Every advisor knows to ask a potential client whether he or she has a will, a living trust or an insurance trust, and knows that beneficiary designations control the disposition of the lion's share of many estates.
But if an advisor wants a thorough picture of a prospective client's estate plan, the line of inquiry has to be broader. All matrimonial agreements belong on a target list. An investigation often has to expand into unexpected legal corners. In certain situations, a lease might prove to be the most important legal document in a family's estate planning repertoire. Confining analysis to obvious estate planning documents such as wills could miss some important issues - as well as some lucrative planning opportunities.
Prenuptial agreements are as common as cappuccino, but the common use of these documents doesn't assure good planning. Agreeing in advance of "I do" to the economic consequences can prevent legal battles and costly settlements. Once married, each spouse has fiduciary obligations to the other. Too often, though, these common agreements fall prey to common errors.
For example, a client's signing the agreement on the day of the wedding could derail protections because it creates a presumption the aggrieved spouse was pressured into signing, rather than being afforded ample time to consider the terms. Similarly, failing to disclose financial data fully and accurately could subject an agreement to a challenge. For example, listing something vague like "art of unknown value" is less likely to be upheld in court than a prospective spouse who details rights to a contemporary collection of American lithographs by listing each work, artist, description and value.
The myriad variations these agreements come in address a wide array of estate planning matters and, too often, planners do not address the nuances. For example, if a wife's brokerage account is deemed a separate asset, but the income is deemed joint property, how should the accounts be set up? The principal assets will be protected if the accounts are set up from inception so that income (as defined by the client's agreement, not how common usage, tax law or any other definition would have it) is credited to a joint money market account and the core investments are left intact.
If, instead, all income is left to accumulate in one account, at best the client has a costly and difficult accounting battle to unravel the amounts. At worst, commingling might mark the entire account as a marital asset, especially if other infractions occurred over the years. Such agreements are not only for soon-to-be-marrieds. If living together, a couple should have an agreement governing their relationship. While the concept of palimony may have begun with the famous 1976 case Marvin vs. Marvin, the law has continued to evolve.
For example, Arizona, California, and Nevada courts have held that decades of cooking, cleaning and managing a household may be adequate proof of a property-sharing agreement between cohabitants. Obligations may exist even if the parties had separate homes but were in a long-term relationship. Failing to address these relationships could expose a client's estate to a costly settlement.
When drafting marital and nonmarital contracts, remember that an agreement may not be enforceable in all states, cautions Wendy S. Goffe of Seattle law firm Graham & Dunn. "Similarly, a same-sex couple legally married in one state may not be able to convince a court to enforce their prenuptial agreement if they later move to a state that does not recognize the marriage. So a possible geographical move should always be contemplated in drafting," she adds.
Many families have bequeathed homes or vacation properties to their heirs, hoping that they'll stay in the family for generations to come. Some use dynasty trusts, while others included restrictions in the deeds used to transfer the property interests, or granted conservation or other easements that restrict the use or transfer of the properties. Before your client can plan how to distribute or dispose of an interest in family property, you must evaluate any restrictions - both governmental and personal.
If a client moves, it can have a big impact on deeds. "Clients may create community property in one state and then move to a non-community property state. This creates problems," Goffe says. More than a dozen states have adopted the Uniform Disposition of Community Property Rights at Death Act, she says. "If a couple is moving to one of those states, they may want to take advantage of the ability to preserve community property."
If a client holds income-producing leases, these would be regarded as valuable assets. But what else might be in play?
Consider this example: A father owns and operates a business. The real estate on which the business operates is held in a family limited partnership, and the operating entity is an S corporation.
There are two children: a son not involved in the business and a daughter who's the heir apparent. The dad decides it's best that his son have no direct involvement in the company, so he can't inhibit the daughter from making decisions, and opts to bequeath the real estate family limited partnership to his son and the S corporation to his daughter.
The location of the business is critical. In fact, the image of the building that houses the showroom is part of the logo. After the father dies, the son reviews the lease, threatens to double the rent and not renew if the daughter doesn't agree to his demands.
Had the lease been prepared in a more protective way, the ensuing battle may have been avoided. For example, the lease might have included an automatic renewal right for the daughter (pegged to a percentage of fair rental with an independent appraisal firm setting the rent every five years). This could ensure the business' right to occupy the premises while protecting the son's passive rental income stream. And perhaps the father could have created the terms while still alive.
Governing documents - a shareholder's agreement governing the operation of a corporation, a partnership agreement or an operating agreement of a limited liability company - are crucial to review. They contain many opportunities as well as many pitfalls.
A mandatory requirement in governing documents to sell equity interests back to a company as a redemption upon death, instead of bequeathing them to heirs, could have a tremendous impact on paying estate taxes, succession planning, cash flow needs, etc. For example, if a client were counting on continued cash flow from a business interest to finance living costs for a surviving spouse after death, he or she would be sorely disappointed.
There are many other issues that might arise as well. Family heirlooms might be kept at company offices, or might be at home but paid for or insured by a company (even if inappropriate). Disability payments and perquisites might obviate the need for disability insurance, or might permit a very long waiting period (or the opposite). These issues will never be identified from a will or trust without scrutinizing the governing legal documents for the family entities.
While the focus of estate planning has and will remain wills, revocable trusts and insurance trusts, there are many ancillary or even independent documents that could have a profound impact on budget projections, planning options, cash flow and liquidity needs and how accounts are structured. And that's why planners need to dig for details.
Martin M. Shenkman, MBA, JD, CPA, PFS , AEP, is based in Paramus, N.J.