Estate Planning Advisor Fundamentals of Community Property A. - - PDF document

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Estate Planning Advisor

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inside this issue

2 Should We Care About Making Annual Exclusion Gifts? 3 Who Will Make Decisions for You? An Essential Part of Your Plan 4 Getting Started in the Exit Planning Process 5 Preparing for the Onset of Dementia

• I. Introduction to Community Property

Washington, Idaho, California, Nevada, Arizona, New Mexico, Texas, Louisiana, and Wisconsin are all “com- munity-property” states. This means that in each of these states, items of a married couple’s property are character- ized as either community or separate, and each spouse’s right to any given piece of property is determined based

• n the property’s characterization—not

necessarily by title. The general concept

• f community property is similar in

each of these states, but the application

• f community-property laws varies by
• jurisdiction. This article will discuss

the fundamentals of community-prop- erty laws in Washington State: what constitutes community and separate property and what it means if an asset is community or separate. How to keep separate property separate, and how to convert separate property into community property, will be discussed in the next issue of the Estate Planning Advisor newsletter.

• A. Rights Affected by Character-

ization as “Community” or “Separate” Although calling property “com- munity” or “separate” may seem like a matter of semantics, characterization actually carries great weight in deter- mining ownership and the rights of the parties. When a marriage dissolves, each spouse will be entitled to half the com- munity property. During a marriage, community property cannot be sold

• r given away by one spouse without

the consent of the other spouse. Upon death, a spouse may give all of his or her separate property as he or she wishes, but may give only his or her half of the community property. Characterization of property also significantly affects the rights of credi-

• tors. A discussion of creditors’ rights

in community and separate property is beyond the scope of this article; if you have a question on this point, you should contact an attorney. B. What Is “Community Prop- erty” and “Separate Property”? In Washington, a couple may agree to characterize their property as com- munity or separate in any manner they desire; this discussion will explain how Washington law classifies property when the parties have not agreed oth- erwise. Community property includes all income earned during the marriage by either party, and all assets purchased with such earned income. In Washing- ton, there is a general presumption that all property is community property, unless specific evidence indicates that a given piece of property is not commu- nity property. Finally, all income earned

• n community assets is community

property. Separate property includes property

• wned by one spouse before marriage,

gifts and inheritances (even if they are received by a spouse during marriage),

Fundamentals of Community Property

by Adrienne P. Jeffrey

adrienne.jeffrey@millernash.com 206.777.7512

2 | miller nash llp | Estate Planning Advisor

Should We Care About Making Annual Exclusion Gifts?

Under federal law, a person can make a gift or gifts to anyone without having to file a gift tax return if the total calendar-year amount of the gifts to that person is under $14,000. But do such gifts really matter anymore now that the estate tax exemption is $5,340,000? The gift tax exemption as de- signed generally applies to gifts to

• children. When a person pays for

the child’s support and education while a minor, such payments are not treated as taxable gifts under federal law. A gift of a sweater or cash for Christmas or a birthday, for example, is normally treated as a gift. If valued under $14,000, such gifts are exempt from the

• bligation to file a gift tax return.

Thus, an annual exclusion gift can definitely be a plus because it avoids the cost and hassle of filing a gift tax return. Another plus of annual exclu- sion gifts is that they do not use up any part of the estate tax exemption of $5.34 million. Thus, if a gift were made in 2014 for $14,000, the estate tax ex- emption of $5.34 million would remain. But a larger gift of, say, $18,000 would consume $4,000 of the estate tax ex- emption, reducing it to $5.336 million. In the past, parents would often attempt to leverage the amount of an- nual exclusion gifts to their children. So if a husband and wife had three children, they could each gift to each child $14,000, for a total gift, all sub- ject to the annual gift tax exclusion, of $84,000 (two parents × three children × $14,000). This is certainly a substantial amount of money. But compared to the estate tax exemption of $10,680,000 ($5,340,000 each for husband and wife), it is only .079 percent of the total

• exemption. If a $10.68 million estate

is composed of real estate, stocks, and bonds, it is likely over the long run to be growing at a compound annual rate of perhaps 7 or 8 percent. Thus the prob- lem with making a smaller gift is that it does not do much to reduce estate taxes for those who have larger estates. Such an estate will continue to grow far faster than it can ever be reduced by annual exclusion gifts. Most of us will never see our estate exceed $5.34 million (adjusted for infla- tion), and thus there is no need to worry about federal estate taxes. In Oregon and Washington, the state estate tax exemptions are at $1 million and $2 mil- lion, respectively. There is no Oregon or Washington gift tax, so unlimited gifts can be made without triggering an Or- egon or Washington gift tax. For those who have an Oregon estate in excess

• f $1 million, but less than the federal

$5.34 million exemption, any gift will reduce the Oregon estate taxes at death. The sole advantage of making a smaller gift within the $14,000 annual exclu- sion, however, is simply to avoid filing a gift tax return. In fact, many clients stick to gifts using the $14,000 annual exclusion amount, since it is a num- ber that they can grab onto. But it is generally too small a gift to save an appreciable amount of federal or state estate taxes. If a couple did have a larger es- tate, one that was over $10.68 mil- lion, the savings in federal and state estate taxes from making an annual exclusion gift of $14,000 will often be equal to 50 percent or more of the amount of the gift. The difficulty is that it will generally take a much larger gift, or utilizing

• ther estate planning techniques,

to significantly reduce the overall estate tax bite.

by Ronald A. Shellan

ronald.shellan@millernash.com 503.205.2541

Estate Planning Advisor | miller nash llp | 3

Who Will Make Decisions for You? An Essential Part of Your Plan

(continued on page 6)

Estate planning can be used to ac- complish various goals, from efficient tax planning to ensuring that assets are protected for future generations. Often, determining whether a specific estate planning tool is appropriate or advisable takes sophisticated analysis, but there are some basic estate planning docu- ments that are useful for each of us, re- gardless of our broader planning goals

• r financial circumstances. The docu-

ments include Healthcare Directives (also called “Living Wills”

• r

“Advance Directives”) and Powers of Attorney for business and healthcare

• decisions. This article briefly

describes how each of these documents functions, and illustrates their importance as a fundamental component

• f any estate plan.

Broadly, these documents help to answer questions such as these: Who should make healthcare decisions for you if you are unable to do so yourself? Who should make financial decisions? And if you are unable to speak for yourself, what are your wishes in terms

• f medical treatment and end-of-life

decision-making? The unrelenting stream of news springing from arguments over these questions is a reminder of the impor- tance of addressing them when we are

• f sound mind, discussing our wishes

with family, and memorializing them in writing. Although legal documents cannot control every outcome, they will at least serve as written records of your wishes regarding your own care, and your wishes regarding who should make decisions on your behalf if you are unable to do so yourself. I. Healthcare Directives (“Living Wills” or “Advance Directives”): Stat- ing Your Preferences Healthcare Directives are docu- ments that communicate your wishes regarding your own physical care; they should be executed when you are of sound mind, and are generally used

• nly if you are later unable to speak on

your own behalf. Each of us has a right to refuse medical care, but it is impossible to exercise that right if you are unable to speak for yourself at the time such care is needed. Healthcare Directives gener- ally communicate a person’s wishes regarding dying a “natural” death, and provide instructions regarding what should be done if he or she is in an irre- versible coma or a persistent vegetative state. These documents can further com- municate your wishes to receive—or to not receive—artificially provided nutri- tion or hydration. A Healthcare Directive directs phy- sicians and family members to follow a patient’s expressed wishes if the patient is later unable to make decisions on his

• r her own behalf; these documents

generally also encourage the person appointed under a Healthcare Power of Attorney to follow the wishes expressed in the Healthcare Directive.

• II. Powers of Attorney: Who Should

Act on Your Behalf if You Are Un- able to Act Yourself? While a Healthcare Directive expresses your own preferences to healthcare providers and family mem- bers, Powers of Attorney are documents in which you appoint other people to make decisions on your behalf. The main purposes of these documents are to clearly name people you trust to make decisions on your behalf, and to avoid the need for a guardianship if you become incapacitated. A guardianship requires that the details of medical and mental conditions be brought before a court and investigated, and is expensive, inconvenient, and often uncomfortable for the entire family. Further, it slows a family’s ability to make decisions on behalf of the allegedly incapacitated

• person. This process can be

avoided entirely by executing a Power of Attorney while competent. Powers of Attorney can be made effective immediately—granting decision-making power to the named individuals immediately—or can be made effective upon incapacity of the principal, meaning that the named individuals would have decision- making authority only if you were deemed incompetent. The timing of the effectiveness of these documents is an important decision, and should be discussed with your attorney. Spouses often take for granted that if anything were to happen to one of them, the other spouse would make decisions on that person’s behalf. While

“Spouses often take for granted that if anything were to happen to one of them, the other spouse would make decisions on that person’s behalf.”

by A. Paul Firuz

paul.firuz@millernash.com 206.777.7443

4 | miller nash llp | Estate Planning Advisor

(continued on page 8)

Nora Chapman’s story was typical

• f most business owners who have

made the tough decision to leave their

• companies. At age 54, she was confi-

dent in finding a meaningful second act and was ready to leave her 25-em- ployee advertising business. Nora was thinking of selling to one or two of her key employees. Nora approached her at- torney and asked, “Is this the right exit choice?” Many of you might find yourself in the same predicament. You are able to envision your life beyond business own- ership, but you don’t have a clear picture

• f how best to “leave your business.” So

what do you and the Nora Chapmans of the world do? First, understand that leaving your company is a process. Realizing that life after your business exit can be as fulfill- ing as your life as a successful owner is simply the first step. The next step is to figure out a way to approach your exit in a methodical, logical, rational man-

• ner. Most owners do not put enough

thought and planning into their exits, because they don’t know how to begin, don’t know that a proven process is available to them, or don’t know exactly what issues to consider and analyze. If that describes your situation, you are not alone. Most owners, and many advisors, don’t realize that planning and implementing their exit process can be methodical, rational, and tailored to their unique exit goals. The process begins by setting your exit objectives and understanding the value of your business. Based on what you want and what you have, you can then examine and choose a proper path for you—be it a sale to a third party, a transfer to children, a sale to an Em- ployee Share Option Plan, a sale to a co-

• wner, or an orderly liquidation. As part
• f the process, you must also consider

what would happen to the business and to your family if your death or disability precedes your planned exit. Simply knowing the process and proceeding down the exit planning path, however, is insufficient. Accord- ing to the Small Business Administra- tion, most business owners who begin the planning process fail because they fail to plan. To succeed, you need a writ- ten plan that:

• Identifies your exit, financial, and
• ther objectives that must be con-

sidered; and

• Documents how you are going to

achieve those objectives. Along with this written plan, you should have a checklist that:

• Assigns responsibility for each task

to be completed throughout the exit planning process;

• Sets dates for each task to be com-

pleted; and

• Designates the person responsible

for completing each task. How do you begin? As skilled and as successful as most business owners are, they cannot, working alone, create and execute their exit plans. Rarely have owners made a career of exiting businesses. Those

• wners who do attempt to craft their
• wn exit plans frequently fail, or at

best, they leave a lot on the table: a lot

• f money, time, or their own happiness.

And as skilled as is your attorney, CPA, or financial and insurance repre- sentative, acting alone, each is unable to craft a successful exit plan. This is because successful exit planning is a multidisciplinary effort that requires you and your advisors to work together. No one profession possesses the breadth

• f knowledge necessary to advise a busi-

ness owner on the wide variety of exit planning issues. For your exit plan to succeed, you will likely need legal expertise, financial advice, tax planning, financial advisory input, and, often, consulting ideas. If you decide to sell to a third party, you may require the services of a business broker or investment banker. No one advisor can be an expert in all aspects

• f exiting a business.

So what does it take to create an exit plan?

• Understand that there is a proven

exit planning process. Learn as much as you can before you make final decisions.

• Commit

to see the process through—holding yourself and

• thers accountable.
• Document your decisions and cre-

ate a written plan.

Getting Started in the Exit Planning Process

by William S. Manne

bill.manne@millernash.com 503.205.2584

“Let us, therefore, decide upon the goal and upon the way and not fail to find some experienced guide who has explored the region towards which we are advancing; for the conditions of this journey are different from those most travel.” — Seneca, “On the Happy Life” (A.D. 58)

Estate Planning Advisor | miller nash llp | 5

by Jack B. Schwartz

jack.schwartz@millernash.com 503.205.2560

The aging of the boomer genera- tion is bringing with it a sharp increase in the numbers of people affected by Alzheimer’s disease and other forms

• f dementia. Estimates of people who

will be affected by dementia over the next few decades range up to 150 mil- lion worldwide. Having a loved one who becomes incapacitated by dementia presents many difficult issues, not the least of which is arranging for proper care at each stage of what is in most cases a progressively worsening condi- tion. On the legal side, the burden on the near and dear ones of a person suffer- ing from dementia can be eased if the following basic documents are in place:

• A general durable power of attorney
• An inter vivos trust for a person’s

significant assets, naming a trustee to serve if the person is incapacitated

• A health care power of attorney
• An advance directive for health care

Once dementia is diagnosed, estate planning provisions should be carefully

• checked. Because dementia is usually

a progressive condition, people in its early stages are often competent to sign these documents. Even in later stages, periods of clarity could provide suffi- cient ability to understand and execute

• them. A further document to consider

is a power of attorney specifically pro- viding for mental health care. If these documents are in place, an incapacitated person’s family may well be spared the need for court-monitored and public guardianship or conservator- ship proceedings to provide authority to manage the person’s assets or arrange for appropriate care.

Preparing for the Onset of Dementia

Where to Begin: Business Valuation and Increasing Value

Please join us for a no-cost executive briefing that will help you easily estimate the value of your business, increase that value, and learn how to plan for your eventual exit from your business. The discussion will be of interest to business

• wners who own 60 percent or more of their business and want to begin planning for the next stage of their lives.

The briefing is intended for business owners; no advisors please. Spouses are welcome. Expected Takeaways:

• Learn why it’s important to have an exit plan and the basic components of a good exit plan
• Find out how to quickly estimate what your business is worth to a qualified buyer in four easy steps
• Get 50 practical and operational initiatives for increasing your business’s value, including how to create a project plan to

address any underperforming aspects of your business

• Walk away with a valuable workbook to help guide you through the process

When: Tuesday, February 25; 8:00-9:30 a.m. (7:45 a.m. check-in) Where: Miller Nash LLP, 111 S.W. Fifth Avenue, Suite 3400, Portland, Oregon 97204 R.S.V.P.: Alison Bailey, 503.205.2367, alison.bailey@millernash.com (Seating is limited)

Presenters: Bill Manne, Miller Nash LLP and Rick Piper, Piper Group International LLC

Exit Planning

6 | miller nash llp | Estate Planning Advisor that is often true, naming an alternate Agent beyond your spouse will ensure that if something happens to both you and your spouse, there will be no ques- tion as to who has the authority to make decisions on your behalf. Further, as we will see, there are some financial decisions that one spouse cannot make

• n behalf of the other spouse without

being appointed as Agent, or without appointing a guardian for the incapaci- tated spouse.

• A. Healthcare Power of Attorney:

Who Should Make Healthcare Decisions for You? The Healthcare Power of Attorney grants the individuals named the au- thority to make healthcare decisions on your behalf. This document can be tai- lored to authorize some decisions and not others. For example, the Healthcare Power of Attorney can be drafted to say that the acting Agent cannot override the wishes expressed in a Healthcare Directive or, alternatively, that the Healthcare Directive is an expression

• f your wishes and should be used as

guidance, but that an Agent you’ve appointed can override the Healthcare Directive if he or she deems it neces- sary or appropriate. B. General or Financial Power of Attorney: Who Should Make Financial Decisions for You? The Financial Power of Attorney also grants named individuals the authority to make decisions on your behalf. The decision-making power authorized can vary, but usually includes the authority to sign your tax returns, buy and sell property, vote proxies, make advance funeral arrangements, and make other decisions of that nature. Although one spouse can normally handle day-to-day transactions on be- half of a spouse who is temporarily incapacitated, several things, including selling jointly owned or community property, cannot be done by one spouse

• alone. As a consequence, without an

Agent designated by a Power of At- torney, a guardian would have to be appointed to represent the interests of the incapacitated spouse.

• III. Conclusion

We are all aware that we could find

• urselves, or our loved ones, in the posi-

tion of asking “what should be done?” and “who should decide?” By preparing Healthcare Directives and Powers of Attorney, you can make the answers to those questions much clearer. Who Will Make Decisions . . . | Continued from page 3

Estate Planning Advisor | miller nash llp | 5 and the income earned from separate

• property. Because of the presumption

in favor of community property, sepa- rate property may become community property if it is not titled properly and kept separate from community prop- erty. Property acquired during marriage in a non-community-property state is

• ften referred to as “quasi-community

property,” and is treated differently from both community and separate property. Also, property acquired during certain long-term committed relationships may be treated as community property. These issues are beyond the scope of this article, and you should contact your attorney if you have any questions about your rights.

• C. Common Misconceptions

Characterization of property as community or separate is often not straightforward or intuitive, and can be difficult to understand. The following examples illustrate common miscon- ceptions about the characterization of property acquired during marriage. Example 1: Imagine that a bank account is created in Wife’s name only, and Wife deposits half her monthly sal- ary into that separate account. No funds from her spouse are ever deposited into this account, and Wife uses the funds for her own discretionary purposes. Assuming that Wife was a mar- ried Washington resident when she earned the money, the account will be characterized as community property. Therefore, her spouse will be entitled to 50 percent of the assets held in the ac-

• count. This is true even though the ac-

count was opened in only Wife’s name, and was funded solely with money that Wife earned. Example 2: Husband purchases a car without consulting his spouse, us- ing money that he earned himself held in a bank account in his own name. Again, if Husband set up the account and funded it with his salary earned while he was a married Washington resident, the car will be characterized as community property—even if the title lists only Husband as owner. Example 3: Wife receives a gift of $14,000 from her parents and deposits it into a separate account, held in her name only. This property, because it is a gift, will naturally be characterized as separate property. By depositing the funds into a separate account, Wife will maintain the property’s separate char-

• acter. Note: if Wife instead deposited

funds into a joint account, the character

• f the property could potentially be

questioned later—this, among other topics relating to changing the charac- ter of community and separate property, will be discussed in the next issue of the Estate Planning Advisor newsletter.

• II. Can

Property’s Character Be Changed? Property’s character can be changed, either intentionally or inad-

• vertently. Changing the character of

property will be discussed in further depth in our next issue, but now that you understand the fundamentals of community property, you can begin to consider your own assets and their characterization. Some couples prefer to convert all property to community property—this is a common tactic to avoid probate on the death of the first spouse, and can be accomplished through an agreement between spouses regarding the char- acterization of their property. Others prefer to keep some or all property sepa- rate, which can also be accomplished via an agreement between spouses. What these types of agreements can achieve, and when they might be advis- able, will be further explored in the next installment of the Estate Planning Advisor newsletter. Our next installment will also discuss your ability to control the char- acter of property that you give to other people—both during life and at death. While giving outright can allow the recipient to commingle assets with his

• r her spouse, potentially turning them

into community property and giving the spouse rights to 50 percent of the property, gifts, and bequests made in trust can easily be structured to retain the separate-property character for the beneficiary.

• III. Conclusion

Married residents of a community- property state are subject to communi- ty-property laws and the state’s default characterizations of property as separate

• r community. These characterizations

have a great impact on each spouse’s rights with regard to that property, and yet many couples are unaware of how their property is characterized. Once a couple understands how Washington law characterizes their property, they can make thoughtful decisions about whether their property should be char- acterized in a different manner. Fundamentals of Community Property | Continued from page 1 7

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Estate Planning Advisor™ is published by Miller Nash LLP. This newsletter should not be construed as legal opinion on any spe- cific facts or circumstances. The articles are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and any specific legal questions you may have. To be added to any of our newsletter or event mailing lists or to submit feedback, questions, address changes, and article ideas, contact Client Services at 503.205.2367 or at clientservices@millernash.com.

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Getting Started in the Exit Planning Process | Continued from page 4

• Hire an experienced team of

professionals—attorney, CPA, and financial or insurance representa- tive (at a minimum)—to help guide you through this process. These professionals should more than pay for themselves by putting money in your pocket. If they cannot, you have the wrong team. If you are to exit successfully, there is much to do. We can help by provid- ing more detailed information on exit planning in general, and by giving you a sense of the time and resources that this planning and implementation process will take. Bill Manne chairs the firm’s tax, trusts and estates, and business-owner exit prac- tice teams and is also a certified public

• accountant. This article was previously

published by Business Enterprise Institute in The Exit Planning Review™.