Over the last few months, as either an advisor or trustee, I have been reviewing various existing and proposed life insurance policies, both conventional and universal life. In each case, my starting point has been to think about the purpose of the policy, the risk tolerance of the client or trust and the assumptions on which the income projections of the policy are based. Often this process involves having the insurance agent run new projections for a policy.

The current environment with low interest rates is by necessity changing the way that all of us need to evaluate the performance of insurance policies. In fact, one of the local companies recently put out a “Due Care Bulletin” that discussed the impact of low interest rates on life insurance products. The long and short is that, as a trustee or an advisor, we need to recognize that future performance, at least for some period of time, is going to be affected by this change in the marketplace.

The other interesting point is that there are a number of products on the marketplace which can help policyholders to deal with the volatility of market returns. I will discuss a couple of these below.

The starting point is to analyze the purpose of the policy. For example, what amount of the proceeds is “mission critical” and what amount is “icing on the cake.” Then it is important to understand the math of a life insurance policy, particularly how much is charged monthly, quarterly or annually against the premium or cash value to pay for the life insurance component. For example, in analyzing a universal life policy, you will see that there is a stated charge for the life insurance portion of the policy. The insurance company deducts this charge annually before funds are available to increase cash value or otherwise benefit the policy.

Next, we should look at what net annual rate of return is really needed for the policy to perform at the level that our client needs or wants, which are two distinct concepts, and what is the risk tolerance of our client.

Once you have a target range for an average annual return, the next step is to look at what tools may be available from the life insurance company to increase the likelihood of obtaining that performance objective. For example, one insurance company product that we recently looked at offers an S&P type of index fund with a 1% floor and an 11% cap. The effect of this collar is that the portion of the account invested in this fund can never have a negative return. Since there is always is a fixed charge for life insurance policies, avoiding a negative return can have a meaningful positive impact. For example, if the timing of the periodic charge is such that it occurs on a down day in the market, there can be a significant negative impact on returns.

Another tool that same insurance company offered was a bond fund with a floor currently at 21/2%. The price for the floor was the loss of liquidity on funds invested in the bond fund in that those funds were locked into the fund for a long period of time with a 10% per annun withdrawal right. However, since the policy holder is already making a long term investment with a commitment of at least some portion of the portfolio to bonds, this loss of liquidity was almost like a ‘freebie’ in the sense that from an investment point of view you would intend to keep a position covered in bonds anyway. In all cases, all funds are freed up immediately for policy termination or death benefit.

The point of all of this discussion is not to promote any particular insurance policy but rather to emphasize that, as a trustee, it is our job to look at all the options and constantly to explore new ways of analyzing the effective and proper way to see that the policies are managed. This is an effort between the attorneys, the accountants and insurance agents who make up the team advising clients in these matters. –Rob Goodman

These days it is very common for estate planning clients to create revocable trusts for probate avoidance and ease of estate administration, even if the clients do not face estate tax liability under the current system. As we are well aware, those clients fail to achieve the probate avoidance benefits of their trusts if they fail to fund their trusts during their lifetimes. Attorneys and other advisors should (and often do) work with clients to ensure that most of their assets, and certainly all the large assets, are in their trusts. We draw deeds to transfer real estate to the trusts. We re-title their brokerage accounts, their stock, their CDs and their money market accounts. Sometimes, we even have clients transfer their regular checking accounts, their vehicles and their tangible personal property into their trusts.

Nevertheless, for most clients, at least something is forgotten. It could be a checking account that hasn’t been used in years, a vehicle, a fractional interest in real estate, or assets purchased or inherited by the decedent after the trust already was in place. In the past, if the value of the forgotten assets was in excess of $15,000, the decedent’s executor had to go through the full probate process. As the result of an update to the law in 2010, this threshold has now increased to $50,000, a much more realistic figure.

Under these circumstances, a small estate affidavit can be used to collect and distribute assets in the decedent’s name as long as the value of the entire probate estate is less than $50,000. Use of a small estate affidavit does not require an executor or administrator to qualify on the estate and does not require any reporting to the Commissioner of Accounts.

In order to use a small estate affidavit, certain criteria must be satisfied, all of which are listed in Virginia Code Section 64.1-132.2. As previously mentioned, the decedent’s entire personal probate estate must not exceed a value of $50,000. Additionally, at least sixty days must have passed since the decedent’s death, no one must have qualified as executor or administrator, and the decedent’s will (if any) must have been probated (meaning, put to record in the Clerk’s Office). The affidavit must name the person or persons entitled to payment of the decedent’s assets. If there is more than one person entitled to the assets, then one of them may be designated by the group to collect and distribute the assets.

If a decedent dies with a pour over will and $30,000 worth of assets which were not transferred to his trust during his lifetime, one option would be for the trustee of the trust to use the small estate affidavit to transfer the probate assets to the trust. However, if it makes more sense for these assets to be distributed directly to a surviving spouse, the surviving spouse could first file claims for family allowance ($18,000) and exempt property ($15,000), which are given priority over any other claims against the estate. Then, the surviving spouse will be the person entitled to be paid the assets of the probate estate, up to her claim amount of $33,000.

The small estate affidavit is another tool which when used properly can make the probate process easier and more cost effective for clients. –Sarah Messersmith

On January 9, 2012, the IRS reopened its successful Offshore Voluntary Disclosure Program to encourage taxpayers with undisclosed offshore accounts to come into compliance with U.S. laws. A previous program, known as the Offshore Voluntary Disclosure Initiative (“OVDI”), was announced on February 8, 2011, and expired on September 9, 2011, following an extension due to Hurricane Irene. The Offshore Voluntary Disclosure Initiative followed the 2009 Offshore Voluntary Disclosure Program (“OVDP”), which was open to taxpayers from March 2009 through October 15, 2009.

Unlike the earlier programs, the current Offshore Voluntary Disclosure Program (“OVDP III”) is available to taxpayers for an indefinite period, until otherwise announced. The penalty structure under OVDP III, however, is similar to that of the OVDI. It requires taxpayers to pay a penalty of 27.5% (up from 25%) of the highest aggregate balance in foreign bank accounts or entities, or the value of foreign assets, during the eight full tax years prior to the disclosure. As with the OVDI, some taxpayers are eligible for reduced penalties of 12.5% (available for accounts that have not exceeded $75,000 in any calendar year during the eight-year period) or 5% (available for a very limited class of inherited or similar accounts meeting certain criteria). Taxpayers who feel the program penalties are disproportionate may opt out of the penalty structure, and the decision to opt out is irrevocable. Participants in the program also must file all original and amended tax returns for the eight year period and include payment for unpaid taxes, interest, and accuracy related or delinquency penalties. On top of those payments, the cost of accountants’ and attorneys’ fees for assisting a taxpayer with compliance may be onerous. Above all, taxpayers and their advisors should be aware that the terms of OVDP III may change at any time. Additional details regarding OVDP III should be available on the IRS website in the coming weeks.

Along with its announcement of the new voluntary disclosure program, the IRS announced that it had collected more than $4.4 billion from approximately 33,000 disclosure filings under the two prior programs, and moreover, that since the expiration of the 2011 OVDI, hundreds of taxpayers have come forward to make voluntary disclosures and avoid criminal prosecution. In addition to the revenue generated by the delinquent taxes, interest, penalties, and future taxes on income and gain resulting from taxpayers’ disclosures, the IRS has obtained a trove of information about specific foreign financial institutions, bankers, financial advisers, and others who have aided U.S. taxpayers in establishing and maintaining undeclared foreign accounts. The IRS clearly has discovered an effective tool to promote tax compliance and raise money for the nation’s coffers.

Any non-compliant U.S. taxpayers who have not yet declared foreign accounts or other reportable assets should be aware of the increasing enforcement efforts of the Criminal Investigation Division of the IRS and growing cooperation among international institutions and tax authorities. While the civil penalties, other compliance costs and overall financial pain may be high, OVDP III offers U.S. taxpayers the opportunity to disclose and comply before penalties increase further, as well as the inestimable benefit of avoiding criminal prosecution.
–Alison Lennarz

Imagine the following situation. Sam and Sue are in their early 80s, live in Virginia Beach, and are the proud parents of 3 children. Two of them, Bill and Betty, are grown, married, and between them have produced 6 wonderful grandchildren, all of whom live on the West Coast. Unfortunately, Jack, the third child, is bipolar and has numerous health issues, including impaired vision and serious periodontal disease. Unable to live on his own at 53 years of age, he lives in a group home in Norfolk. Jack receives Medicaid and Supplemental Security Income (“SSI”), both of which are primary means-tested government benefits.

Jack’s parents have been supplementing his needs at the group home for things not covered by the benefits he receives. This has included fishing trips and the purchase of fishing equipment. Jack loves to go fishing in the area lakes as well as deep sea fishing out of Oregon Inlet. They have also been paying for the extensive dental care that he needs as well as regular visits to his optometrist need to deal with a detached retina and macular degeneration. Dental care and eye care are not covered by Medicaid nor are the fishing trips.

Neither Bill nor Betty wants the responsibility of caring for Jack following Sam and Sue’s death. They have never been close to Jack and they live so far away that they believe it would not be practical for them to assume the responsibility. Sam and Sue want to treat their children equally but they are concerned that leaving one-third of their estate outright to Jack would perhaps not be a wise thing to do. Not only is Jack financially irresponsible; but, additionally, both Medicaid and SSI are means-tested government benefits that could be lost if a portion of their estate is left to Jack.

In general there is a $2,000 resource limit for an SSI recipient with cash or other liquid assets, as well as real estate and personal property the person owns being considered as resources. 20 C.F.R. 416.1205(c). Jack’s parents have thought about leaving their estate to Bill and Betty with the hope that they will continue to provide Jack with “the extras” that Jack has been receiving from them – the fishing trips, uncovered dental and eye care, extra clothing, etc. They are concerned, however, that Bill and Betty might decide that the extra funds they get could be better used for the educational expenses their own children and grandchildren are incurring. Sam and Sue also are concerned that the assets transferred to Jack’s siblings would expose those assets to the creditors of the siblings. These are all valid concerns.

Situations such as this are well suited to the use of a special needs trust (“SNT”) especially one funded with assets owned by Sam and Sue. This type of SNT is often referred to as a third party SNT (versus what is generally known as a self-settled SNT) and it can be established by anyone other than the beneficiary or the beneficiary’s spouse. One of the advantages of this type of trust is that it is not subject to the restrictions imposed by 42 U.S.C. 1396 which, among other things, require that any funds remaining in the trust at the death of the beneficiary be used to repay the state up to an amount equal to the total of the medical assistance received by the beneficiary. Also, unlike a self-settled trust, a third party trust can be created either by will or by a revocable or irrevocable trust.

It is important to remember that the trust must be drafted and administered carefully and the trustee may only supplement the needs of the beneficiary receiving government benefits. Thus, if the trustee provides distributions to cover items that are or that could be provided under the government program, the eligibility of the beneficiary for Medicaid or other government benefits being received may be lost. The trustee of the SNT, therefore, should not use trust income or principal to provide basic needs such as food or shelter or medical care covered by Medicaid. Trust income and principal should only be used for extra items not provided for under the available governmental programs.

Under a third party SNT assets remaining in the trust at the death of the beneficiary may pass according to the terms of the SNT (Sam and Sue might provide, for example, that the remaining assets pass to Jack’s siblings), or according to the exercise of a power of appointment in the beneficiary’s will. The important thing is that the remaining assets do not have to be used to reimburse the state for the Medicaid assistance received by the beneficiary.

Several suggestions for Sam & Sue in setting up a SNT are:

1. Their own estate planning documents should provide that debts, taxes, and expenses of their estates are not to be satisfied out of assets in the SNT. This makes it clear that they want the assets to be used solely for the beneficiary during the life of the beneficiary.
2. They might want to give the trustee the power to use trust assets for basic needs for food and shelter in the event SSI payments received by the beneficiary are not sufficient to meet those needs. This could result in a reduction in SSI benefits, however.
3. The trust should limit payments directly to the beneficiary. In many instances the beneficiary will not have sufficient financial responsibility to handle the distributions. However, in some cases, the beneficiary might be perfectly competent mentally, but might be profoundly physically handicapped and therefore eligible for the government benefits. In either event, distributions directly to the beneficiary from the SNT are treated as income that would reduce government benefits being received. The trust could require that payments be made directly to the vendor or provider of services.

Where parents or grandparents have a child or grandchild eligible for Medicaid and SSI, a third party SNT can be a valuable tool for their use to ensure the eligible beneficiary receives the extras they want that beneficiary to receive while not resulting in disqualification to receive the available Medicaid or SSI benefits and without requiring repayment of those benefits from any remaining trust assets at the death of the beneficiary of the trust. Careful drafting of the trust and as well as administration by a trustee familiar with the ins and outs of a SNT are required for this to be completely successful. –Robert H. Powell III

When Congress passed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the 2010 Tax Act) in December 2010, it finally provided some guidance and certainty — albeit for just two years — for the estate tax planning world. Most of the characteristics of the estate tax regime created by the 2010 Tax Act resemble the estate tax planning regime in effect during the past decade – unlimited marital and charitable deductions and limited individual exemptions for estate, gift and generation skipping transfer (GST) taxes. Notably, however, the estate tax, gift tax and GST tax exemptions increased to $5 million from the 2009 levels of $3.5 million, $1 million and $3.5 million respectively. Additionally, the 2010 Tax Act created a new concept that had not been a part of the prior estate tax regime – the concept of “portability.”

In basic terms, portability allows a surviving spouse to use the estate and gift tax exemption that went unused by his or her deceased spouse. Recall that historically the use of one’s estate and gift tax exemption was a “use it or lose it” proposition. If an individual did not use his or her exemption, which was most commonly accomplished through lifetime gifting or the establishment of a credit shelter trust at death, the family had no way of benefitting from any unused exemption.

At first blush, the concept of portability appears to greatly simplify estate tax planning with couples whose combined assets do not exceed their combined exemption amounts, currently $10 million per couple. Even without establishing a credit shelter trust at the first spouse’s death, the surviving spouse can still get the benefit of any unused exemption by simply relying on portability. Before tossing existing estate planning documents into the shredder in favor of estate planning documents that rely on portability, such as “I love you” wills or simple trusts without estate tax planning provisions, however, clients should take notice of the many potential pitfalls surrounding portability:

Remarriage Issues
Only the unused exclusion amount of one’s last deceased spouse can be used. Therefore, if a surviving spouse remarries and his or her new spouse again dies first, the unused exemption from the first deceased spouse is lost. The surviving spouse may, however, utilize the unused exemption of the second spouse to die if the executor of that spouse’s estate makes the portability election. In contrast, if a credit shelter trust is established at the death of the first spouse to die, the exemption of both deceased spouses may be fully utilized.

Threat of Decreased Exemption Amounts
The 2010 Act provides that if the estate tax exemption amount goes down after the death of the first spouse to die, portability is limited to the lower exemption amount. For example, if the first spouse dies with a $5 million unused estate tax exemption, but the estate tax exemption decreases to $3.5 million by the time of the surviving spouse’s death, the amount of exemption that is portable is $3.5 million. This results in a loss of $1.5 million of estate tax exemption compared to a scenario where a $5 million credit shelter trust is set up at the first spouse’s death. Further, the portability amount will not go up if the estate tax exemption amount goes up after the first spouse’s death. Thus if the first spouse dies with a $3.5 million unused estate tax exemption and the estate tax exemption increases to $5 million by the time of the surviving spouse’s death, the amount of exemption that is portable is still the lower amount, $3.5 million. It is also important to note that the appreciation of assets in a credit shelter trust is protected from estate tax, whereas the appreciation of assets for which a portability election is made may be subject to estate tax.

Election Must be Timely Made
To use portability, the executor of the first spouse to die must make an election by timely filing an estate tax return (even if an estate tax return would not otherwise be required because the estate is below the filing threshold). Depending on the assets of the estate of the first spouse to die, this can be a substantial undertaking. Once made, the election is irrevocable. Note that a credit shelter trust can be created by the first to die even if no estate tax return is required because the estate is below the filing threshold.

Loss of Nontax Benefits of a Credit Shelter Trust
While estate tax planning is typically the driving force behind the establishment of a credit shelter trust, there are may other benefits to establishing a credit shelter, such as creditor protection from the claims of the beneficiaries’ creditors and ensuring that assets pass to one’s own children and not to a subsequent spouse and/or his or her children if the surviving spouse remarries. Therefore, for many estate planning clients, establishing a credit shelter trust may be advisable regardless of the ability to rely on portability.

2010 Tax Act Expires in 2013
The 2010 Tax Act is set to expire January 1, 2013. Therefore, unless new legislation is passed that continues to allow for portability, portability could only be used where the first spouse dies after December 31, 2010 and the second spouse dies before January 1, 2013. While most commentators believe any new legislation would continue to allow for portability, there is no guarantee portability will continue.

Conclusion
Portability is certainly a welcomed and important new tool available to estate planners. In particular, it will be invaluable for estates where a decedent’s estate plan contains no estate tax planning. Portability also can be an important component for those with borderline taxable estates, estates where retirement assets pass outside of a credit shelter trust directly to a spouse and estates where there are insufficient assets to fully fund a credit shelter trust for the first spouse to die. Because of the potential benefits and pitfalls discussed above, it would benefit the vast majority of fiduciaries of estates of a first to die spouse to discuss the portability election with his or her tax counsel. –Alexander W.  Powell Jr.

The sale of real estate under Virginia law in connection with a decedent’s estate can involve a number of legal and practical considerations that can be affected by whether a decedent dies with or without a will.

The Intestate Estate

If the decedent dies intestate (without a will), title to his or her real property passes immediately upon death directly to his heirs at law. In such cases, the real property is not an asset of the estate. The filing of a list of heirs will establish chain of title to the heirs as co-owners (tenants in common) based on their respective interests determined under the course of descent provided in Va. Code § 64.1-1.

Although an administrator of an intestate’s estate has the power under the law to sell and distribute the decedent’s tangible and intangible personal property, they do not have authority to sell the decedent’s real estate, even if the personal property is insufficient to pay estate debts and estate administration expenses. Although the heirs at law do not become personally liable on a mortgage secured by the property, as a practical matter they will need to make arrangements for such payments or risk foreclosure; and prompt arrangements should be made for payment of real estate taxes, insurance and utility payments for the property.

To sell the real property, the heirs at law as co-owners must all agree upon all the typical questions in the sale of property: whether to sell the property, the timing and manner of sale (by realtor or by owners), the purchase price and other terms of sale; and they must all sign the deed conveying the property to the purchaser. This can present problems if the co-owners cannot agree on these matters and can present practical issues if some of the owners live in other states or other countries. The sale can be further complicated if any of the heirs at law are minors or incapacitated.

The Testate Estate

Decedents who die testate (with a will) may provide direction in their will regarding the sale or disposition of their real property. Most well drafted wills contain provisions granting power of sale of real property to the executor named in the will. This authority is commonly incorporated by specific reference in the will to the statutory powers contained in Va. Code § 64.1-157. This express power of sale allows the executor to sell the real estate if the personal property is insufficient to pay the estate debts and estate administration expenses or because of other estate or beneficiary circumstances.

There may be some question as to whether an executor should or can sell real estate of the estate if it is not necessary based on the circumstances of the estate, particularly if the beneficiaries of the real estate under the will prefer to receive the real estate in kind. If a person (testator) preparing a will believes that it would be best for the executor to sell real estate, he can provide in his will that the executor is directed to sell the real property, or even more effectively provide that the real estate is devised to the executor to be sold, with the proceeds to be received as an estate asset for distribution to the beneficiaries.

In the event of sale of the real property by the executor under the terms of a will, the executor typically has authority to determine the arrangements and terms for sale of the property. The net proceeds from the sale of the real property will be disbursed by the executor in accordance with the terms of the will. Pending the sale of the real property, the executor normally pays any mortgage payments, insurance and real estate taxes from the estate assets, unless that is not possible based on the circumstances of the estate.

Under Virginia law, even when a decedent leaves a will with power of sale over real estate, title to the real estate nevertheless passes upon the decedent’s death to the beneficiaries of the real estate under the will. Probate of the will establishes the beneficiaries’ chain of title to the property. These rights will be divested if the executor sells the real estate in accordance with the terms of the will.

It is possible that a will does not contain authority for the executor to sell real estate due to oversight or perhaps the testator did not intend to grant power of sale to the executor and intended that title to the real estate pass directly to the beneficiaries under the will. In such cases the beneficiaries will encounter many of the same issues mentioned above for heirs at law of intestate estates.

Some Practical Considerations

In cases where there is no power of sale available to an administrator or executor and if sale of the decedent’s real estate is necessary or advantageous based on the circumstances of the estate or the beneficiaries, the administrator or executor can, pursuant to Va. Code § 64.1-57.1, petition the Circuit Court for an order granting power of sale to the executor or administrator.

Also, where an administrator or executor does not have power of sale, and if all of the heirs at law or beneficiaries of the real estate are competent adults and can agree, they can appoint an agent by special powers of attorney with authority to market and sell the real property upon agreeable terms. The appointed agent could be the administrator, executor or other person(s). This approach would avoid the expense of a court petition.

When preparing estate planning documents, a testator who clearly wants his executor to sell the real estate, can provide in his will that the real estate is devised to the executor to be sold, with the net proceeds of such sale to be disposed as directed in the will.

A decedent’s real property is by law subject to the payment of creditor claims against the decedent. Personal property is the primary fund for the payment of creditor claims unless otherwise stated in a testator’s will. If the personal property is not sufficient to pay such claims, an executor with power of sale under a will can and should sell the real property and use the net proceeds to first pay such claims. If title to the real property passes to the heirs at law or beneficiaries under a will (with no power of sale), the creditors may, under Virginia law, file a creditor’s suit to subject the real estate to the payment of such claims, if such claims are not resolved between the heirs or beneficiaries.

Real estate sold within one year after a decedent owner’s death is not a valid conveyance against creditors of the decedent. Therefore, the purchaser or the purchaser’s title company will typically insist that the net proceeds of sale be held pursuant to an indemnity and escrow agreement for one year after the decedent’s death, or that the sellers purchase a decedent’s debt bond to protect against such creditor claims.

The Last Resort – Partition Suit

If title to real estate passes directly to a decedent’s heirs at law or beneficiaries under a will without a sale by the administrator or executor and the co-owners cannot agree regarding a sale of the real estate, what happens then? This situation can often be further complicated if one of the heirs or beneficiaries is living at the property, is not paying rent, is not maintaining the property and refuses to leave the property.

In such cases, any of the co-owners may file a partition suit in the Circuit Court for the jurisdiction where the property is located requesting an order for sale of the property and also file an action for eviction of the heir or beneficiary living at the property. In the partition suit, one or more co-owners may request approval for purchasing the interests of the other parties. If no such purchase is requested or approved, and if the property cannot be physically partitioned between the parties, the court will enter an order providing for the sale of the property by a special commissioner appointed by the court, with the net proceeds of sale to be distributed to the co-owners according to their respective interests in the property. –Ed Stolle

One of the hot topics among planners over the last several years has been how to utilize the laws enacted by several states (now five) allowing a person to create his own self settled trust or domestic asset protection trust (called a “DAPT”), which have been promoted as not reachable by creditors, if they satisfy the elements of the particular state statue. In this type of trust, the client transfers his own assets to a Trust in which he is a beneficiary and, while trying to get the best of all worlds, remains a beneficiary of his own assets, but prevents creditors from reaching those assets if financial times turn south on him. Clients also have utilized the laws of foreign jurisdictions such as Bermuda, Cayman Islands and other offshore havens which were friendly to debtors and not so to creditors to try to achieve these same goals with mixed success. A recent case in the Bankruptcy Court for the District of Alaska, one of the five states having such favorable legislation, has raised a real question of whether these DAPTs will work, especially if a bankruptcy is involved.

 In Battley v. Mortensen, an Alaskan resident who was solvent at the time, set up his own DAPT, which was for his own benefit as well as his children. Subsequently he fell into hard times and filed for bankruptcy protection within the 10 year clawback period under the applicable Federal Bankruptcy Code provisions. The Bankruptcy Trustee successfully attacked the trust on behalf of creditors and was able to reach the assets. Battley claimed under Alaska law that the Trust met all the safe harbors rules, including that it was not created to hinder, delay or defraud creditors as he was solvent at the time it was created. The Bankruptcy Court did not agree, however, and held that the Federal Bankruptcy law superseded Alaska law, which had a 4 year clawback period. The Court’s view was that one of the purposes for a person to create one of these types of DAPTs was to do exactly that, i.e. to hinder, delay or defraud creditors at some time in the future, even though they were solvent at the time such Trust was created. The case was ultimately settled and therefore will not be appealed. Where the law goes from here is only a matter of speculation and time as this favorable result will clearly spur creditors to challenge these types of trusts in order to try to reach their assets.

Why does this matter to a Virginia resident? There have been groups advocating for similar legislation to be passed in Virginia in order to be on parity with these other states. Also, some advisors have recommended Virginia residents create a DAPT under the laws of the one of the states which has this favorable legislation, attempting to create enough nexus with that other state to have their trust governed by that state’s favorable laws. The question of what is sufficient to create that nexus has always been an open question, especially in current times, with each respective state trying to generate more revenues, through taxes and applying its own laws to reach such income. If there is not sufficient nexus, there is an additional risk that the trust may not be recognized under the other state’s laws.

So does this mean that a client should not utilize DAPTs? One must remember that the Mortensen case involved a bankruptcy within the 10 year clawback period under the Bankruptcy Code. If there had been no bankruptcy, there may have been a different result. A client needs to realize that if he elects to utilize one of these Trusts, he must have the risk tolerance of operating in a world where the rules are uncertain and sometimes develop after the fact in ways which may be substantially different than assumed under his plans. However, there still remain other alternatives for Virginia residents to consider. These include trusts set up by parents or other third parties for the person to be protected, transfers to spouses, joint tenancies, transfers to trusts for children and the use of LLCs and other entities to protect the assets from claims of creditors. If the Mortensen case remains good law (which clearly is not known at this point), it appears that there still may be no such a thing as a free lunch. –James G. Steiger

In my practice, I am often faced with the difficult issue of evaluating the capacity of an older adult client. In the beginning stages of dementia, does the client have the capacity to make important decisions and sign legal documents? Another challenging situation, which frequently occurs concurrently with capacity issues, is undue influence. Adult children and other family members often exert significant persuasive powers and control over elderly adults. When does the level of influence constitute undue influence and potentially invalidate the actions of the elderly adult? This year, the Virginia Supreme Court addressed both of these topics in the case of Parish v. Parish¹ .

In the Parish case, Eugene Parish (“Eugene”) received a head and spinal cord injury in 1982 and the following year was declared incompetent in Florida because he was “incapable of caring for himself or managing his property.” Several years later, Eugene was moved to a facility in Tennessee and his brother, David Wayne Parish (“David Wayne”), took over duties as Eugene’s conservator, asserting to the Tennessee Court that Eugene was a “disabled person . . . in need of partial or full supervision, protection and assistance by reason of mental illness, physical illness or injury, developmental disability or other mental or physical incapacity.”

In 2002, David Wayne facilitated the preparation and execution of a Will by Eugene. During the meeting to discuss the Will, David Wayne acted as the translator for Eugene because Eugene spoke through a voice box as the result of a tracheotomy and was difficult to understand. David Wayne was present in the room when the Will was executed by Eugene. The Will left 25% to David Wayne, 25% to David Wayne’s wife, Diane Parish (“Diane”), 25% to Eugene’s son, David M. Parish (“David”), and 25% to other family members. The Will also named David Wayne as Executor and Diane as successor Executor. If Eugene died without a will, all of his assets would pass to his son, David, who was not told about the Will.

In 2004, the guardianship and conservatorship was transferred to Eugene’s son, David, based upon a petition filed by David and a determination by the Virginia Beach Circuit Court that Eugene was “incapacitated to such an extent that he is unable to care for himself, make medical decisions, manage his estate or understand his debts as they come due.” Eugene died in 2006 and David qualified as the administrator of his estate without a will. Diane petitioned the Court to have Eugene’s Will admitted to probate and to permit her to qualify as Executor².  David claimed that his father did not have the testamentary capacity to execute the Will and that David Wayne and Diane exercised undue influence over Eugene.

The trial court found in favor of Diane and David appealed. The Virginia Supreme Court opined that even though a person has an appointed guardian and conservator, this does not create a presumption of incapacity for purposes of executing estate planning documents. The Virginia Supreme Court has repeatedly held that mental weakness is not inconsistent with testamentary capacity and that less capacity is required to execute a will than to execute a contract or to transact ordinary business. All that is necessary to have the legal capacity to sign a valid will is that, at the time the will is signed, the individual generally must (i) know the assets he owns, (ii) know his immediate family who would typically be beneficiaries of his estate (i.e. the natural objects of his bounty), (iii) know that he is engaged in signing his will and (iv) know how he wishes to dispose of his assets. 

The guardianship and conservatorship statutes of the three states in which fiduciaries were appointed for Eugene (Florida, Tennessee and Virginia) do not require a particular factual finding that Eugene was incompetent to such an extent that he was unable to execute a valid will. Acknowledging that the proponent of the Will has the burden of proving testamentary capacity by a preponderance of the evidence, the trial court heard the testimony of several witnesses, including the paralegal who assisted Eugene in drafting the Will, Eugene’s treating physician and Eugene’s social worker. The Supreme Court held that the evidence in favor of Eugene’s testamentary capacity was sufficient to uphold the trial court’s decision and affirmed that Eugene had the required testamentary capacity to execute the Will.

With regard to the undue influence issue, the Supreme Court stated that the general rule is that a presumption of undue influence is created when the testator was old at the time a will was executed, the testator named a beneficiary who was in a position of confidence or dependence and the testator previously had expressed an intention to make a different disposition under his will. In this case, however, the requirement that the testator be “old” did not apply. Eugene was 22 years of age at the time of his brain injury and 41 years old at the time he executed his Will. Additionally, Eugene had not previously expressed a different intention with regard to the disposition of his estate. At 22 years of age he did not have significant assets until after his injury. The Supreme Court agreed that there was insufficient evidence of undue influence to create a presumption which would shift the burden of proof to Diane. However, even if the presumption had been applied, the trial court indicated that the facts would have been insufficient for the court to come to a different conclusion. For example, the trial court noted that “notwithstanding the impairments that he suffered, [Eugene] was a stubborn man . . . if he did not want to do something, he . . . knew how to resist.” As a result, the Supreme Court affirmed the trial court’s ruling that there was no undue influence.

The Parish case is a good reminder that although an estate planner cannot avoid family disputes or will contests in the future, he or she should take steps to ensure that the preparation and execution of wills are handled appropriately. For example, when a client comes to my office accompanied by a family member or friend, I always take the opportunity to meet with the client alone. The client must be given an opportunity to speak openly with me about his or her wishes, outside of the presence of any other person. Engaging a client in a discussion of his or her thoughts and reasoning is better than asking questions that merely require yes or no answers. If I have concern about a client’s competence, or if I anticipate a challenge to the client’s Will after death, I request that the client obtain a current statement of capacity from a physician. Finally, it is always beneficial to prepare a memorandum to my file outlining the estate planning process.
–Lawrence G. Cumming

¹ 281 Va. 191, 704 S.E.2d 99 (2011).
² Apparently, David Wayne declined to serve as Executor.

As the variety of trust instruments available to estate planners increases, the amount of boilerplate or form language in such instruments seems to increase as well. When representing fiduciaries in trust and estate litigation, I see a surprising number of disagreements that arise from language no one likely gave much thought to when the document was drafted. A recent Virginia Supreme Court case reinforces why it is so important to review even the most mundane language of each and every instrument to make sure it accurately portrays the wishes and desires of each client.

The case of Dolby v. Dolby involved a parcel of property with a large mortgage. Under Virginia law, property specifically devised in a Will passes subject to the mortgage. In this case, however, the property passed outside of probate, and whether the mortgage ran with the land or stayed with the Estate was a question that required more detailed analysis of the language of the Will. The language focused on by both the trial court and the Virginia Supreme Court, in reaching different opinions, was not language specifically drafted for Mr. Dolby to address his specific situation, but instead was form language similar to that found in almost every Will.

Five years before his death, Cornelius Dolby, a commercial real estate developer, bought a house secured by a mortgage of more than $1.5 million. Originally, he purchased it in his own name, and lived there with his girlfriend and longtime employee. Almost four years later, the couple married. Mr. Dolby then executed a deed of gift transferring the property from him alone, to him and his new wife as tenants by the entireties, with the right of survivorship. Upon the death of Mr. Dolby, by operation of law, the widow Dolby became the sole owner of the property in fee simple.

Mr. Dolby also had a Will and a Revocable Inter Vivos Trust. The Will left all of Mr. Dolby’s personal property to his wife, and directed that the residuary pour over into the Trust. The Trust had a series of complicated disbursement instructions.

Because of the ownership as tenants by the entirety, the property was not included in Mr. Dolby’s Estate. Trouble arose, however, because of the mortgage encumbering the property. After the deed of gift was recorded, Mrs. Dolby was never added to the loan, which remained Mr. Dolby’s sole obligation. After Mr. Dolby’s death, Mrs. Dolby took title to the property, but asserted that the mortgage was an obligation of the Estate. Mr. Dolby’s three adult daughters by his first marriage, who were beneficiaries of the Estate, disagreed. Seeking an answer to whether the mortgage should become the obligation of the wife or the Estate, the co-executors, Mrs. Dolby and two brothers of Mr. Dolby, filed a petition for aid and direction with the local circuit court.

Noting that the intent of the testator is always the most important factor in interpreting Wills, the circuit court judge relied upon language stating that the executors “shall not be required to pay prior to maturity any debt secured by mortgage, lien or pledge of real or personal property owned by me at my death, and such property shall pass subject to such mortgage, lien or pledge.” The attorney who drafted the Will testified that this language was “boilerplate” language he placed in every Will. Nevertheless, the judge decided that it indicated an intent to have the property pass subject to the mortgage, and Mrs. Dolby was obliged to pay the debt. Noting that Mrs. Dolby had received $3 million in life insurance proceeds as well as the property (which was valued at almost $2.9 million at the time of death) while the children had received no distribution from the Estate, the judge held there was no evidence that Mr. Dolby intended to leave his widow almost $6 million in assets, while forcing the Estate to pay off his mortgage and leaving his children essentially nothing from an otherwise substantial estate. The judge therefore ordered Mrs. Dolby to pay the mortgage.

The Virginia Supreme Court disagreed. In doing so, it focused on a completely different portion of the same “boilerplate” language. The Supreme Court focused on the portion of the same sentence that relieved the Estate of the obligation to pay debts secured by property held “at my death.”  Finding that Mr. Dolby did not own the property at his death, because it had passed to his widow at the moment of death, the Supreme Court held that the Estate was obligated to pay the mortgage.

This result highlights the dangers of inserting seemingly innocuous, boilerplate language into any testamentary instrument, without first considering its effect on the intent of the person for whom it is drafted. Oftentimes, such language is glossed over by both the drafter and the client, only to rear its head in later litigation. It is important to remember a court will assume such language embodies the specific client’s intent. In this case, as pointed out by the circuit court judge, there was no evidence Mr. Dolby intended to leave his widow the house and the substantial life insurance proceeds, while leaving his children essentially nothing from an otherwise substantial estate after the mortgage was paid. Yet, because the boilerplate language inserted in the instrument did not make clear any intent to the contrary, this was the final result. –W. Hunter Old

Buy-Sell Basics
Buy-sell agreements funded by life insurance are a popular tool in planning for the succession and longevity of a business upon the death of a business owner. Through buy-sell agreements, business owners can agree to a predetermined disposition of each owner’s interest in the business upon his or her death or upon other events. The two main buy-sell planning scenarios generally involve an agreement among the business owners under which: 1) the business entity will buy back the deceased owner’s share upon death (referred to as a “redemption agreement”), or 2) the other owners will directly buy out the deceased owner’s share upon death (referred to as a “cross-purchase agreement”). As one might imagine, the unexpected death of a business owner can quickly create the need for liquidity to fund these obligations under a buy-sell agreement, and accordingly, life insurance on the lives of business owners is frequently used to provide this needed liquidity.

Limitations of Traditional Buy-Sell Planning
Despite the many benefits of the traditional buy-sell strategies, there remain significant limitations that prevent widespread implementation among many businesses that could greatly benefit from buy-sell planning. Below are a few of the frequently cited limitations of traditional buy-sell planning:

1. The cash value and death benefit of the life insurance policies often can be reached by creditors of the business (under a redemption agreement) or creditors of the individual business owners (under a cross-purchase agreement).
2. Under a cross-purchase buy-sell agreement, the number of policies required to carry out the plan can become difficult to manage depending on the number of business owners, as each owner must own a policy on the life of each other owner. For example, in a business with three owners, six policies are needed.
3. The success of a buy-sell plan can be largely dependent on the responsibility and oversight of the individual owners and the plan can be compromised if the individual owners fail to pay the premiums on their policies or if they refuse to pay over or use the death benefits pursuant to the buy-sell agreement.
4. The financial burdens of the premiums may be allocated disproportionately if younger owners have to own policies on older owners, which carry higher premiums and vice versa.
5. Undesired income tax consequences can be triggered by the “transfer for value” rule when remaining policies are transferred between owners, as will be necessary at the death of an owner, as well as other times during the plan.

The Benefits of Using an LLC
A recent advancement in buy-sell planning is the use of a limited liability company (LLC) separate from the underlying principal business entity to own the buy-sell insurance. Under this approach, the business owners would still execute a “cross-purchase” agreement, but would form an LLC to own a life insurance policy on the life of each owner. Using an LLC to own and administer the insurance policies can combine the benefits of “redemption” and “cross-purchase” agreements, while eliminating the disadvantages of both. The use of an LLC can lessen the administrative burden, make use of tax benefits, afford flexibility in structure, and provide numerous other benefits as discussed below.

1. Avoids Numerous Policies: Typically, a cross-purchase buy-sell agreement requires each business owner to own a policy on the life of each other business owner. However, by using an LLC to own the buy-sell insurance, the LLC owns all the policies, so only one policy per shareholder is needed.
2. Protection from Creditors: In a typical buy-sell agreement situation, if the policy is owned by the principal business entity, the policy may be subject to the creditors of the business. Similarly, if the policies are owned by the business owners in their individual capacities, the policies may be subject to the reach of creditors of the individuals. However, by using a separate LLC whose main purpose is to own the buy-sell insurance, the policies generally are protected from the reach of creditors of the principal business and creditors of the individual business owners. Further, IRS guidance supports the valid business purpose of such an LLC used solely to own insurance.
3. Tax Benefits: Typically in buy-sell planning, unwanted income tax consequences are often triggered as a result of the “transfer for value” rule under Internal Revenue Code §101 which treats as income any valuable consideration received in exchange for the transfer of any right to receive life insurance proceeds. This situation can arise in numerous scenarios during traditional buy-sell planning. For example, in traditional cross-purchase buy-sell planning, when any owner dies, the surviving owners typically purchase the life insurance policies owned by the deceased owner at his death (which the deceased owner owned on the other owners). This can trigger the “transfer for value” rule requiring income to be recognized. However, when using the LLC structure the transfer of policies generally is not necessary, and one of the exceptions to the “transfer for value” rule is the transfer to or from a partnership in which the insured is a partner, so this exception applies when transfers are necessary. Finally, IRS guidance provides that, so long as properly structured, insurance proceeds payable to the LLC would not be includable in the estate of a deceased owner.
4. Transferability: The use of an LLC to own buy-sell insurance allows much easier transitions by permitting new owners to join the LLC and participate in the existing insurance framework, while also allowing current owners to exit the LLC prior to death, without triggering the “transfer for value” rule. At the death of an owner, his or her death benefit is used to buy the deceased owner’s interest in the principal entity and to cancel his or her interest in the LLC, eliminating any ongoing obligations.
5. Economics: The use of an LLC allows for flexibility in structuring how the premium costs for insurance policies are borne by the owners. Among numerous other options, the LLC can be seeded with income producing assets to fund the premiums. Another option is that the principal entity can pay the premiums indirectly through presumably equal distributions, dividends or compensation to the members or shareholders of the principal entity, who then contribute the funds to the LLC for payment of the premiums.
6. Ease of Administration: The use of an LLC in buy-sell planning provides a centralized vehicle to administer the policies, rather than leaving the responsibility and oversight up to the individual owners.

The use of an LLC to own life insurance in conjunction with a properly structured buy-sell agreement can provide the ideal structure for a smoother transition and more security for small businesses upon the death of individual business owners. –Will Holt