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Estate Planning Overview , Part II
By Paul Nicolosi

Your Durable Power of Attorney

For most people, the durable power of attorney is the most important estate-planning instrument available-even more useful than a will. A power of attorney allows a person you appoint – your “attorney –in-fact “ – to act in your place for financial purposes when and if you ever become incapacitated.

In that case, the person you choose will be able to step in and take care of your financial affairs. Without a durable power of attorney, no one can represent you unless a court appoints a conservator or guardian. The court process takes time, costs money, and the judge may not choose the person you would prefer. In addition, under a guardianship or conservator ship, your representative may have to seek court permission to take planning steps that she could implement immediately under a simple durable power of attorney.

A power of attorney may be limited or general. A limited power of attorney may give someone the right to sign a deed to property on a day when you are out of town. Or it may allow someone to sign checks for you. A general power is comprehensive and gives your attorney-in-fact all the powers and rights that you have yourself.

A power of attorney may also be either current or “Springtime”. Most powers of attorney take effect immediately upon their execution, even if understanding is that they will not be used until and unless the grantor becomes incapacitated. However, the document can also be written so that it does not become effective until such incapacity occurs. In the power of attorney be clearly laid out in the document itself.

While you should seriously consider executing a durable power of attorney, if you do not have someone you trust to appoint it may be more appropriate to have the probate court looking over the shoulder of the person who is handling your affairs through a guardianship or conservatorship. In that case, you may execute a limited durable power of attorney simply nominating the person you want to serve as your conservator or “guardian”.

Your Medical Directive

Any complete estate plan should include a medical directive. This term may encompass a number of different documents, including a durable power of attorney for health care and a living will. The exact document or documents will depend on the choices you make. This document designates someone you choose to make healthcare decisions for you if you are unable to do so yourself. A living will, discussed below, instructs your health care provider to withdraw life support if you are terminally ill or in a vegetative state.

Power of Attorney for Health Care The statutory power of attorney for health care, mentioned above, is one example of a medical directive. The power of attorney is a much more efficient and powerful tool than the living will, but the living will has the advantage that it is self-actuating and needs nothing else but to be available when needed. The delay in locating the agent under a health care power of attorney may mean that the health care provider must act without the limitations expressed in the power of attorney, at least initially. If you are traveling when health care is needed, the existence of the living will may be easier to confirm through your physician or family members. It should also be noted that there may be a conflict between the directions in one document and those contained in the other. In Illinois, the power of attorney takes precedence over the living will as long as an agent under the power is available to act. This issue is important if it is necessary to withdraw food and hydration, since doing so is prohibited in living wills in Illinois.

Living Will

Living wills, like many legal documents have certain strengths and certain weaknesses. It is often an advantage to have a self-actuating document that will allow the health care provider to withdraw or not commence artificial life support measures in the limited circumstances prescribed by the statutory language of the living will, especially when the agent named in a power of attorney for health care is unavailable on an emergency basis. However, the limitation imposed by the statutory language, which requires the maintenance of food and water, may frustrate the intent of the terminally ill person, and that limitation is not a factor with an agent under a power of attorney for health care unless the principal specifically imposes that restriction.

Mental Capacity Requirements

Proper execution of a legal instrument requires that the person signing have sufficient mental “capacity” to understand the implications of the document. While most people speak of legal “capacity” or “competence” as a rigid black line—either the person has it or doesn’t—in fact it can be quite variable depending on the person’s abilities and the function for which capacity is required.

One side of the capacity equation involves the client’s abilities, which may change from day to day (or even during the day), depending on the course of the illness, fatigue and the effects of medication. On the other side, greater understanding is required for some legal activities than for others. For instance, the capacity required for entering into a contract is higher than that required executing a will.

The standard definition of capacity for wills has been aptly summed up by one court as follows:

Testamentary capacity requires ability on the part of the testator to understand and carry in mind, a general way, the nature and situation of his property and his relations to those persons who would naturally have some claim to his remembrance. It requires freedom from delusion which is the effect of disease or weakness and which might influence the disposition of his property. And it requires ability at the time of execution of the alleged will to comprehend the nature of the act of making a will.

That is a relatively “low threshold,” meaning that signing a will does not require a great deal of capacity. The fact that the next day the testator does not remember the will signing and is not sufficiently “with it” to execute a will then does not invalidate the will if he understood it when he signed it.

The standard of capacity with respect to durable powers of attorney varies from jurisdiction to jurisdiction. Some courts and practitioners argue that this threshold can be quite low. The client need only know that he trusts the attorney-in-fact to manage his financial affairs. Others argue that since the attorney-in-fact generally has the right to enter into contracts on behalf of the principal, the principal should have capacity to enter into contracts as well. The threshold for entering into the contracts is fairly high. The standards for entering into a contract are different because the individual must know not only the nature of her property and the person with whom she is dealing, but also the broader context of the market in which she is agreeing to buy or sell services or property.

One court defined the competency required to execute a contract as follows:

Competency to enter into a contract presupposes something more than a transient surge of lucidity. It requires the ability to comprehend the nature and quality of the transaction; together with an understanding of what are “going on”, but an ability to comprehend the nature and quality of the transaction, together with an understanding of its significance and consequences.

As a practical matter, in assessing a client’s capacity to execute a legal document, attorneys generally ask the question “Is anyone going to challenge this transaction?” If a client of questionable capacity executes a will giving her estate to her husband and then to her children if her husband does not survive her, it’s unlikely to be challenged. If, on the other hand, she executes a will giving her estate entirely to one daughter with nothing passing to her other children, the attorney must be more certain of being able to prove the client’s capacity.

While the standards may seem clear, applying them to particular clients may be difficult. The fact that a client does not know the year or the name of the President may mean that she does not have capacity to enter into a contract, but not necessarily that she can’t execute a will or durable power of attorney. The determination mixes medical, psychological and legal judgments. It must be made by the attorney (or a judge, in the case of guardianship and conservator ship determinations) based on information gleaned by the attorney in interactions with the client, from the other sources such as family members and social workers, and, if necessary, from medical personnel. Doctors and psychiatrist cannot themselves make a determination as to whether an individual has capacity to undertake a legal commitment. But they can provide a professional evaluation of the person that will help an attorney make this decision.

Because you need a third party to assess capacity and because you need to be certain that the formal legal requirements are followed, it can be risky to prepare and execute legal documents on your own without representation by an attorney.

Trusts

Trusts have one set of beneficiaries during their lives and another set – often their children – who begin to benefit only after the first group has died. The first are often called “life beneficiaries” and the second “remaindermen”.

Uses of Trusts

There can be several advantages to establishing a trust, depending on your situation. Best-known is the advantage of avoiding probate. In a trust that terminates at the death of the person who creates it (the “grantor”), any property in the trust prior to the grantor’s death passes immediately to the beneficiaries by the terms of the trust without requiring probate. Think of a trust much like a legally binding contract that the trustee must follow. By avoiding probate, trusts save time and money for the beneficiaries. Certain trusts can also result in tax advantages both for the grantor and the beneficiary. These are often referred to as “credit shelter” or “life insurance” trusts. Other trusts may be used to protect property from creditors or to help donor qualify for Medicaid. Unlike wills, trusts are private documents and only those individuals with a direct interest in the trust need know of the trust assets or then distributions. Provided they are well drafted, another advantage of trusts is their continuing effectiveness even if the grantor dies or becomes incapacitated.

Kinds of Trusts

Trusts fall into two basic categories: testamentary and inter vivos.

A testamentary trust is one created by your will, and it does not come into existence until you die. In contrast, an inter vivos trust starts during your lifetime. You create it now and it exists during your life.

There are two kinds of inter vivos trusts: revocable and irrevocable.

Revocable Trust

Revocable trusts are often referred to as “living” trusts. With a revocable trust, the grantor maintains complete control over the trust and may amend, revoke or terminate the trust at any time. This means that you, the grantor, can take back the funds you put in the trust or change the trust’s terms. Thus, the grantor is able to reap the benefits of the trust arrangement while maintaining the ability to change the trust at any time prior to death or incapacity.

Revocable trusts are generally used for the following purposes:

Asset Management. 1. They permit the named trustee to administer and invest the trust property for the benefit of one or more beneficiaries.

Probate Avoidance. 2. At the death of the person who created the trust, the trust property passes to whoever is named in the trust. It does not come under the jurisdiction of the probate court and the probate process need not hold up its distribution or diminish its value by extra cost. However, the property of a revocable trust will be included in the grantor’s estate for estate purposes.

Tax Planning. 3. While the assets of a revocable trust will be included in the grantor’s taxable estate, the trust can be drafted so that the assets will not be included in the estates of the beneficiaries, thus avoiding taxes when the beneficiaries die.

Irrevocable Trust

An irrevocable trust cannot be changed or amended by the donor. The trustee as provided for in the trust document it may only distribute property placed into the trust according to the trust specific terms. For instance, the donor may set up a trust under which he or she will receive income earned on the trust property, but that bars access to the trust principal. This type of irrevocable trust is a popular tool for Medicaid planning and or estate tax planning.

Testamentary Trusts

As noted above, a testamentary trust is a trust created by a will. Such a trust has no power or effect until the will of the grantor is probated. Although a testamentary trust will not avoid the need for probate and will become a public document, as it is a part of the will, it can be useful in accomplishing other estate planning goals. For instance, the testamentary trust can be used to reduce estate taxes on the death of a spouse or provide the care of a disabled or minor child.

Supplemental Needs Trusts

The purpose of a supplemental needs trust is to enable the donor to provide the continuing care of a disabled spouse, child, relative or friend. The beneficiary of a well-drafted supplemental needs trust will have access to the trust assets for purposes other than those provided by public benefits programs. In this way, the beneficiary will not lose eligibility for benefits such as Supplemental Security Income, Medicaid and low-income housing. A supplemental needs trust can be created by the donor during life or be part of a will.

Estate Taxation

Under the tax law enacted in 2001, whatever you own is subject to the federal estate tax upon your death, until 2010. For the year 2010, estates will be entirely free from federal taxation. However, the law that includes these provisions expires at the end of 2010. Thus, unless Congress acts in the interim, the estate tax rules will then revert to those prevailing in 2001.

For 2001, the tax rate on estates begins at 37 percent and rises to a maximum of 55 percent. depending on how much is being passed to your heirs. Between 2002 and 2009, the top tax rate will gradually be lowered to 45 percent (see box below).

That said, not all estates will be taxed while the estate tax is in effect. First, spouses can leave any amount of property to their spouses free of federal estate taxes so long as their spouse is a U.S. citizen. Second, the federal tax applies only to estates valued at more than $1,000,000 in 2002. This amount will rise to $1.5 million in 2004 and then increase incrementally until it reaches $3.5 million in 2009 (see box). The federal government allows you this tax credit for gifts made during your life or for your estate upon your death. Third, gifts to charities are not taxed.

Illinois has an estate tax. But this is a so-called “sponge” tax, which ultimately doesn’t cost your estate. The way this works is that Illinois takes advantage of a provision in the federal estate tax permitting a deduction for taxes paid to the state up to certain limits. Illinois simply takes the full amount of what you are allowed to deduct off the federal taxes.

Federal Estate Taxes: Top Tax Rate Unified Exemption Equivalent 2001 55% 675,000 2002 50% 1,000,000 2003 49% 1,000,000 2004 48% 1,500,000 2005 47% 1,500,000 2006 46% 2,000,000 2007 45% 2,000,000 2008 45% 2,000,000 2009 45% 3,500,000 2010 N/A N/A

Making Gifts: The $10,000 Annual Rule

One simple way you can reduce estate taxes or shelter assets in order to achieve Medicaid eligibility is to give some or all of your estate to your children (or anyone else) during their lives in the form of gifts. Certain rules apply, however. There is no actual limit on how much you may give during your lifetime. But if you give any individual more than $10,000 during a calendar year, you must file a gift tax return reporting the gift to the IRS. Also the amount above $10,000 will be counted against the unified exempt equivalent that you may give tax-free during your life or upon your death.

The $10,000 figure is an exclusion from the gift tax-reporting requirement. You may give $10,000 to each of your children, their spouses, and your grandchildren (or to anyone else you choose) each year without reporting these gifts to the IRS. In addition, if you’re married, your spouse can duplicate these gifts. For example, a married couple with four children can give away up to $80,000 a year with no gift tax implications. In addition, the gifts will not count as taxable income to your children.

Nicolosi & Associates - Attorneys at Law Since 1948. Skilled in the law. Experienced in business. http://www.nicolosilaw.com

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