is appropriate. Whether it’s a lot more or just enough to be dangerous, we as advisors know more than our client which is great until it isn’t. Some of the most common mistakes advisors make when educate their clients with respect to charitable giving are as follows.
• Failing to make sure your client truly understands the full and potentially ongoing financial impact of the contribution.
• Placing to much reliance on canned (even though they may be customized) models and other educational pieces.
• Failing to put the client’s best interest above and beyond that of the charity.
• Utilizing overly complicated techniques when simple accomplishes the same result.
• Promoting new or aggressive techniques that have not passed the test of time.
• Failing to follow through with the monitoring and maintenance of ongoing charitable techniques.
III. MISTAKE 3: FAILING TO “KNOW YOUR CLIENT”.
A. Gathering Basic Information.
While basic background information may be gathered via the initial client interview, this process may give the estate planner a false sense of client understanding while reducing the time spent asking the pointed and often more difficult questions which lead to a true understanding of the client and his or her goals. In other words, time spent writing down names and addresses, while creating a sense of accomplishment, may be better spent assessing the stability of a client’s marriage, relationship with children, etc. In order to reduce the time necessary to gather general background information, the planner should consider developing and consistently using an estate planning questionnaire. The questionnaire should be detailed enough to provide the planner with names, addresses, phone numbers of the client, potential beneficiaries and potential agents as well as a general idea of client’s assets and liabilities. In addition, the questionnaire can be used to secure information on marriages, citizenship, children (including parentage) and prior domiciles (for identification of potential community v. separate property classification issues). On the other hand, the questionnaire should not be so detailed as to create an incentive for the client or potential client to disregard its use.
While the client questionnaire provides the attorney with the background information and time to conduct a more effective initial client conference, it also serves the additional purposes of documenting client disclosures in the event of future claims against the drafting attorney and providing an attorney checklist to help ensure that important questions are not overlooked. For example, assets passing to a non-citizen spouse do not, without proper inter vivos or post-mortem planning, qualify for the federal estate tax unlimited marital deduction. In today’s global society, it is impossible to make any worthwhile guess as to the potential citizenship based on a one or two-hour interview. Without the “checklist” it may be easy for the planner to overlook this basic, but extremely important, piece of information.
B. The Client Interview.
The client interview is the chance for the planner to really get to know his or her client and draw out their true planning goals. If the planner walks away from every client conference with the understanding that the client wants to “make sure my spouse and children are provided for and minimize taxes,” or “take care of my spouse and kids plus help my [church, alma mater, etc]. I suggest that the planner has, at best, missed the opportunity to know and truly assist his or her client and, at worst, attempted to fit the client to his or her standard Will or other estate planning form. In order to move beyond the “provide and minimize” surface, the planner must be willing to ask the difficult questions. For example:
How is your marriage?
Can your spouse effectively manage your estate and property after your death? Are you comfortable with your spouse serving as trustee of a trust for his or her benefit?
How is your relationship with your children?
How is the relationship(s) between your children? Do they get along with their sibling’s spouses?
How are your children’s marriages? Do you get along with your children’s spouses?
Do any of your children (or their spouses) have any problems handling money?
Do any of your children or grandchildren have any type of disability?
Do any of your children (or their spouses) have any problems with addictions, compulsive behavior, or other psychological problems?
How is the relationship between your spouse and her stepchildren (i.e., your children)?
How will your children react to the appointment of your spouse (i.e., their stepmother) as executor?
Are you comfortable with your spouse serving as trustee over a trust that also benefits or will ultimately benefit her stepchildren (i.e., your children)? Are you comfortable that your children will respect your spouse (i.e., their stepmother) as a trustee?
Are you responsible for the care of an elderly parent or other family member? Would your children continue this care if you were to predecease that parent?
Is there anyone outside your immediate family that you would like to benefit? Why?
Is there anyone inside or outside your immediate family that you would not like to benefit? Why? In all circumstances (e.g., even if they are your sole heir)?
What kind of support have you provided your [charity] in the past?
Do you give to your [charity] because of the cause they work for or because you like the way they specifically carry out their charitable mission.
Is your support crucial to your [charity]?
Why did you choose [charity]
Do you believe that your children can successfully run the family business after you die? What about your children who do not work in the family business—should they share equally in ownership after you die?
Have you thought about selling your business before you die?
What would you do with the proceeds of the sale of your business today if it were to sell?
If the planner will ask these and other tough questions, it is difficult to believe that the planner will continue to find that all clients goals are merely to “provide and minimize” and that many individuals and families have various concerns, situations and relationships that make the standard “form” Will less than ideal or even inappropriate for their particular situation.
C. Truly Counsel Your Client.
While posing the difficult questions to your client can be intimidating, counseling your client that their desired course of action may be a bad idea can be even more challenging. The desire to keep a current client happy or to secure a new engagement may create an incentive to follow your client’s wishes, even those which could lead to future problems. For example:
Due to troubled relations with a child, a client may wish to disinherit a child or all of their children. While the able planner should be able to easily draft to accomplish this goal, and while the other siblings or a charity may be happy with the windfall from the client’s decision, the planner must caution the client that disinherited children are disappointed children and disappointed children are often Will contestants.
Due to relations with a child, a client is certain that he or she wants to disinherit a child—no matter what! Again, fairly easy to accomplish from a drafting standpoint. However, even in the situation of highly troubled relations, the planner should advise the client that, for example, combining a more than nominal pecuniary bequest to the “disinherited” child with a no contest provision could provide a significant disincentive for the “disinherited” child to contest the Will. While the child may clearly get more than they deserve, the benefits of avoiding a potential will contest often outweigh the emotional cost of making the gift.
Your client wishes to name children as co-fiduciaries in an effort to give each child a voice. While this may seem like a good idea in theory, the careful planner will surely advise the client that the family dynamic, even among the families with the best relations, can significantly change after the death of one or both parents thereby inviting family tension, disagreement or litigation. If relations among children are not good to begin with, the careful planner will strongly counsel his or her client in an attempt to avoid almost certain future problems. This is even worse when the planner places all “disinherited” children who never got along to begin with on the board of the testamentary foundation to force relations.
Your client wishes to name his current spouse as trustee of a bypass trust for the benefit of his spouse and his children from a prior marriage. Once again, even when relations between the current spouse and prior children is good, this may be a recipe for disaster after your client’s death and your client must be counseled accordingly.
Your client wants to name their priest, pastor or rabbi as trustee of charitable planning vehicles.
In order to protect her current spouse as trustee, your client wishes to give her spouse a testamentary power of appointment over a trust for the benefit of her spouse and her children from a prior marriage. As before, relationships which are good can quickly sour following the death of a family member. While the power of appointment is often a recommended tool to avoid interference with a trustee, the use of a third-party trustee or a substantially restrictive special power of appointment may avoid an unintended disinheritance of your client’s children.
While discussing these issues with a client, especially in the context of a joint representation where conflict is always lurking on the horizon, can be difficult. It is crucial that the estate planner be straightforward, honest and unafraid to counsel his or her client in order to prevent, or try to prevent, a potentially disastrous course of action.
IV. MISTAKE 4: FAILING TO CREATE A FULLY INTEGRATED ESTATE PLAN.
Fundamental to every estate plan is coordination of the client’s assets. Failure to coordinate assets can render the best estate planning essentially useless. In addition, asset coordination can be particularly important when the plan may ultimately be challenged.
A. Coordination of Estate Planning Vehicles.
One of the most important characteristic of an estate plan is that it meets the client’s overall objectives. When various estate planning techniques or options are used, it is crucial that these techniques form a well coordinated overall estate plan. The failure to coordinate various vehicles often leads to future disputes and disappointment. This is especially likely when the client has utilized the services of multiple estate planning professionals, often in differing jurisdictions.
The creation of a fully coordinated estate plan begins with a detailed review of all existing estate planning vehicles. Making estate planning recommendations and creating new estate planning vehicles in a vacuum almost always leads to an overall plan that does not meet the client’s goals. To avoid this result, the planner must:
Review the dispositive provisions of each estate planning to create a clear picture in the mind of the planner and, through counseling, the client, of the existing dispositive scheme.
Review individual assets to clarify which assets, if any, are subject to each of the various vehicles.
Review tax, expense and debt allocation provisions of each vehicle, where applicable, to determine the amounts passing to each beneficiary before and after the payment of transfer taxes, debts and expenses.
Review to administration and fiduciary provisions of each vehicle (including powers of attorney and other ancillary documents) to determine the rights and limitations of each fiduciary with respect to each other fiduciary.
Review each vehicle for intended (and unintended) powers of appointment.
When applicable, coordinate the proper exercise or non-exercise of each inter vivos or testamentary powers of appointment being careful to include all required specific references to each exercised power to avoid future claims of ineffective exercise.
Review all non-probate assets and quantify expected non-probate transfers.
B. Asset Coordination.
The advantages of various gift and estate planning techniques, especially advanced charitable and non-charitable planning techniques, are premised on the transfer of assets to such vehicles. To obtain the maximum benefit, the intended assets must be controlled by the proper vehicle. In addition, by passing clear title to the entity or fiduciary, there is a reduction in the amount of assets that may be subject to a guardianship proceeding or will contest. Efforts should be made to coordinate and transfer the various assets to the selected trust, limited partnership, foundation or other vehicle. In some cases, this can be accomplished by simply listing the assets on an attached exhibit to the relevant document and stating that such assets have been conveyed to the respective entity. This approach should be used with caution, however, because it may lead to future disputes regarding ownership and control between one or more fiduciaries – for example an agent and a trustee. Thus, real estate should be conveyed by deeds, accounts should be restyled with the financial institution, and title to tangible personal property should be confirmed by appropriate transfer documents or at a minimum a bill of sale.
C. Coordination of Non-Probate Assets.
1. Titling of Accounts.
Improper asset titling can easily gut the most carefully crafted estate plan. Under the Estates Code Chapters 111 and 113, unmarried and married individuals can create accounts or other assets (although, due to historical prohibitions, usually no real property) which pass at the death of one owner to the surviving owners by right of survivorship rather than passing by the provisions of the decedent’s Will. See Tex. Est. Code Ann. § 111 and 113 et seq. Determining whether one or more assets will pass by survivorship is, unfortunately, not always an easy task. While some monthly or annual account statements may designate survivorship, the absence of such labeling is not always indicative of the true character of the asset. Rather, the true nature of the asset is governed by the terms of the account agreement or the signature card. See, Dickerson v. Brooks, 727 S.W.2d 652 (Tex. App.—Houston [1st Dist.] 1987, writ ref’s n.r.e.) (Signature card and application controlled survivorship as to certificate of deposit despite the fact that certificate of deposit did not denote survivorship feature.)
In order to prevent potential planning disasters, the planner must confirm the true nature of all accounts and, when he or she deems it appropriate, ensure that such accounts are re-titled to eliminate all survivorship claims unless specific reason exists for such result. While this re-titling will be ideally accomplished on an account by account basis, time or the number of accounts may make this difficult. Fortunately, the Estates Code provides a shortcut solution in the form of a written notice to financial institutions. See Tex. Est. Code Ann. §§ 113.156, 113.157. The Code provides that a party to an account can alter the payment terms of the account at death by virtue of a written order. In order to satisfy the provisions of the section, the order must be:
• signed by a party (any party to the account);
• received by the financial institution during the party’s lifetime;
• and not countermanded by the same party during the party’s lifetime.
Note, however, that such notice merely alters the payment terms upon death but does not otherwise affect the rights of the various parties to the account with regard to the contractual terms of the account. A.G. Opinion No. DM-10 (1991).
2. Coordination of Beneficiary Designations.
Assets such as life insurance, qualified and non-qualified retirement plans and annuities pass by virtue of the written contract rather than by Will. Therefore, like improper asset titling, failure to coordinate beneficiary designations with other estate planning vehicles can also gut an otherwise well-crafted estate plan. Unlike survivorship accounts, however, the coordination of beneficiary designations in many instances involves trade-offs between future transfer tax savings and current income tax savings. For example, life insurance generally passes to the designated beneficiary income tax free so the naming of a trust or a testamentary trustee as a beneficiary for purposes of securing potential future estate tax savings can usually be done without concern.
If a client has charitable inclinations, naming a charity as a beneficiary of such qualified retirement plan may be the most tax efficient way to accomplish charitable goals. It is important for the client to understand, however, that a charity is not a qualified designated beneficiary for income tax purposes. Clients should be made aware of income tax implications of naming beneficiaries on certain non-probate assets. If the non-probate asset involved is a "qualified" retirement plan (IRA, 401(k), pension, thrift, profit-sharing, KEOGH, etc.) or tax-deferred annuity, the best income tax result (i.e., longest deferral period) is generally achieved only if the beneficiary meets the requirements to be treated as a "designated beneficiary" under the Internal Revenue Code and Treasury Regulations. See I.R.C. § 401(a)(9)
Although a charity cannot be a "designated beneficiary," when benefits are distributed to a charity, the charity will receive the benefits free of income tax, as opposed to individuals or trusts who would have to pay income tax on the distributions received from such retirement plans. See I.R.C. §§ 691(a), 501(a).
While a complete discussion of the nuances involved in such a determination are outside the scope of this article, income tax implications should be considered when planning for these qualified non-probate assets.
In the non-charitable context, the decision-making process is equally nuanced. A qualified retirement plan may provide substantial current income tax savings and additional income tax-free growth through the use of a spousal rollover at the expense of future transfer tax savings while the naming of a trust or testamentary trustee, while providing potential future transfer tax savings, may result in significant current income taxation. Therefore, the careful planner will carefully coordinate all beneficiary designations to maximize estate planning benefits and flexibility.
V. MISTAKE 5: FAILING TO GIVE FULL CONSIDERATION TO TAX PLANNING.
A. The Scope of Gift & Estate Tax Planning (Charitable or Otherwise).
Historically, the most obvious and potentially most detrimental mistakes to a client were those caused by tax traps or missed tax opportunities that they and their planning attorney or other advisors failed to recognize. Conversely, clients and planners often overemphasized tax savings, at the expense of creating a practical plan. While those issues will continue to exist to some degree, the recently enacted Tax Cuts and Jobs Act (the “Act”) made some significant changes to on both the income and transfer tax landscape that remove tax, to a large degree, from the decision-making process. For the charitably inclined client the primary changes to be aware of are as follows:
• The charitable income tax deduction was retained. While other itemized deductions will have been eliminated or subject to limitations. The charitable deduction only applies, however, to taxpayers with can itemize.
• State and local taxes are deductible only up to a combined annual limit of $10,000. Deductions for mortgage interest are limited to $750,000 of debt for those married filing jointly.
• The law increased the standard deduction to $12,000 for singles, $24,000 for married couples filing jointly, and $18,000 for heads of households. Your deductions (including your charitable deductions) will not reduce your income tax unless their total exceeds your applicable standard deduction amount.
• There is an increase in the adjusted gross income (AGI) limitation on charitable gifts of cash to public charities from 50% of AGI to 60% of AGI. The AGI limitation on charitable gifts of appreciated property to public charities will remain 30% of AGI. If you itemize, you will continue to be able to carry forward deductions subject to either limitation for up to five years.
• The gift tax, estate tax, and generation skipping tax will continue and estates will still be entitled to an unlimited estate tax deduction for charitable gifts. However, the exemption amounts for each of these taxes will double to $11.18 million per individual, ($22.4 million for gift and estate tax for married couples).
• The law repeals the 80% charitable deduction for gifts made in exchange for college athletic event seating rights.
• The charitable direct rollover contribution to charity from an IRA up to $100,000 annually continue to apply for taxpayers over 70 ½
• The Act leaves the treatment of the donation of appreciated stock and of tax-deferred assets unchanged.
• The Act leaves the treatment of donor advised funds unchanged.
• The Act seems to have left many of its aspects inapplicable to trust structures however caution should be used before trying to secure a benefit that has been eliminated but virtue of structuring the transaction in a trusts wrapper.
While it’s unclear how the Act will ultimately effect charitable giving, it is clear that the benefits of charitable giving from a tax standpoint appear to have shifted significantly away from the idea of estate tax saving and more to the potential for income tax savings. For example, even the taxpayer who does not meet the threshold for itemization can meet their charitable goals and secure income tax savings through the contribution of appreciated stock or tax deferred assets to charity. Conversely the same taxpayer may elect to use a donor advised fund to bunch all planned charitable contributions over a period of years into a single large charitable gift to, for example, their donor advised fund.
1. Applicable Credit Amount and the Bypass Trust.
Historically planners were forced to make a decision on whether to advise on the use of bypass planning with the knowledge that whatever remaining unused credit would simply evaporate causing many planners to over plan with full blown taxable even in remotely taxable situations. In other situations, improperly drafted beneficiary designations or other non-probate transfers went outright to beneficiaries left the estate with insufficient assets to fully fund the tax planning provided contemplated under testators will.
In recent years the availability of "portability" of a deceased spouse's unused federal estate tax exemption amount in recent years negated or minimize the risk of under-planning and underfunding in some circumstances. However, to take advantage of portability, a federal estate tax return must be filed for the deceased spouse within 9 months of his or her date of death (or within 15 months with a timely filed extension request). I.R.C. § 2010(c)(5).
Now, under the Act, the it is difficult to imagine under-planning or under-planning for estate tax purposes. And if so, portability still applies. While this may be the case, planners should make sure that this determination is made on the basis of full and accurate information that is often not easy to determine. For example, many clients do not know the true value of their assets. Clients often attach unrealistic values to their total estate for a number reasons including asset changes, book value versus going concern or liquidation values, or failing to understand what may be included in their estate (e.g., life insurance is tax free right?)
2. Marital Deduction Planning.
Internal Revenue Code provides an unlimited marital deduction against estate tax for assets passing to a surviving spouse. IRC § 2056. In most instances, clients will favor the idea of deferring estate taxation by taking advantage of this deduction. I.R.C. § 2010(c)(5). While it is relatively easy to qualify for this deduction, there are a few relatively common mistakes which may jeopardize this qualification including:
• Creating a marital QTIP trust which allows distributions to individuals other than the surviving spouse. In order to qualify for the unlimited marital deduction as a QTIP, the surviving spouse must be the sole beneficiary. IRC § 2056(b)(7)(B)(ii)(II).
• Creating a marital QTIP trust which fails to mandate the distribution of income to the surviving spouse at least annually. In order to qualify for the unlimited marital deduction as a QTIP, the surviving spouse must be entitled to all income at least annually. IRC § 2056(b)(7)(B)(ii)(I).
• Making a marital bequest to a non-citizen spouse without including Qualified Domestic Trust provisions. If a planner fails to consider the citizenship, he or she will face the dilemma of advising a surviving that he or she will not inherit $4.0 million tax-free, but rather may have to pay taxes of approximately $2.0 million or have the assets placed in a specially created post-death trust. IRC § 2056A.
3. GST Planning.
A discussion of GST planning is beyond the scope of this article, however, it is important to realize that no mistake will be potentially more expensive than a GST planning mistake. While the planner is afforded substantial protection via the GST exemption amount, an inadvertent generation-skip will cost almost $0.50 on the dollar—a steep price for attorney error. Common mistakes include:
• Assuming that a transfer into a trust that meets the requirements for the gift tax annual exclusion also meets the requirements for the GST annual exclusion. Remember only certainly narrowly tailored trusts which are for the sole benefit of a single skip-person qualify for the GST annual exclusion. IRC § 2642(c)
• Failing to affirmatively allocate GST exemption to one or more testamentary trusts. While reliance on the deemed GST exemption allocation rules may work for smaller estates, this may result in trusts with inclusion ratios of between 0 and 1 in larger estates. IRC § 2632(b).
• Failing to remember that non-lineal descendant beneficiaries can also be skip-persons based on their age relative to the donor or testator. IRC § 2651(d).
B. The Act—Other considerations.
With the advent of the Act, serious consideration of transfer tax planning issues becomes extremely important (once again). While the following examples are in no way exhaustive, they illustrate the issues and problems arising under the Act.
1. Increases in the GST Exemption and Applicable Credit Amounts.
Under the Act the GST exemption and applicable credit amount have increased dramatically to $11.2 million per individual and $22.4 million for a married couple. While not an outright repeal, it is tantamount to one for all but a handful of taxpayers. But, like EGGTRA its predecessor, the Act repeals itself in 2026 returning us to the law as it existed in 2017.
a. Planning Considerations.
Although many open transfer tax issues regarding repeal are impossible to plan for and will remain unanswered until after repeal, the effects of the scheduled changes, and repeal in and of itself, on many standard drafting practices must be carefully considered. Areas of concern include:
(i). Formula Gifts May Yield Unwanted Results.
Planners often utilize formula gifts to carry out the intentions of the testator. When formulas are based, however, on uncertain or highly volatile GST exemption or applicable credit amounts, undesired results may follow. For example:
Caution should be used whenever drafting a formula where a maximum GST exempt or applicable credit amount goes into trust for one group of beneficiaries while the non-exempt or remaining assets pass to another group. In this situation, the difference between a death in 2016 and a death in 2020 will mean a wealth shift of up to $5.2 million--likely not the testator’s intent.
Caution should be used in the second spouse, children of the first marriage situation. In this case, planners may draft a formula bequest allocating the maximum GST exempt amount to lifetime trusts for children and descendants while the non-exempt amount passes to the surviving spouse. Like situation (1) above, the formula may either shift more to the children than the testator.
(ii). “Active” GST Plans continue to be Complicated by Equalization of GST Exemption and Applicable Exclusion (Estate Tax Exemption) Amounts.
GST tax planned or “second generation” wills normally fall into two categories; “active” GST plans utilizing formula gifts to create GST exempt and nonexempt trusts and “passive” plans which rely on the post-death severance of trusts with inclusion ratios between 0 and 1 to create two trusts, one with a GST inclusion ratio of 0 and one with an inclusion ratio of 1. As a result of the pending equalization of the GST exemption amount and the applicable exclusion (estate tax exemption) amount, it is possible that a decedent’s applicable exclusion amount will be less than the decedent’s remaining GST exemption since it is possible for lifetime gift to utilize only GST exemption or applicable exclusion, but not both.
While EGTRRA forced many planners to review their drafting and advise clients of potential pitfalls of pre-EGTRRA language, many documents continue to exist that were never changed. These issues are only magnified under current credit and exemption levels.
2. Automatic GST Allocations--IRC § 2632(c).
Section 2632(c) provides for the automatic allocation of a transferor’s unused GST exemption to property transferred by indirect skip to the extent necessary to make the inclusion ratio for such property zero. Under the new automatic allocation rules, GST Exemption will be automatically allocated to all "Indirect Skips" made on or after January 1, 2001. An Indirect Skip is any transfer that constitutes a completed gift to a GST Trust. IRC § 2632(c)(3)(A). Generally, under IRC §2632(c), a donor’s unused GST Exemption is automatically allocated to all Indirect Skips.
a. The GST Trust.
The determination as to what is a GST Trust is the key to the new deemed allocation rules. Specifically, a GST Trust is "a trust that could have a generation-skipping transfer with respect to the transferor." IRC § 2632(c)(3)(B)[emphasis added]. Basically, this applies to essentially every irrevocable trust used in the estate planning context; however, there are 3 categories of exceptions to the general rule:
• Category One: Generally, trusts "likely" to vest 25% or more in a non-skip person are not GST Trusts.
• Category Two: Generally, trusts any portion of which would be includable in the gross estate of a non-skip person if that person died immediately after the transfer are not GST Trusts.
• Category Three: Most charitable split interest trusts, the non charitable beneficiary of which is the transferor or a non-skip person, are not GST Trusts.
b. Planning Considerations.
The trust instrument, however, cannot specify that the trust is to be–or is not to be–a GST Trust, nor can it direct the Trustee to effectively elect one way or the other, nor do the transferor's prior allocation decisions have any relevance. A trust's status as a GST Trust is solely a function of the actual dispositive terms of the trust and the facts and circumstances relating to the beneficiaries of the trust. From a pure planning perspective, a trust could be drafted to definitely meet the definition of a GST Trust (or not), but even then, changed circumstances could result in changed status.
In addition, nothing in the statute mentions the transferor's prior exemption allocation decisions. Therefore, a transferor’s prior allocation decisions appear to be irrelevant to the GST Trust analysis. In other words:
• If the transferor has consistently allocated GST Exemption to every transfer to a particular trust, but that trust is not otherwise a GST Trust, there will be no automatic allocations to his gifts to that trust. Therefore, planners will need to continue to advise their clients to make affirmative allocations of their GST exemption amount via a timely filed IRS Form 709.
• Likewise, if the transferor has consistently declined to allocate GST Exemption to his transfers to a particular trust, but that trust qualifies as a GST Trust, there will be automatic allocations to his future gifts to that trust. This second result is particularly troubling. For example, many planners will utilize ILIT planning utilizing term life insurance in the family trust context (i.e., ILIT provides for distributions to surviving spouse and children, dividing into individual lifetime trusts for children and descendants at death). In most instances, this type of ILIT would satisfy the definition of GST Trust and be subject to the new automatic allocation rules. Many times, however, individuals elect not to allocate GST to these ILITs due to the possible termination of the ILIT on the termination of the ILIT’s term insurance. Prior to the new automatic allocation rules, it was easy not to file a gift tax return allocating GST exemption. Now, planners must review old planning files to determine which, if any, of these types of situations will require an affirmative election out of the automatic allocation rules.
VI. MISTAKE 6: FAILING TO GIVE FULL CONSIDERATION TO THE SELECTION OF FIDUCIARIES.
A. Selection of Fiduciaries.
The importance of the selection of fiduciaries is often over-looked. Planners routinely suggest that spouses first name each other as first named executors, trustees and agents with little thought as to whether the surviving spouse is well suited to these roles. Prior to making any selection of fiduciaries the planner and the client to consider some or all of the following:
• Does the individual fiduciary have the experience and judgment to do the job?
• Can the individual fiduciary treat those affected without bias? Can a second spouse treat the children of a marriage and children of a previous marriage fairly?
• Does the fiduciary have any conflicts of interest? Can a business partner deal fairly with the estate which now is the co-owner of his business? Is the Pastor placed in a difficult position regarding funds for the church.
• Will the appointment create family tension? How will naming the eldest child affect that child’s relationship with his or her siblings? Would the use of a third-party professional fiduciary help maintain family harmony and avoid potentially costly litigation?
• Does the individual have the investment knowledge and sophistication to manage a potentially large portfolio? Are they willing to engage professional investment advice? Do private foundation trustees know anything at all about charitable matters or foundation governance.
• Will the age of the fiduciary adversely affect his or her ability to satisfy his or her duties on a long-term basis?
• Is the individual sensitive to the needs of the beneficiaries and others affected by his or her appointment?
• Does the fiduciary possess the organizational skills to maintain adequate books and records and ensure compliance with any tax filing requirements? How about charitable entity filing requirements?
• Does the fiduciary have legal capacity to serve? Is a child incapacitated as to age? Does the foreign bank have the authority to act as a fiduciary in Texas.
• What will be the fees associated with the appointment of a certain fiduciary?
B. Appointment of Successor Agents.
It is advisable for a client to appoint both original and successor fiduciaries. Third parties may attempt to either intimidate a fiduciary into non-action or resignation, or the fiduciary may not be able to serve due to incapacity or death. A client will have greater assurance that his or her desires will be carried out by preferred fiduciaries when he or she designates a number of persons who can act if the predecessor fiduciary cannot serve or qualify.
Furthermore, if the client intends to appoint non-family members as his or her fiduciary the attorney should understand the reasons for the appointments in the event this becomes an issue in the future. This is especially critical with regard to an agent under a power of attorney. This knowledge will allow the attorney to assist the client in carrying out his or her desires and potentially avoid a guardianship should one be sought by the client’s family members.
C. Appoint Agents Who Do Not Have Potential Conflicts Of Interest.
A client should consider appointing at least one fiduciary or successor fiduciary that would not have a potential conflict between his duties as a fiduciary and his individual or other interests. For example, a person who also serves as both attorney-in-fact and trustee for the client could face subsequent claims of conflict arising from his duty to account while the client is incapacitated. A court considering an application for guardianship may determine a guardian of the client’s estate should be appointed to provide independent review and oversight to avoid this potential situation. A client should also consider appointing at least one (1) person who, if possible, has no duty to account to the client in any other capacity.
VII. MISTAKE 7: FAILING TO GIVE FULL CONSIDERATION TO THE CONTROL AND PROTECTION OF FIDUCIARIES.
The selection of one or more estate planning techniques provides the framework for implementing the client’s plan. To complete that framework, consideration should be given to building in future control and protection yet, at the same time, allowing for flexibility to modify terms to address future events and yet to be discovered opportunities.
A. Include Comprehensive Fiduciary Provisions.
Clear and comprehensive fiduciary provisions reduce the opportunity for interference by third parties or even courts. Furthermore, the more comfortable the fiduciary is with the scope of his or her role and the built-in protections, the greater the likelihood that he or she will continue to act in such capacity. Each instrument should be reviewed to confirm it includes comprehensive and workable provisions, including:
the clear appointment of the necessary fiduciaries;
whether it appoints any trust advisors or protectors;
removal rights;
provisions to provide for subsequent appointments without court intervention;
clarification as to who can be appointed;
clarification as the rights and powers of multiple fiduciaries;
process to allow dispute resolution between fiduciaries and beneficiaries;
provisions to allow or restrict the appointment of foreign fiduciaries;
provisions to allow or restrict the relocation of the situs of the trust, etc.;
provisions that provide suitable exoneration; and
provisions that provide appropriate indemnity provisions.
provisions that clearly set forth the structure of a testamentary private foundation and provide the fiduciary the authority to establish the same.
B. Draft Clear Distributions Standards.
Distributions standards should be carefully drafted to avoid ambiguity, clarify preferences as between beneficiaries, and provide clear guidance to the fiduciary in making distributions. The ability to do so often depends of the type of gifts and the related tax issues.
1. Marital Gifts.
Marital gifts in trust often create issues due to the need to qualify for the unlimited marital deduction. To qualify as a QTIP trust, the trust must meet certain requirements including the distribution of all income. This may lead to conflicts between the distribution requirement of the spouse and the responsibilities to the remainder beneficiaries. Options to reduce conflicts may include:
Express language regarding the ability to exhaust the trust in supporting the surviving spouse;
Preferences as between the spouse and remainder beneficiaries;
Allowing a trustee to make the discretionary principal distributions to spouse using an ascertainable or non-ascertainable standard;
Including a unitrust or total return trust standard;
Clarifying whether a trustee must take into account other resources when making distributions of principal;
Clarifying whether any applicable lifestyle standard is as of the client’s death or at the applicable time;
A spouse’s rights of withdrawal; and
Giving a spouse a power of appointment.
2. Non-Marital Gifts.
Similar to marital trust, it is advisable to include provisions that reduce conflicts between various beneficiaries. Options to reduce conflicts may include:
Clarifying a trustee’s degree of discretion (i.e., may versus shall);
Preferences as between the various beneficiaries;
Allowing the trustee the ability to make discretionary income and principal distributions using an ascertainable or non-ascertainable standard;
Clarifying whether a trustee must take into account other resources when making distributions of income and principal;
Clarifying whether any applicable lifestyle standard is as of the client’s death or at the applicable time;
Educational incentives and objectives;
Clarifying a trustee’s ability to treat distributions as advancements;
Distributions in satisfaction of a beneficiary’s duty of support;
Distributions during periods of minority, incapacity, commitment, divorce, or other conditions;
Methods of payment; and
Powers of appointment.
C. Consider Including Powers of Appointment.
Powers of appointment (a/k/a powers of disappointment or redirection) remain one of the most commonly utilized tools to dissuade interference by potential beneficiaries. Generally, any beneficiary has standing to question or challenge a trustee’s actions. That desire is often tempered when the beneficiary can be summarily removed from the plan. However, the right to remove can also lead to the exclusion of intended beneficiaries. Thus, the powers of appointment should be drafted and included in a manner that promotes the client’s overall intent.
Furthermore, a person with a general power of appointment has the ability to release a trustee from actions or liability under the Texas Trust Code. See Tex. Prop. Code Ann. § 114.032(b) (Vernon Supp. 2005). This may provide additional protection to the trustee from potential claims by tentative beneficiaries.
D. Consider Trustee Removal Powers.
Giving a beneficiary or trust protector a power of removal may reduce the chance of discord between beneficiaries and corporate trustees. The power can be used, however, by beneficiaries to “blackmail” trustees into favorable distribution decisions so caution should be exercised in this regard. For example:
“Corporate Trustee Removal Without Cause. The first named Trustee Appointer who is then living and not Incapacitated may remove any bank or other corporation serving as Trustee of any trust at any time with or without cause and appoint a Qualified Corporation (as defined in Section ____) as successor Trustee of such trust.”
or
“Corporate Trustee Removal Without Cause. The first named Trustee Appointer who is then living and not Incapacitated may remove any bank or other corporation serving as Trustee of any trust at any time with or without cause and appoint a Qualified Corporation (as defined in Section ____) as successor Trustee of such trust. Provided, however, no Trustee Appointer shall have the authority to remove and bank or other corporation serving as Trustee of any trust, within the first 24 full calendar months of that bank or other corporation’s appointment as Trustee of that trust.”
E. Consider Trust Protectors and Advisors.
The use of trust protectors in domestic trusts has increased over the last few years. At a minimum, many planners utilize a trustee appointer or advisory committee for purposes of filing a vacant office of trustee. For example:
“Trustees. I appoint the following, in the following order, as sole Trustee of every trust created under this Will: ______, otherwise ______, otherwise ______. If all of the above (and any successors) fail or cease to serve as Trustee of any trust and the resulting vacancy is not filled under the provisions of Section ____, the Trustee Appointer (designated in Section ___) shall appoint a Trustee of that trust in accordance with the provisions of Section ____.”
“Trustee Appointer. I name the following persons, in the following order, to serve as the Trustee Appointer: (i) _____, otherwise (ii) ______, otherwise (iii) ______, (vi) as to any Descendant's Trust or Contingent Trust, the named beneficiary, if legally competent, otherwise the parent or guardian of the named beneficiary, if any, otherwise (v) my oldest then living adult descendant, if any.”
The protector concept can, however, have much broader applicability. While often used in offshore trusts, the use of trust protectors in domestic trusts provides a means to increase flexibility regarding future trust modifications and may add some additional protection for a trustee. For example:
“Trustees. We appoint the following, in the following order, as sole Trustee of every trust created under this instrument: ______, otherwise ______, otherwise ______ Toomey. If all of the above (and any successors) fail or cease to serve as Trustee of any trust, the Protector (designated in Section ___), or his successors, shall appoint a Trustee of that trust in accordance with the provisions of Section ___.”
“Protector. There shall be a Protector of each trust created by or pursuant to this instrument. We appoint the following as sole Protector of every trust created under this instrument: ______, otherwise ______. If all of the above (and any successors) fail or cease to serve as Protector of any trust, and if a successor Protector has not been appointed as provided in Section ___, the Trustee of that trust shall appoint a Protector of that trust in accordance with the provisions of Section ____.”
“ARTICLE ___ - PROTECTOR PROVISIONS. The provisions of this Article govern the office of the Protector. When used in this instrument, where the context permits, the term Protector means the protector or co-protectors from time to time serving and the "estate" of the Protector means the particular trust estate being protected by the Protector.
. Protector Appointment Authority. The Protector shall have the power to appoint additional Protectors and a successor or successors to any Protector hereof. Any such appointment may be changed by the Protector from time to time prior to the time it becomes effective. If a Protector resigns or otherwise ceases to act as such and there is at least one other Protector then acting as such, then the remaining Protector or Protectors shall continue to act. If a sole Protector resigns or otherwise ceases to act as Protector of any trust and a successor Protector for that trust has not been appointed in accordance with the preceding provisions of this Section, then the Trustee of that trust, within ninety (90) days from the date the Protector resigns or otherwise ceases to act, shall appoint a successor Protector, but may not appoint itself or any related or subordinate party, as described in Code Section 672(c), to itself as Protector. The failure of the Trustee to appoint a successor Protector within such ninety (90) day period shall not be considered to be a waiver of the Trustee's duty to appoint a successor Protector.
. Protector Appointment Procedures.
. Generally. Any appointment of a successor or additional Protector shall be by a written instrument delivered to the Trustee of the trust, and to the appointee and shall be effective at the time or under the conditions specified in such instrument (but in no event shall such appointment be effective prior to the time that the Trustee receives actual notice of such appointment) and shall be attached to this instrument.
. Qualified Individual Or Entity. In deciding who to appoint as a successor or additional Protector, the Protector or Trustee, as the case may be, should determine that the individual or entity has the requisite experience, expertise, and education to discharge the office of Protector in accordance with the terms of this instrument. Additionally, that individual or entity should be willing and able to commit the time and resources necessary (a) to know and understand the personal situation of each beneficiary and his or her economic and financial circumstances to the extent necessary to act on behalf of each beneficiary and (b) to take the actions required to protect each beneficiary in a meaningful way. Provided, however, no Protector of any trust created by or pursuant to this instrument shall be any of the following: (i) either one of us, (ii) the beneficiary of any trust created under this instrument, or (iii) any individual or entity who, during our lifetimes, is related or subordinate to either one of us within the meaning of Code Section 672(c) or any individual or entity that is otherwise related or subordinate to either one of us.
. Protector Incapacity. If any Protector (i) become Incapacitated, (ii) becomes subject to any bankruptcy laws; or (iii) if the Protector is a company or other entity and (a) enters into liquidation, whether compulsory or voluntary, provided that such liquidation is not merely a voluntary liquidation for the purposes of amalgamation or reconstruction, (b) enters into receivership, (c) has an administrator of the Protector appointed, or (d) becomes subject to any bankruptcy laws (or being in any analogous state or subject to any analogous action in any jurisdiction), such Protector shall thereupon be deemed to have resigned as Protector, and the appointment of a successor Protector shall be governed by this Article.
. Protector Resignation. A Protector may resign as Protector of any one or more trusts created under this instrument at any time, with or without cause, by delivering a resignation notice in recordable form to the Trustee. Any resignation of a Protector shall take effect upon the receipt of the written notice by the Trustee and shall be attached to this instrument.
. Protector Liability. The Protector shall have the benefit of the same indemnities, protections, and exculpations as conferred on the Trustee by the operation of law or under the terms of this instrument.
. Duty To Act. The Protector shall have absolutely no duty whatsoever to act or not to act with respect to any activity or action that the Protector is empowered to undertake hereunder and the Protector shall not be liable for so acting or not acting. The Protector shall also have no duty whatsoever to consent or not to consent to any activity or action that the Trustee is empowered to undertake hereunder with the consent of the Protector, and the Protector shall also not be liable for so consenting or failing to consent.
. Trustee Removal And Appointment Authority. Without regard to any other provisions of this instrument, the Protector shall have the following powers which are exercisable from time to time and at any time.
. Trustee Removal. The Protector may remove any trustee of any trust created by or pursuant to this instrument.
. Trustee Appointment. The Protector may appoint an additional trustee or additional trustees of any trust created by or pursuant to this instrument. The Protector may also appoint a successor or successors Trustee of any trust created by or pursuant to this instrument in the event any Trustee is removed, resigns or otherwise ceases to act. Provided, however, any appointment of an additional trustee or successor trustee may be changed by the Protector prior to the time it becomes effective.
. Trustee Appointment And Removal Procedures.
. Generally. Every appointment (or removal) of a Trustee must be evidenced by a written instrument in recordable form, signed by the Protector and delivered to the appointee (or Trustee being removed). The instrument must identify the appointee (or Trustee being removed), state the effective time and date of appointment (or removal), and every appointment must contain an acceptance by the appointee. Except as otherwise provided, every Trustee appointed under this instrument must be either a Qualified Corporation or one or more Qualified Individuals (defined below).
. Qualified Individual. The term Qualified Individual means any legally competent adult individual (other than either of us, but including any beneficiary of any trust created under this instrument) who has attained the age of thirty, and who is willing to serve under this instrument.
. Qualified Corporation. The term Qualified Corporation means any corporation having trust powers that is qualified and willing to serve under this instrument and that has, as of the relevant time, either (i) a minimum capital and surplus of at least five million dollars ($5,000,000 U.S.), or (ii) at least one hundred million dollars ($100,000,000 U.S.) in trust assets under administration; provided, however, the Protector, in his sole discretion, may waive the capital, surplus and assets under administration requirement of this provision.
. Delivery Of Trust Estate. Upon the appointment of a successor trustee, the Trustee shall immediately stand possessed of the estate of such trust upon trust for the new trustee or trustees, and shall transfer the same to the new trustee or trustees as soon as possible, so that such estate shall continue to be held upon the applicable trust or trusts hereof, but subject to and governed by the laws of the applicable jurisdiction, whether the State of Texas or a new jurisdiction designated by the Protector to govern any trust established by or pursuant to this instrument.
. Administrative Authority. Without regard to any other provisions of this instrument, the Protector shall have the following administrative powers which are exercisable from time to time and at any time.
. Designation Of Governing Jurisdiction. Without regard to the provisions of Section _____, the Protector shall have the power exercisable at any time, and from time to time, to designate the law of any jurisdiction (under which the terms of any trust created by or pursuant to this instrument shall be capable of taking effect) to be the governing law of any trust created by or pursuant to this instrument, and to declare that such trust shall thereafter be governed by and take effect according to the laws of the jurisdiction so designated. The Protector shall also have the power to declare that the courts of such jurisdiction may or shall become the forum for the administration of such trust. Such a designation and declaration shall be set forth in an acknowledged written instrument which shall contain the powers and provisions which are necessary to enable such trust to be capable of taking effect under the laws of such jurisdiction (including, but not limited to, any applicable rule against perpetuities), and which may also contain such other powers and provisions as the Protector may determine to be in the best interest of the beneficiaries. Upon the declaration by the Protector that the Trust or any trust established by or pursuant to this instrument shall be governed by the laws of a new jurisdiction, the rights of all persons, parties, and entities, and the construction and effect of each and every provision of the trust shall be subject to and construed only according to the laws of the designated jurisdiction.
. Demand For Accounting. Without regard to any other provision of this instrument, the Protector shall have the power, exercisable at any time, and from time to time, to demand an accounting by the Trustee, setting forth the receipts, disbursements, and distributions of both principal and income during the period of accounting and the invested and uninvested principal and undistributed income that is in existence at the beginning and at the end of such accounting period.
. Demand For Bond. Without regard to the provisions of Section 6.5, the Protector shall have the power, exercisable at any time, and from time to time, to require in writing that the Trustee, or any person or entity to whom the Trustee has delegated a power pursuant to any provision of this instrument, be required to give a bond or other security for the faithful administration of its or their duties under this instrument.
. Power To Change Beneficial Enjoyment Of Trust Property. The Protector shall have the power, exercisable at any time, and from time to time, to alter the beneficial enjoyment of the _____________ Gift Trust by naming any one or more entities that are then in existence and described in Code Section 2055 (describing public, charitable and religious organizations), as additional beneficiaries of the _________.
. Consent Of Protector. Any provision of this instrument which requires the consent of the Protector shall require the Protector's written consent. Furthermore, failure by a Protector to give any such consent or make any decision or to communicate with the Trustee regarding any such consent or decision shall be deemed for all purposes as a refusal to consent and shall be treated by the Trustee as a refusal to consent.
. Death Of Protector. The duties and powers of the Protector shall be personal and shall cease upon the death of the person holding such office (if an individual) or upon the dissolution of the entity acting as Protector (in the case of a corporation or other entity acting as Protector). The powers of the Protector shall not be capable of being delegated or of being exercised by any representative (whether a personal representative or otherwise), agent, receiver, or liquidator of the Protector.”
However, this role of a trust protector remains ill defined or understood in Texas. As discussed previously, the uncertainly provides a planning opportunity. As a safeguard, the client may appoint one or more trust protectors and grant them the authority to modify a trust or limit their authority to make certain modification. Also, the trust protector can be used to appoint a trustee, remove a trustee, ratify decisions of the trust, terminate a trust, move a trust to another jurisdiction, or even insulate a trustee from liability. The uncertainty of the role, however, also results in uncertainty as to the protector’s potential liability to beneficiaries. Logic would dictate that the protector or advisor role is in and of itself, a fiduciary role. Therefore, exoneration, indemnity, and arbitration provisions should expressly include protectors.
F. Provide for Reasonable Accountability.
Provisions that clarify a fiduciary’s duty to account often reduce future disputes. Therefore, consideration should be given to:
the duty of a fiduciary to account;
whether the burden is on the fiduciary to provide an account periodically or whether the beneficiary must request an accounting;
the type of accounting or information required;
how often an accounting will or should be provided; and
how the cost of the accounting will be allocated.
Note that the failure of a fiduciary to comply with accounting requirements may lead to claims of breach of trust and grounds for removal. Therefore, provisions placing the obligation on the fiduciary to provide an accounting to certain beneficiaries regardless of a request should be made clear to the fiduciary to avoid an inadvertent breach of his or her duty.
G. Plan for Capacity Disputes.
One of the most difficult provisions to draft relates to defining when the client will be considered to be incapacitated. A determination of incapacity may result in the authority for an attorney-in-fact to act under a power of attorney, the removal of a client as trustee of his management trust, or the payment of trust distributions to persons other than the client. Provisions dealing with a client’s incapacity must provide a process to determine when the client has become incapacitated. They should also allow the client to manage and control his or her affairs for so long as reasonably possible.
1. Include a Definition of Incapacity.
Every trust agreement generally provides a method for the appointment and removal of trustees. Typically, the grantor serves as trustee or co-trustee until he or she resigns or becomes incapacitated. Unfortunately, many trust agreements do not provide a definition of incapacity, provide for the removal of a trustee while the grantor is incapacitated, or address the authority of the grantor’s attorney-in-fact in matters relating to the trust. Each of these considerations should be addressed in the trust agreement. See discussion infra.
(a) Grantor’s or Trustee’s Incapacity.
To avoid an issue of when a client is “incapacitated,” estate-planning documents should define when a client, trustee, or relevant party is incapacitated for purposes of enforcing the terms and provisions of the document at issue. For example, the document may define incapacity of the grantor or trustee as follows:
“For purposes of this document, a person, including the grantor or a trustee, shall be considered “incapacitated” when two (2) physicians certify in writing that, based on such physician’s examination of such person, the person is mentally incapable of managing his or her financial matters. By executing this instrument or accepting appointment as trustee, each grantor and trustee hereby authorizes each physician who examines such person to determine his or her incapacity, to disclose such person’s physical or mental condition, the physician’s diagnosis or opinion, and release a written certification of the results of the physician’s finding to any third party including, but not limited to, the grantor, a named successor trustee, a beneficiary, and the attorney-in-fact or personal representative of any grantor or beneficiary.”
The grantor may further restrict the proceeding standard by requiring a specific physician or the selected physician to be board certified in neurology or psychiatry in order to certify a grantor or trustee as being incapacitated.
(b) Beneficiary’s Incapacity.
A determination of a beneficiary’s capacity is sometimes more difficult because he or she has typically not executed the trust agreement or otherwise entered into a contractual relationship that authorizes the disclosure of the beneficiary’s medical or mental heath information. Therefore, a determination of a beneficiary’s incapacity should be drafted to provide the trustee greater flexibility when a physician cannot certify the beneficiary’s capacity. For example, the document may define incapacity of a beneficiary as follows:
“An adult individual beneficiary under this [Will/Trust] shall be considered incapacitated upon a good faith determination made by the fiduciary charged with making such evaluation that such individual lacks the physical or mental capacity, personal or emotional stability or maturity of judgment needed to effectively manage his or her personal or financial affairs (whether because of injury, mental or medical condition, substance abuse or dependency, or any other reason). Individuals under the age of majority shall be considered legally incapacitated.”
2. Include Notice Provisions.
In the event of a beneficiary, trustee, or any other interested individual’s incapacity, the instrument at issue should provide a means to notify certain individuals of such person’s incapacity. These provisions create at a minimum the perception of responsibility on a client, children, spouses, grantor, trustee, or beneficiary, to notify appropriate individuals of the potential incapacity.
Furthermore, documents such as powers of attorney and trust agreements should provide a means for the principal or beneficiary to designate one or more persons who should serve as their designated representative for purposes of receiving notices, reports, or other information during any period that they may be incapacitated. As discussed previously, a power of attorney may require that the agent notify and provide information to a client’s spouse, financial advisor, or other designated individuals. See discussion supra. A trust may include a provision that requires a trustee to notify a minor or incapacitated beneficiary’s parents or legal guardian of any information, reports, or accountings to be provided under the trust agreement. Such a provision may provide as follows:
“Any action permitted to be taken by a minor or other incapacitated person shall be taken by the person’s parents or guardian. Any notice or report required to be delivered to a minor or other incapacitated person shall be delivered to such person’s parents or guardian. If both parents of a minor are living, any such action shall be taken by, and any such notice shall be given to, the parent to whom I am more closely related.”
3. Include a Procedure to Avoid Disputes Based on Capacity.
If possible, documents should provide a general means to avoid disputes based on a client, fiduciary, or beneficiary’s capacity. These provisions provide a method to mitigate disputes and resolve differences in a less adversarial manner. Furthermore, the courts will generally enforce the terms of the contract provided they are not void as a matter of law or against public policy. As discussed previously, arbitration provisions can provide a valid process in which parties may resolve these disputes outside a public litigation. Possible processes to resolve or avoid disputes based on incapacity may be as follows:
Arbitration provisions, see discussion infra;
Presumption of capacity unless the person at issue has been adjudicated to be incapacitated by a guardianship proceeding in the State of Texas;
Presumption of capacity unless two or more doctors certify that such person lacks the requisite capacity;
Requirement that the person in issue submit to a mental and physical exam within 30 days of written request by a trustee, agent or client, or be presumed to be incapacitated for purposes of the governing document.
H. Include Indemnity/Exoneration Provisions.
An indemnity provides an additional layer of protection against liability arising from claims relating to a specific act. Indemnities often provide the necessary incentive to allow an agent or representative to accept his or her appointment or exercise power that may result in claims against the fiduciary. For example, an indemnity may provide comfort to a physician asked to certify the principal’s capacity or allow an agent to consider more aggressive tax planning on behalf of the principal.
Indemnification clauses are, however, usually strictly construed. Therefore, the failure to draft clear indemnification, duty to defend, and hold harmless clauses can result in limited protection and unanticipated liability for the indemnity. Examples of possible indemnity provisions follow.
1. Indemnity of Third Parties.
An example of an indemnity of third parties relying on a power of attorney or trustee’s authority is as follows:
“I hereby INDEMNIFY, DEFEND, and HOLD HARMLESS any third party for any claims, costs or expenses, including attorneys fees and expenses, that arise against or are incurred by such third party because of such party’s reliance upon this power-of-attorney [or trust agreement] at any time prior to the date such party receives actual notice of the revocation of this power of attorney [or trust agreement].”
2. Indemnity of Physician and Healthcare Workers.
When a durable financial power of attorney is drafted to become effective upon the principal’s incapacity, the document should clearly provide a procedure to determine the principal’s disability or incapacity. Section 490, which sets forth the statutory durable power of attorney forms, provides the following suggested language:
“If Alternative (B) is chosen and a definition of my disability or incapacity is not contained in this power of attorney, I shall be considered disabled or incapacitated for purposes of this power of attorney if a physician certifies in writing at a date later than the date this power of attorney is executed that, based on the physician's medical examination of me, I am mentally incapable of managing my financial affairs. I authorize the physician who examines me for this purpose to disclose my physical or mental condition to another person for purposes of this power of attorney. A third party who accepts this power of attorney is fully protected from any action taken under this power of attorney that is based on the determination made by a physician of my disability or incapacity.”
To obtain the required medical, it is advisable to bolster the suggested statutory language regarding the release of the principal’s medical information. This may include express limited authority to release the principal’s medical information and an indemnity related to such release. For example, the power of attorney may include the following provision:
“I do hereby authorize the release of my medical and mental health information to my agent under this power of attorney and hereby INDEMNIFY, DEFEND and HOLD HARMLESS any third party including, but not limited to all physicians or other healthcare professionals including, by way of example but not limitation, physicians, psychiatrists, psychologists, neurologists, registered nurses, and/or physical therapist, for any claims that arise against such person or persons due to such person or persons examining me for the purpose of determining whether I am incapacitated, and issuing a written opinion certifying the results of their examination as to my mental and/or physical capacity or incapacity to manage my financial affairs. I hereby INDEMNIFY such person or persons from claims by myself, my agent, my guardian, my personal representative, and any third parties including, but not limited to attorneys’ fees and expenses, experts, and litigation costs.”
3. Indemnity of an Agent.
An example of an indemnity of an agent for possible claims by “disappointed” family member, heirs and beneficiaries follows:
“My agent shall not be liable for any loss or depreciation in value of my properties, except any loss attributable to gross negligence, a willful breach of fiduciary duty or bad faith on my agent’s part, and my agent shall not be accountable or held liable for any act or omission if my agent has used good faith and ordinary care in the exercise of his powers under this power of attorney. I do hereby INDEMNIFY, DEFEND, and HOLD HARMLESS my agent from claims by any third person, including by a guardian appointed for my person or estate and the personal representative of my estate upon my death; provided, however, I expressly do not indemnify my agent (i) from any claims by me in my individual capacity, or (ii) from any claims in the event my agent seeks, directly or indirectly, the appoint of a guardian of my estate, or (iii) claims or losses attributable to gross negligence, the willful breach of fiduciary duty or bad faith on my agent’s part. For the purposes of this paragraph, claims by any third party may relate to the exercise of any power of my agent authorized by this power of attorney including, but not limited to, the my agent’s decision to make tax-motivated gifts of my property, to disclaim any asset I may otherwise have a right to receive, create a management trust solely for my benefit during my lifetime, or to exercise or not exercise any power granted to my agent under this power of attorney.”
I. Consider the Benefit of a No Contest Clause.
Most estate planning lawyers are generally familiar with the use of no contest clauses in wills. Less often, no contest clauses have been used effectively to avoid disputes involving the dispositive provisions of a trust. A no contest clause, however, does not need to be limited to dispositive provisions of an instrument. Rather, Texas law recognizes that no contest provisions can be drafted as broadly or narrowly as the testator or grantor deems appropriate. Provided the no contest clause is specific and direct in its intent, Texas courts will often enforce these provisions. Furthermore, the testator or grantor can provide that a potential beneficiary’s interest shall be void even if the challenge is made in good faith.
Therefore, a client may consider using a no contest provision to avoid interference both during his lifetime and at his death. A no contest provision in a will or trust may be expanded to provide that if any named beneficiary challenges any action of the client’s attorney-in-fact, under her duly executed power of attorney, or a trustee, pursuant to a trust created by the client, the interfering beneficiary’s interest under the will and trust shall be avoid. Although arguably not necessary, it would preferable to require that the challenged client’s agent or trustee be required to give written notice of the no contest clause to the potential heir and that the potential heir be allowed a reasonable period of time in order to withdraw his challenge, contest, or other means of interfering with the client’s designated agents and representatives. Furthermore, a no contest provision should be drafted in a manner that balances the interest of the client to avoid interference, with the ability of third parties to raise valid complaints should an agent, trustee, or executor, be using the no contest provision as a sword instead of a shield.
J. Consider Including An Arbitration Clause.
Arbitration continues to provide parties an alternative forum in which to settle disputes and often avoids unwanted publicity or disclosures associated with a public proceeding. To be binding, parties must contractually agree to submit their disputes to arbitration in lieu of, or in addition to, other remedies available under Texas law. In the past decade, arbitration procedures have been routinely included in agreements involving business associations such as partnerships, employment, purchase and sale, and professional services agreements. While there is no Texas law specifically addressing an arbitration clause in a trust agreement, it is generally believed that a grantor and trustee may agree to the inclusion of a binding arbitration provision in a trust agreement. By creating a trust agreement, a grantor is bound by all of its terms, including the arbitration clause. Furthermore, by accepting appointment as trustee, the trustee effectively agrees to be bound by all agreements set forth in the trust agreement, including the arbitration clause. An argument can also be made that a trust beneficiary is also bound by the arbitration clause as he or she takes his or her interest subject to all of the terms and conditions of the trust, including the arbitration provision. An arbitration clause generally will not, however, be effective at resolving disputes relating to the capacity of a client to execute the underlying agreement because the arbitration provision itself will not be valid and enforceable if the underlying agreement fails as a matter of law.
Among the aspects that the grantor may require to be submitted to arbitration could include disputes regarding any trustee’s incapacity. The grantor of a trust has the ability to fashion arbitration provision as he or she chooses, as there are no specific requirements with regard to submitting disputes to arbitration. If arbitration is desired, the arbitration provision should expressly address the matters that may be submitted to arbitration, the process of arbitration, who shall pay the fees of arbitration, and whether there are any specific requirements as to the proposed arbitrators, such as doctors, board certified lawyers, etc. A sample arbitration provision generously provided by Mr. Hal Moorman, with Moorman, Tate, Moorman, Urquhart & Haley, L.L.P., is attached to this article.
FORM: A sample of an Arbitration Clause is attached as Exhibit A.
K. Utilize Debt and Tax Allocation Clauses.
Even though this outline primarily focuses on non-tax issues, it is impossible to exclude a discussion of debt and tax allocation clauses. It is important to coordinate the payment of debts and transfer taxes. The instruments should clarify how debts and death taxes should be allocated between and among non-probate assets, specific bequests, marital and charitable beneficiaries and residuary gifts.
Alternatively, the use of a tax and debt allocation clause may be beneficial in allowing selected beneficiaries to receive certain assets tax and debt free, while requiring others to take any remaining property subject to such debts and expenses. For example, a potential will contestant may be mislead into believing that he or she will receive a significant portion of a decedent’s estate and, therefore, not challenge a will, only to learn that the majority of the probate assets will be required to satisfy the death taxes due to the inclusion of non-probate assets passing to the intended beneficiary.
L. Include Attorney Fee and Expenses Allocation Clause.
Similar to debt and tax allocation clauses, it is important to consider how legal fees and expenses should be allocated between and among beneficiaries. The instruments should address whom and under what circumstances such fees and expenses will be allocated against a particular beneficiary’s share or interest. The instrument may also limit the circumstances when a beneficiary can seek reimbursement for his or her legal fees. See Donaho, Offensive and Defensive Estate Planning, State Bar of Texas 25th Annual Estate Planning and Probate Course, June 2001.
VIII. MISTAKE 8: FAILING TO PLAN FOR FLEXIBILTY.
While we assume that most estate planning documents are flexible, if for no other reason that the client’s ability in mot instances to revoke and re-execute new documents, planning for flexibility is still crucial. Failing to plan and draft for flexibility can be especially problematic for the elderly client who may lose the ability to revoke and re-execute in the event of incapacity. Additionally, many estate planning documents will continue to govern the lives of the client’s beneficiaries long after a client’s death. During this time, a number of events can occur which will render the client’s initial plan unsatisfactory. For example, the premature death or incapacity of a child, wide variations in the relative financial success of children, the souring of family relationships, etc. Building in flexibility allows the client’s estate plan to become a living, adaptable instrument, capable of changing to meet a client’s expressed goals, while failing to do so often results in substantial deviations from those goals.
A. Address Powers To Modify or Revoke.
With the exception of a client’s will, the governing documents should address who and when the instruments can be modified. Of particular importance will be the power to modify a trust over the next decade as Congress continues to debate (or not debate) changes in the transfer tax structure.
1. Agent Under a Durable Power of Attorney.
An agent under a power of attorney cannot modify or revoke a trust unless expressly authorized. Therefore, the agent’s authority to create, modify, or terminate a management trust should be clearly set out in the durable power of attorney. The agent may be granted broad discretion or allowed only to make non-dispositive modifications. At a minimum, the client should consider granting the agent sufficient authority to take advantage of potential transfer and income tax opportunities, such as modifying funding provisions to maximize basis adjustments in a carry-over basis environment. Note, however, care should be taken to avoid creating a general power of appointment in the agent and thereby creating the potential inclusion of trust assets in your agent’s estate at his or her death.
Likewise, when the client owns an interest in a partnership, the partnership should clarify the rights of any partner’s agent to modify or withdraw for the partnership. It should also address the rights of the agent to act as a partner or whether his or her interest will be limited to that of an assignee.
2. Guardian.
A guardian generally cannot modify or revoke a trust unless expressly authorized. Generally, this is advisable in order to discourage attempts by third parties to use a guardianship proceeding to interfere with administration of the trust. The problem is that the appointment of a guardian may void a power of attorney and thus prevent the agent from taking advantage of potential transfer and income tax opportunities, such as the modification of funding provisions to maximize basis adjustments discussed above. As a safeguard, the trust may provide that a guardian may be authorized to make certain limited modification, or allow only certain selected persons, if appointed guardian, to effectuate such amendments or modifications.
Again, when a partnership is involved, the partnership agreement should clarify the rights of any partner’s guardian to modify or withdraw for the partnership or to act on behalf of the partner.
3. Others.
As discussed above, the appointment of a guardian will suspend and may effectively and terminate an agent’s powers unless reinstated by the court. There are no such provisions, however, with regard to trust protectors. Rather, the authority of the trust protector remains an ill-defined and little understood capacity in Texas. This uncertainty provides a planning opportunity. As a safeguard, the client may appoint one or more trust protectors and grant them the authority to modify or terminate trust or limit their authority to make certain modification. See discussion supra.
B. Ability to Make Future Gifts.
If future gifts are a possibility, the governing documents should grant the power to make gifts and coordinate the various fiduciaries rights and powers to implement a gift program. For example, the ability to make gifts under a power of attorney is useless if all the assets have been transferred to a management trust and the trustee refuses to distribute assets to effectuate the contemplated gifts. Furthermore, a trustee may be concerned about being sued for breach of fiduciary duty when the instrument does not authorize him or her to distribute trust assets to allow for the gifts planned by the agent. Thus, consideration should be made to:
who has authority to make gifts;
how the gift can be made;
to whom or what charitable entity the gift can be made;
whether the agent has the authority to request distributions from a trust for purposes of implementing a gifting program;
the liability or exoneration of a trustee in distributing such either to the agent or the designated donee;
the right or power of a trustee to make gifts; and
inclusion of crummey powers.
C. Consider Including Powers of Appointment.
Powers of appointment remain one of the most commonly utilized and powerful tools to provide flexibility. Powers of appointment in favor of descendants or charity provide broad flexibility with a class of beneficiaries most people are comfortable with including.
Often on the drafting a will or trust, the testator or grantor does not know how the lives of his or her various beneficiaries, especially young beneficiaries, may progress. For example, following the death of one parent, child number one may become the next Bill Gates while child number two elects to become a teacher in a small Texas town. If the surviving parent who is the beneficiary of the bypass trust created by the deceased spouse holds a special testamentary power of appointment, the exercise of that power can avoid compounding child number ones looming transfer tax problems and provide extra security for child number two in order to allow their continued pursuit of their noble profession.
In another instance maybe both children become wildly successful or maybe both end up in prison, or maybe both do both, the potential to appoint all assets to a charitable beneficiary provides a nice alternative to what it a wasted, for difference reasons, gift in each circumstance. The most important aspect of drafting powers of appointment is making sure that the client fully understands the scope of the power and, when appropriate, to limit the power accordingly.
D. Consider Trust Protectors and Advisors.
See discussion of Trust Protectors infra.
IX. MISTAKE 9: FAILING TO PLAN FOR POSSIBLE CAPACITY CHALLENGES.
When a client suffers from a condition that may raise an issue whether he or she lacks capacity to execute a will or similar estate planning documents, consider including additional provisions and/or taking extra precautions that may be beneficial in the event that the document is later challenged. A discussion of some commonly utilized techniques follows.
A. Gather Evidence of Client’s Capacity.
First, determine whether it would be beneficial to obtain additional evidence as to client’s capacity to engage in the contemplated transaction. In making this determination, an advisor should review the client’s age, current and prior health, family relationships, possibility of conflicts and challenges, and complexity of the anticipated transaction. Evidence of a client’s capacity is often beneficial when a client is advanced in age and foresees a challenge to his or her estate plan. Such evidence is particularly important when the client suffers from an existing disability that could call his or her capacity into question. Each of these points is discussed in below.
1. Non-Medical Evidence.
Most estate planning representations begin with a face-to-face meeting with the client or potential clients. It is during the initial meeting that an attorney, either knowingly or instinctively, begins the process of evaluating his or her client for purposes of gathering evidence of a client’s requisite mental or testamentary capacity. Such assessment is vital to ensuring that the client’s wishes are carried out. Often the estate-planning attorney is the single most important witness in a subsequent challenge to the client’s capacity. It is his or her observations that are the foundation of the proponent’s case when asserting the client had the requisite capacity to execute the will, trust, or other estate-planning document. Because capacity is a fundamental requirement to execute the will, the attorney can typically venture into areas that would otherwise be considered outside the scope of legal representation. Often the client understands it is necessary to ask these questions to increase the likelihood the will or estate planning document will be enforceable in the future.
The extent of this evidence-gathering process generally depends on the age, medical condition, and any possible disabilities of the client. Therefore, when the client is in their forties, has suffered from no accident or head injury, and appears to exhibit no signs of the questionable capacity, the initial assessment may be nothing more than asking about his or her family, property, and his or her proposed disposition. When a client is in the first stages of Alzheimer’s, however, additional information should be requested as part of the initial assessment. For example, the attorney may ask about the client’s family history including, but not limited to, children, grandchildren, brothers, and sisters, even though these individuals may not be included in the estate plan. It is the attorney’s ability to testify that the client was aware of all these individuals that will further clarify or provide evidence that the testator knew of his family, even the extended family, at the time he or she executed his or her will. If the testator intends to leave his or her property to someone other than the “natural objects of his or her bounty,” such as a charitable entity the attorney and client should discuss the client’s reasons for this disposition. Regardless of the reasons, if the client’s intent is founded on a reasonable basis, this will support the admission of the will and the client’s capacity.
Additionally, the lawyer should discuss in detail the client’s property interests. Again, this will allow the attorney to testify that the testator was familiar with the nature and extent of his or her property.
Finally, the attorney should discuss with the client his or her medical condition, the medications he or she is taking, and, if appropriate, ask the client to recall various matters of local or national significance. Often a client will not be insulted when asked these questions after a candid conversation with regard to your desires to make yourself a fact witness so his or her intent can be carried out at a later date.
2. Medical Evaluations.
In certain cases, it may be appropriate for the client to seek a medical evaluation before proceeding with the estate planning representation. This evaluation serves two (2) purposes. First, it may be questionable whether the client has the requisite capacity to execute his or her estate planning documents. This sometimes occurs after a client has had a stroke, brain injury, or is subject to a guardianship. In these situations, the medical evaluation may be beneficial in determining the client’s capacity to proceed with the requested representation. Second, while the attorney may be comfortable the client possesses the requisite capacity to pursue the representation, the client’s family or financial situation may indicate that a subsequent will contest is likely. In such cases, a medical evaluation on or around the time of the execution of estate planning documents often provide additional evidence that the testator had the requisite capacity to engage counsel and execute his or her estate planning documents.
(a) Documentation.
The medical evaluation may simply be recorded in the physician’s medical records. For example, on the day the document is signed, the client may schedule his annual physical. The client would ask his physician to note that he is good health, oriented, alert, etc.
Alternatively, the results of an examination may be preserved in the form of a letter from the client’s treating physician or a complete psychological or neurological evaluation. A letter may range from a simple confirmation of an examination to a lengthy letter that advises the attorney of the results of a full mental health evaluation.
(b) Selecting the Physician.
Generally, a client’s long-term treating physician should be first considered to provide or document a client’s capacity. However, not all physicians will be automatically recognized as competent to provide an opinion of a person’s capacity. See Broders v. Heise, 924 S.W.2d 148 (Tex. 1996) (Texas Supreme Court affirmed exclusion of emergency room doctor’s testimony offered to establish relationship between patient’s head injury and death). For example, in Broders, the Texas Supreme Court found medical experts are not automatically qualified to testify as to all matters simply because they possess a medical degree. Id. at 153 (citing Ponder v. Texarkana Memorial Hosp., 840 S.W.2d 476, 477-78 (Tex.App. – Houston [14th Dist.] 1991, writ denied)). Texas courts will generally recognize internists, psychiatrist, neurologist and those with a geriatric specialty as experts on capacity issues. Opinions by other medical specialists, i.e., an orthopedist, gynecologist or podiatrist, may not be automatically recognized.
If a physician is to be retained for purposes of completing the medical evaluation, a psychiatrist or neurologist is preferable. A good approach to selecting a physician is to ascertain and hire a physician that the court routinely appoints to conduct an independent psychiatric examination in guardianship proceedings. These individuals generally have the court’s respect and the requisite level of expertise in the areas of capacity and mental examinations.
Regardless of the physician selected, he or she should be board certified, if possible, and have adequate credentials. At the time of the testing, the physician should be aware of the applicable capacity test, including testamentary, and any other capacity which may be required, in order to execute the proposed documents. When the client is subject to a guardianship, permission of the ward’s guardian, and possibly the court, may be required to proceed. This can be generally handled by the guardian submitting an application to the court advising it of the ward’s requests and seeking permission to proceed with psychological and neurological testing of the ward in order to determine whether he or she has the requisite capacity to execute estate planning documents.
In Houston it is not unusual to see charitable gifts made to one of our outstanding medical institutions. If possible select a physician that is not affiliated with the proposed charitable entity if at all possible.
B. Drafting Considerations.
1. Simplicity Versus Complexity.
Inherent in the definition of capacity is the requirement that the person understood the transaction in which he or she was engaged. For example, testamentary capacity requires that the testator understood he or she was executing a will, and the effect of its terms. Due to our current transfer tax structure, most wills include lengthy and complex provisions that address a plethora of administrative and tax issues. While generally advisable, these additional provisions can create a lengthy and onerous document.
When a challenge based on capacity may be an issue, the advisor should opt for simplicity over complexity. A contestant of the will may attempt to convince a jury that the testator could not have understood the contents of the will and thus could not have had the requisite testamentary capacity. Putting the proponent on the stand and asking him or her to explain certain portions of the will can illustrate this. While the test for testamentary capacity does not require that the testator understand every provisions of his or her will, a jury may be persuaded by this argument.
When drafting a will or other estate planning instruments, the drafter should attempt to simplify the document based on the facts and circumstances of the particular client. For example, a client that has a marginally taxable estate may benefit from a shorter will that provides for the outright disposition of his or her estate and only includes necessary boilerplate to ensure the bequests are carried out. The drafter may choose to exclude standard provisions providing for contingent trusts, addressing administrative issues, and providing for the payment of transfer taxes, including tax apportionment, etc. Also, for example, the drafter may elect to utilize the more straightforward statutory durable power of attorney over his or her potentially more effective but likely more complicated non-statutory long form durable power of attorney. Finally, an outright charitable gift is clearly s simple alternative to the creation of a private foundation or any more sophisticated continuing charitable strategy arising at death.
2. Identify Family Members – Included and Excluded.
One of the elements of testamentary capacity is that the testator is aware of the natural objects of his or her bounty. See discussion supra. It is advisable to identify the testator’s family in the will even if he or she does not intend to provide for them. This evidences that the testator was aware of these individuals. The will may also include a statement that the testator has made no provision for them in his or her will, however, any stated reasons should be carefully drafted to avoid a potential claim of testamentary slander. If the documents identify the beneficiaries by name, it is important to make sure the testator has their names spelled correct.
In the charitable beneficiary context it may be easier to draft the statement of intent in terms of the reason the testator desires to benefit the charity rather than the reasons for not benefitting the natural objects of his or her bounty.
3. Identify Assets - Generally.
Another element of testamentary capacity is that the testator is aware of the nature and extent of his property. See discussion supra. As evidence, the drafter should consider identifying the testator’s assets. A detailed listing is not necessary. Rather, the will may include a general listing of the assets in the will. For example, they may provide that the testator owns a home in Austin, a vacation house in Kerrville, cash, securities, automobiles, furnishings and personal effects and other real and personal property. Again, this provides some evidence in a subsequent will contest of the testator’s capacity.
With regard to a specific charitable gift of a specific asset consider gathering more specific evidence as to the asset and why that specific asset of assets were selected.
C. Accommodations for Visually Challenged Clients.
When the testator suffers from impaired vision, consideration should be given to how the testator will review the document prior to its execution. The computer age provides a number of tools to assist in this regard. If the testator has limited sight, the drafter should consider enlarging the print size. Similarly, double-spacing the document and/or a magnifying glass often assists the testator when reviewing the proposed will and ancillary documents. If, however, the testator has such limited sight that he or she cannot review the document, the drafter, in the presence of witnesses, should read the will and ancillary documents to the testator. Pour-over wills may be recommended in these situations. This allows the drafter to read the entire will and the dispositive provisions of the trust to the testator in a reasonable period of time.
D. Fully Funded Management Trusts.
A fully funded management trust is an effective defense against a subsequent will contest. Unlike a will, a trust does not require adjudication prior to its enforcement. The trust is presumed to be valid until a person with standing is successful in establishing the client lacked capacity to create the trust. Therefore upon the client’s death, the trust increases the likelihood of continued uninterrupted administration and disposition of all assets funded into the trust prior to the client’s death.
The trust can also provide for the payment of a named executor’s legal fees to pursue the probate of the client’s will. This prevents the named executor being placed in a financial stranglehold pending the admission of the will and the payment of his fees and expenses incurred in admitting the client’s will to probate.
Of course, the key is to have transferred the majority, if not all, of the client’s assets to the trust prior to the client’s death to avoid the need to engage in a protracted will contest. Therefore, the client should attempt to execute the necessary deeds and conveyances while he or she has capacity. The client’s attorney-in-fact should also be expressly authorized to transfer the client’s assets to the trust. See discussion supra.
E. The Execution “Ceremony”.
1. Location, Location, Location.
When there is an increased likelihood of a contest, the drafter should give careful consideration to where the document is executed as this is often a focus in a subsequent will contest or similar proceeding. If possible, the client should execute his or her estate planning documents at the drafting attorney’s office. This is indicative of a typical business arrangement and that the client’s health was sufficient to travel to the attorney’s office. If at all possible, the client and the drafting attorney should exclude all beneficiaries and designated agents (including development officer of a benefitting charity) from the execution arrangements. While the client may depend on these persons, it is that dependency that can lead to claims of influence or manipulation. The client should be encouraged to drive him or herself, if able, or arrange another means of travel that indicates a level of capacity.
If it is necessary to execute documents at home or in a hospital, arrangements should be made to ensure independent and credible witnesses and a Notary Public are present. It is also helpful if the witnesses and Notary Public are persons who can be readily located in the future.
When significant charitable dollars are at stake, under no circumstances should the execution ceremony take place in the charities conference room nor should anyone associated with the charity be present.
2. Persons Present at Execution.
As discussed supra, all potential beneficiaries and agents (including development officer of a benefitting charity) should be excluded from the execution ceremony. The advisors should also encourage the client to exclude potential beneficiaries and agents (including development officer of a benefitting charity) from all arrangements related to the drafting of the documents, including driving the client to meetings, reviewing drafts of the will and other documents, reading the documents to the client, being present at any meeting between the client and his attorney, and paying (directly or indirectly) for the estate plan. Further, at least two (2) credible and competent witnesses and a Notary Public should be present during the entire ceremony. See discussion infra.
3. Selecting Witnesses and Notary Public.
It is important to select witnesses that will be good witnesses in the future. The Notary Public is a witness as to the formalities and his or her observations. Potential witnesses may include, attorneys, legal assistants, the client’s accountant or other professional advisor, long-term friends of the client, or a spiritual advisor. Consideration should be given to witnesses that will be available and willing to testify in the future. At the execution ceremony, it is advisable to encourage these individuals to engage in conversation with the client and, if appropriate, ask questions to satisfy any capacity questions or concerns. The extent of the conversation and interaction depends on their prior contracts with the client.
If capacity is a significant issue, the attorney should also consider involving a medical professional in the execution ceremony, either as an attesting witness or consultant prior to the execution. It is advisable to weigh the impact his or her presence may have in triggering an inquiry by an interested party or the court which might not otherwise occur. This requires a balancing act. If undecided, err on the side of caution and involve the medical professional.
When the client is hospitalized, the attorney should consider whether to discuss with the client’s physician or the nurse on duty the client’s present condition prior to executing the estate planning documents. It may also be beneficial to find out whether the client had visitors and, if necessary, interview them. In certain circumstances, it may be advisable to review the client’s medical chart and encourage a notation as to the client’s mental state at or near the time of the document execution.
The drafter should also consider whether it would be beneficial to review each provision of the will and other documents with the client in the presence of the witnesses. When reviewing a will or trust, explain the effect of a particular provision on the bequests made to other family members. Also, secure a confirmation of a large gift to one child. If the client confirms that he or she understands the effects of his or her plan, the drafter will have more assurance that the client fully understands the entire estate plan. As an extra precaution, it may be useful to read the instrument in the presence of the attesting witnesses. If possible, the will should be simple and easy to understand. Simplicity ensures that the client understands each provision and will not tire before the will is read and executed.
Finally, the execution ceremony should be conducted with a high level of formality. The witnesses and Notary Public should remain in the client’s presence during the entire execution ceremony. They should all be in each other presence when signing the documents. After the documents are signed, the Notary Public should administer all required oaths and require each witness to raise their hand while doing so. It is these details that will be the subject scrutiny if the documents are challenged.
F. Memos to File.
Upon the conclusion of the execution ceremony, the attorney should consider dictating a memo to his or her file. The memo may later refresh the recollections of the attorney in the event of a challenge to the documents. The memo should reflect the persons in attendance, the place of execution, any significant matters discussed, for example, the identity of family members, why a specific charitable entity or cause is provided for, the reasons for executing the documents, and that the client understood the documents he or she was executing. Furthermore, the memo should reflect when persons entered and left the place of execution, and the time and sequence of the execution ceremony, for example, which documents were signed first, who took the requisite oaths, etc. If possible, the witnesses and the Notary Public should prepare similar memos for the attorney.
G. Storage of Documents.
An attorney should discuss with the client where the documents should be stored. Some clients may be better served when the attorney keeps the original documents. Other clients want to take possession of the original documents. This can, however, lead to future claims of loss, revocation, and destruction by third parties. Regardless of the ultimate decision made, the attorney should document the storage of the documents in their file. If the instruments are given to the client, the attorney should follow up with a letter to the client confirming that the client decided to take possession of these documents. The attorney may also suggest that the documents be placed in a safe deposit box to avoid access by third parties. Alternatively, if the client requests that the attorney continue to maintain the originals in his or her offices, this should be confirmed in a letter. Finally, in the event a large charitable distribution is contemplated and if the client doesn’t desire anonymity, have the client consider giving a copy to the development office of any specifically identified charitable entity.
Also, if the client does not want the attorney to release the will or ancillary documents to third parties (other than, for example, named agents in ancillary documents), in the event of future incapacity, this fact should be confirmed in a letter to the client. Such a request becomes significant in the event a guardian of the client’s person and/or estate is appointed. See discussion infra.
H. File Maintenance.
Efforts should be taken to maintain the client’s file. The attorney’s file is generally the first documents subpoenaed in a lawsuit involving the validity of the estate plan. This will occur after the client’s death in a will contest; however, it may occur sooner when a guardianship proceeding is commenced involving the client’s person or estate. Therefore, at the conclusion of the engagement, a review should be made of the file to confirm it is in good order in the event it must be produced. A review may include confirming that the attorney’s notes are in good order (if retained), deciding whether any phone message reminders should be retained, and deciding whether any drafts with the client’s (or another’s) handwriting should be retained. Copies of the signed documents should be included in the file. Affidavits of any witnesses and Notary Publics, and memos to the file should be placed in the client’s file. It is also beneficial to include a copy of the page in the Notary Public’s record book relating to the documents. It is important to recognize that once a file is subpoenaed or subject to a document production request, it must be produced in its then existing form.
I. Provide a ‘Defense’ Fund
1. Lifetime Gifts.
A well-planned lifetime gifting program may provide an intended beneficiary sufficient funds to retain counsel to pursue the probate of a client’s will. Given, however, the expenses of a will contest, the beneficiary may or may not have received or retained sufficient funds to fully fund the anticipated cost.
2. Life Insurance.
Life insurance may be used to provide a beneficiary initial funds to retain counsel to pursue the probate of a client’s will. However, if the client recently changed the beneficiary designation, the contestant may be successful in convincing a court or even the insurance company to suspend the release of the death benefit pending a challenge.
3. Funded Trust.
A funded trust can often provide the proponent of a will the funds to defend the client’s will. The terms of a trust should be drafted to authorize the trustee to either engage counsel to defend the will or to make distributions to the proponent to engage counsel to defend the will. However, a contestant may attempt to enjoin the trustee from making distributions pending a challenge to the validity of the trust.
4. Right of Survivorship Accounts.
Similar to life insurance, a right of survivorship account may be used to provide a beneficiary initial funds to retain counsel to pursue the probate of a client’s will. However, if the client recently created or changed the beneficiary designation, the contestant may be successful in convincing a court to enjoin the release of the account pending a challenge over the validity of the designation.
5. Saving Bonds.
Savings bonds can provide an effective means for a beneficiary to generate initial funds to retain counsel to pursue the probate of a client’s will. Federal savings bonds can be issued in the name of the client and another person. Upon the client’s death, the ownership passes by federal statute to the other named person. As they are governed by federal law, third parties and even courts are less inclined to enjoin the sale of such bonds by the named beneficiary.
X. MISTAKE 10: FAILING TO PAY ATTENTION TO THE DETAILS.
Attention to detail may be the greatest attribute of the successful estate planner. Unfortunately, the failure to pay attention to detail may be as detrimental in the estate planning context as in any other aspect of legal practice. This section provides a checklist of selected detail items which warrant careful consideration.
• Have I properly identified the testator, spouse, and children? If not, you may arguably disinherit by defining an individual out of a class of beneficiaries such as children.
• Have I addressed pretermitted children? If not, children adopted or born after the execution of the will may either (i) receive less than the testator desired due to the method of calculating the pretermitted child’s estate share or (ii) receive more than desired if, for example, the residual beneficiary was a charity and the calculation of the pretermitted child’s share resulted in all assets passing to the pretermitted child.
• Have I revoked all prior wills and codicils? If not, all prior wills and codicils will be read together in order to “piece together” the testator’s intent.
• Have I inadvertently made gift more than once? By including a pecuniary bequest to an individual or charity in the wills of both spouses without some limiting language such as “if my husband predeceases me” may result in a gift being made two times.
• Have I failed to be consistent within the will? Do not make a gift of the same property to more than one individual or charitable beneficiary.
• Have I made adequate provisions for the lapse of a gift? If a beneficiary predeceases the testator, the gift will generally lapse unless specific provisions are made otherwise.
• Have I verified that gift ademption is consistent with the testator’s intent? If not, a testator may advise you to give a beneficiary his $5,000 watch when the testator’s real intent was for the beneficiary to receive some gift with a value of $5,000, even if the watch no longer existed.
• Have I verified that the testator’s intent was to make a specific gift of an asset free and clear of all liens? If not, the payment of debts and liens on specifically gifted property may frustrate the testator’s purpose with regard to the passage of the residuary estate.
• Have I addressed the possibility of lifetime gifts being treated as advancements? If not, the testator’s payment of a beneficiary’s school expenses, the down payment on a beneficiary’s home or other pre-death transfer could result in a substantial unintended windfall for that beneficiary.
• Have I verified that the Section 322B abatement rules are consistent with the testator’s intent? If not, Section 322B may serve to eliminate gifts to certain beneficiaries in a manner wholly inconsistent with the testator’s intent.
• Have I verified that the Section 322A tax apportionment rules are consistent with the testator’s intent? If not, certain beneficiaries may receive far less than the testator anticipated after the payment of transfer taxes.
• Have I reviewed the will for typographical errors? While the misspelling of a client’s or beneficiary’s name can irritate a client, it can also result in the inadvertent distribution of property to the wrong beneficiary, class of beneficiaries or charitable entity.
• Have I disposed of the residue of the estate? If not, the laws of descent and distribution will govern the transfer of the residue. This is also a great place to consider a charitable contingent disposition which, by the way, should also insure full disposition of the residue.
• Have I correctly identified the charity that the testator intends to benefit? Incorrectly identifying a charity can lead to the gift being made to the incorrect charity or not being made at all. See Estate of Kenneth E. Starkey v. United States where attorney/son incorrectly identified the intended charitable beneficiary church resulting in the court’s decision that the description described and unspecified class of beneficiaries and did not provide the language or express an intent under IRC Section 2055 necessary to qualify the gift for a charitable deduction and its denial of a $1 million charitable deduction. The attorney/son advised the court that he "never claimed to have any estate or charitable planning expertise." Unfortunately he did not attend a course such as our today.
CONCLUSION
As the foregoing discussion illustrates, estate planning mistakes and traps exist through every step of the planning process. The author believes these issues are amplified when you introduce a non-family beneficiary such as a charitable entity. With care and diligence, however, the smart planner can minimize the risks of many common pitfalls. Hopefully you now have some food for thought.
EXHIBIT A
SAMPLE ARBITRATION PROVISION[2]
I. Arbitration of the Issues of Incapacity of a Trustee. The issue of the incapacity of a Trustee shall be resolved by arbitration as provided herein, and the resolution of the dispute as provided herein shall be final as between the parties to the dispute and may be enforced or preserved upon application to any court of competent jurisdiction. The reference to “Trustee” hereinafter shall refer to my initial or successor Trustee under this agreement. The purpose of this section is to provide an impartial, fair, and private means to determine the incapacity (as defined herein) of a Trustee. A Trustee is “incapacitated” when the Trustee lacks the physical or mental capacity, personal stability or maturity of judgment needed to effectively give prompt, intelligent, and rational consideration to business matters or financial affairs (whether because of a medical condition, substance abuse or dependency, or another reason). A person under age 25 is deemed to be incapacitated without the need for arbitration.
A) General Rules. Except as provided herein to the contrary, all proceedings required herein shall be conducted in accordance with the Commercial Arbitration Rules of the American Arbitration Association (“AAA”) as then in effect; provided that such rules shall be applied in accordance with Texas law and that any questions which are not resolved by such rules shall be determined by Texas law. All parties to an arbitration proceeding herein shall make all reasonable efforts to perform their obligations herein promptly, recognizing that time is of the essence.
B) English Rule - Loser Pays. The parties prevailing in an arbitration proceeding herein or in a legal proceeding brought in a court of competent jurisdiction to enforce or preserve the rights awarded pursuant to an arbitration proceeding herein, including all appeals, shall be entitled to recover from the other parties all costs and expenses incurred by the prevailing parties with respect to all of the proceedings, including reasonable attorney’s fees. If a Trustee is determined to be incapacitated, the Trust shall pay the cost of the proceedings. If a Trustee is determined not to be incapacitated, the person bringing the action to have the Trustee declared to be incapacitated shall pay all costs, including attorneys’ fees and expenses, and shall not be entitled to reimbursement from the Trust estate under any other provision of this agreement.
C) Arbitration Procedures.
i) Written Notice of Arbitration. Any party wishing to submit the issue of a Trustee’s incapacity to arbitration (“Petitioner”) shall provide written notice of the arbitration containing the information required below to all Trustees serving hereunder and all income beneficiaries of the Trust currently entitled to receive trust distributions (or their parents if such beneficiaries are under the age of 25) (“Respondents”) and simultaneously shall file copies of the written notice or arbitration with the regional office of the AAA for Houston, Texas, together with the appropriate fee as provided in the AAA’s administrative fee schedule. All communications with the AAA regarding the arbitration proceedings shall be directed to the regional office for _________, Texas, unless the AAA directs otherwise. The written notice of arbitration shall provide a brief description of the nature of the dispute and the resolution sought by Petitioner.
ii) Written Response. Within twenty days after receiving the notice of arbitration, each of the Respondents shall provide the Petitioner and the AAA with a written response describing the Respondent’s opinion of the nature of the dispute and the resolution desired by the Respondent.
iii) List of Arbitrators. As soon as reasonably possible after receiving each response notice, the AAA shall compile a list of arbitrators which are available and are qualified to arbitrate the dispute by having knowledge of the subject matter of incapacity, which list shall contain the names of a number of arbitrators equal to three plus the number of parties to the dispute (Petitioner plus each Respondent) in rank order, and shall provide that list to Petitioner and each of the Respondents, together with a return date which is seven days after the date on which the AAA sends the list to the Petitioner and each of the Respondents, excluding Saturday, Sunday, and holidays.
iv) Qualifications of Arbitrators. The AAA shall compile a list of arbitrators that are available and are qualified to arbitrate the dispute by having knowledge of the subject matter of incapacity. Of the arbitrators selected by AAA and the parties, one arbitrator shall be a medical doctor certified in neurology or psychiatry, and at least one arbitrator shall be an attorney who is either (i) board certified to serve as an ad litem in the State of Texas, or (ii) board certified by the Texas Board of Legal Certification in Estate Planning and Probate Law.
v) Deletions from the List of Arbitrators. Unless otherwise agreed, Petitioner and each of the Respondents shall meet on the return date specified by the AAA at the Principal Office at 10:00 A M., _________, Texas time, at which time each of them shall strike one name from the list of arbitrators provided by the AAA, and if any party fails to attend the meeting, the AAA shall strike one name from the list on behalf of each missing one of them. Unless the arbitrators do not meet the required qualifications, the three highest ranking arbitrators whose name remains on the list after an arbitrator has been stricken by or on behalf of Petitioner and each of the Respondents shall be the arbitrators of the dispute. If the selected panel of arbitrators do no meet the required qualifications or an arbitrator selected in this manner for any reason fails to perform as required by this Exhibit, the procedures provided in this paragraph shall be repeated until the required number of arbitrators are selected as herein provided.
vi) Arbitration of the Dispute. The arbitration shall be held in ___________, Texas, at a location determined by the AAA. The decision of the arbitrator shall be final as between Petitioner and Respondents and may be enforced or preserved upon application to any court of competent jurisdiction.
vii) Standing. The issue of incapacity may be brought to arbitration by a Co-Trustee, a named successor Trustee, an income or remainder beneficiary of the Trust, the parent or guardian of an incapacitated beneficiary, the spouse of the Trustee, the siblings of the Trustee, or such siblings’ child if such child is over the age of 25, the children of the Trustee age 25 or older, or the parent of the children of the Trustee, if such children are all under the age of 25. [This provision can be modified to provide sufficient standing to address the issue but avoid granting standing to potential interlopers].
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[1] The authors would like to thank Arielle M. Pragner of Davis Willms, PLLC for her contribution related to non-probate transfers from her article entitled: Planning for the Transfer Of Non-Probate Assets at Death and Bernard E. Jones, for the use of sample language excerpts from his FLEXDRAFT document system.
© Patrick J. Pacheco 2018, All Rights Reserved
[2] The author sincerely thanks Mr. Hal Moorman for providing the preceding suggested arbitration provision.
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