The Best Laid Plans or How Cheap Wrecks Estate Plans

Most do-it-yourselfers pride themselves on saving money by doing things without professional help. Many of those things work out just fine. When they go bad, it can be a disaster. Plumbing repairs seem great until they leak and instead of fixing a pipe the homeowner has to fix a flooded home.

Estate planning is the same. Do-it-yourself arrangements reach the desired result most of the time. Sometimes they do not work and the result can be distribution different than the decedent wanted to lawsuits.

Some mistakes can almost be predicted. Putting different children as death beneficiaries or even co-owners of different accounts can fail when an account is closed or depleted. Asset values change over time so leaving an equal amount to each child can be difficult to arrange through asset titles. And, what happens when the intended death recipient dies first? 

Do it yourself Wills can leave out important provisions. In Florida, power to sell real property must be given to the personal representative (Florida term for an executor) or the personal representative has to apply to a court for authority to sell real property, even if probate is opened! Some people forget to include a residuary clause after listing specific assets to named beneficiaries. That means anything left over after the listed assets is distributed as if the decedent did not have a Will. 

The most common mistake by the do-it-yourself estate planner is not considering who gets distribution if an intended beneficiary dies first. That is especially true when leaving assets to children, as many do not even think about a child dying first. The result can be a lot different than what the person would want.

Tax consequences are often ignored, much to the chagrin of the recipient. Parents often want to give their children assets before they die or at least give them ownership under survivorship title in case the child dies first. They do not give a thought to taxes, but they should.

When a parent places a child on title, it is a gift. Gift tax return is required when gifts to a person exceed $17,000 in a year. That happens instantly with most real estate. The tax is likely $0 because there is currently a lifetime exemption from gift and estate tax of $12.92 million. The real tax trap happens when mom or dad dies and the child decides to sell.

The tax code provides the recipient of a gift gets the gift valued at the lesser of the donor’s basis (roughly what the donor paid for it) or what it is worth at time of the gift. Most real estate appreciates over time, so the child is treated as having “paid” the donor’s basis for the child’s gifted share. When the child later sells, the child pays taxes on the difference between the donor’s basis and sale price. 

When an asset is inherited, the recipient is treated as having “paid” market value for it. That means, the child inheriting real estate and selling it likely pays no income tax. The child who got the gift before a parent dies pays income taxes when sold calculated as if the parent still owned it and sold it. That can make a lifetime gift expensive to the recipient!

Another do-it-yourself mistake involves leaving or giving assets to one child to distribute to others. Sometimes this is done by making the “trusted” child a co-owner. Other times it is done by leaving everything to that child in a Will or a trust. The trusted child is to do what the decedent tells the child just before he or she dies. The plan is to avoid changing a Will or a trust or even drafting one. What could go wrong?

The trusted child might not do what the decedent intended or even told them to do. That child now owns the asset. The parent believed the trusted child would do the right thing. Even without intent the trusted child might fail if that child has creditor issues, is incapacitated or dies before distributing assets. And, if the trusted child gives more than $17,000 to anyone, gift tax return is required.

If assets were placed in the trusted child’s name before the donor died, tax problems are compounded as everyone who gets the assets inherits the original owner’s basis. Ouch!

Some parents go to the trouble of drafting a Will or trust but leave assets through the Will or trust to the trusted child to distribute. That way at least the tax problem of lifetime gifts is avoided, but the plan might not work as intended. 

The case of Turkish v. Brodyis a great example of a plan that might not have worked. In that case, the grantor set up a revocable trust. The trust appointed a son and granddaughter to be trustees when the grantor died and gave the trustees authority to distribute the trust assets among that son and the grantor’s other child in the trustees “absolute discretion.” The son distributed all to himself and the other child sued for breach of fiduciary duty. The court ruled the distribution was authorized and within the son’s authority so the other child got nothing.

Even attempts to give a child a bank account can go awry. The case of Larkins v. Mendez may be a good example.

In the Larkins case, dad added his oldest son as co-owner of a bank account. The addition occurred years before dad died and involved signature cards signed by both dad and son. The account had $314,168.41 when dad died. After probate opened, the son claimed the account was his. His brothers disagreed and litigation followed. After a four-day trial, and an appeal, the court ruled the account a convenience account and an asset of the estate.

A convenience account is just what it sounds like: an account set up for convenience of the original owner to allow use by another, usually for benefit of the original owner. The court was certain the account was a convenience account, but what did dad really intend?

A lot if these do-it-yourself estate plans are an effort to save attorney fees. Instead of paying an attorney to draft, the do-it-yourselfer sets up accounts and puts beneficiates on them or finds a form somewhere and uses the form. That may save cost of drafting but opens the door to unforeseen problems. Sometimes, these plans are penny-wise and pound-foolish in addition to failing the creator’s intent.