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«ESTATE PLANNING A Simplified Guide for Oklahoma Farm and Ranch Families Circular E-726 Oklahoma Cooperative Extension Service Division of Agriculture ...»

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The main advantage of selling the farm for a lifetime annuity is that the farm is not included in the seller’s estate for estate taxes. The main disadvantage to the selling parent is that the buyer’s promise is unsecured and the parent is left with little financial protection if the buyer dies or becomes bankrupt. To enjoy the tax saving features of a private annuity requires that the buyer’s promise must not be secured by seller retaining rights in the property involved. Thus, it is different from a typical installment sale. Each annual payment to the parent is usually comprised of ordinary income, return of capital, and capital gain.

A situation in which the lifetime annuity might be justified is where the parent has several farms, is short of liquid assets, such as cash, is unable to take advantage of the annual gift tax exclusions and all of his children are interested in buying a farm. In this case, if a default occurs, the parent would still have land and income remaining from the other farms. Also, if all children were involved, a charge of favoritism to one child could not be made.

The parties involved in a private annuity should seriously consider all tax ramifications of private annuity transactions. Private annuities often result in liability for income and gift taxes. Check with your attorney and tax accountant for further details on private annuities.

Insurance Life insurance is normally purchased to provide cash for three primary purposes: (1) for income for dependents in case of premature death, (2) for retirement income, and (3) for the payment of estate settlement costs such as debts, claims, lawyers’ fees, and estate taxes. Adequate insurance may prevent a forced sale of business assets on a depressed market in order to meet costs in settling the estate. It may be used to provide liquidity in the estate of both spouses. The importance of insurance is sometimes overlooked in the estate of the surviving spouse, but it may be sorely needed since the surviving spouse’s estate will not be eligible to use the federal marital deduction. Recognizing the need and providing for liquid assets is a part of estate planning.

Sometimes owners will leave the farm to a farm-operating heir, and proceeds of a life insurance policy to the nonfarming heirs. This method serves two purposes: it leaves the farm intact, and it treats the heirs fairly. Many partners’ “buy and sell agreements” are financed with life insurance. Life insurance trusts are discussed in the section under trusts.

Gifts of life insurance policies are sometimes made in large estates, especially when most of the assets are in one spouse’s name. Although the unlimited marital deduction has to some extent reduced the need for concern about equaling the estates of both spouses, it still may be desirable. A gift of an insurance policy removes the proceeds from the estate of the insured. However, the cash value of the policy will become part of the estate of the new policy holder. Forms and instructions may be obtained from the insurance company. The gift of the insurance policy (slightly more than the cash value) would be subject to gift taxes. Oklahoma law permits the assignment of any or all incidents of ownership of group term life insurance.

Generally, life insurance proceeds payable to the estate or policies in which the decedent retained “incidents of ownership” would be included in the decedent’s estate for estate tax purposes. Incidents of ownership include the right to change beneficiaries, use the policy for a loan, borrow against the policy, cancel or surrender the policy, assign or revoke the assignment of a policy, or convert the policy to another form of insurance. Incidents of ownership also include a reversionary interest in the policy or proceeds if the value of the reversionary interest immediately before the death of the decedent exceeded five percent of the value of the policy. “Reversionary interest” includes a possibility that the policy or its proceeds may return to the decedent or his estate. Thus, when a gift of insurance is made, action should be taken to ensure that a reversionary interest does not exceed five percent, that is, it will not pass back to the donee by inheritance.

If additional insurance is desired on a parent’s life, the children should consider purchasing the insurance. Since the children would be the owners of the policy, it would not be included in the parent’s estate. If a child should die first, only the cash value of the policy would become part of the child’s estate.

Trusts The trust is becoming more popular as a tool in estate planning. The trust is a written agreement by which an owner of property (the trustor) transfers his title to a trustee for the benefit of persons called the beneficiaries. Both real and personal property may be placed in a trust. The trustee may be a person or persons, a corporation, or a combination of the two. A trust can continue for any period of time set by the owner–for a lifetime, until the youngest child reaches age 21, and so forth. If the trust extends beyond a lifetime, there are limitations that should be explained by your attorney.

An important advantage of the trust is its flexibility. The trustee can be empowered to “sprinkle” or “spray” trust property among the beneficiaries as their respective needs may require; this feature especially accommodates the unpredicted emergency or misfortune that might arise. In addition, the trustor (settlor) may place numerous restrictions and requirements in the trust relative to the payments to be made to the beneficiaries. For example, the income earned by the trust, a fixed percent of the assets or part of the principal may be paid out each year. These requirements must be carried out by the trustee.

Kinds of Trusts Basically there are two kinds of trusts, living trusts and testamentary trusts. The living or inter vivos trust is created and made effective while the trustor is living. A living trust is in essence an agreement between the trustor and the trustee and may be revocable or irrevocable.

The testamentary trust is so-called because it is established under the provisions of a last will and testament. The testamentary trust does not become effective until the will has passed through probate. Since a testamentary trust does not go into effect until death of the owner, there is no tax saving in his estate. However, the trust may be drafted to save estate taxes in the estates of the beneficiaries. A testamentary trust is also useful when the heirs are minors or inexperienced in money matters.

Duration of Trusts Trusts may be either revocable or irrevocable. The revocable trust can be terminated or altered and offers no special estate tax advantage. In other words, the assets of a revocable trust are included in the estate of the deceased creating the trust. It can, however, be written in such a manner as to substantially reduce the estate taxes of the beneficiaries. For example, a person placing property in trust for a son for life with a remainder interest to the grandson would skip one generation of estate taxes. Although a generation-skipping transfer tax may be imposed, the value of the property in trust would not be included in the son’s estate. The revocable trust, while offering no estate tax advantages to the grantor’s estate will, however, eliminate the cost of probate applicable to his trust property. The probate costs may include executor’s fees, attorney’s fees, court costs, and appraisal fees.

The irrevocable trust cannot be amended, altered, revoked, or terminated. The trustor cannot get his property back.

Assets placed in an irrevocable trust are removed from the estate of the person creating it. It is, therefore, useful in estate planning because it will reduce estate taxes. Gift tax rules would apply when the property is placed in trust. If the value exceeded the gift tax exemption, a tax would be due.

Special Purpose Trusts

There are a number of special named trusts depending on their purpose and use. A few of them are as follows:

• A charitable trust may be either permanent or short term (reversionary) depending on the objective of the grantor.

For example, a man could set up a permanent trust with the income payable to his wife for her lifetime. At her death, the remaining assets could be paid over to the charitable or educational institution. The grantor in this case would receive an immediate charitable deduction from his taxable yearly income for the “present value” of the amount that the institution will receive from the trust fund. The amount is calculated from actuarial tables. The total assets would be removed from the grantor’s estate for estate tax purposes provided all requirements are met.

• A short term reversionary trust may be used as a tax-saving tool for making annual donations to charity. For example, securities might be placed in trust to provide $1200 of income per year. The trustee pays the whole income to the charity without it having been taxed as part of the grantor’s income. A charitable trust may last for as short a period as two years and still relieve the grantor of the tax on its income.

• Marital deduction trusts are used to take maximum advantage of the estate tax laws. Usually they are divided into two parts. One-half of the trust assets are given to the spouse for life with a general power of appointment. The other half would name him or her as the beneficiary for life with a remainder interest to the children. It is usual to suggest that the spouse use money from the part one trust first in order to reduce estate taxes at his or her death.

• The reversionary trust or short term trust is sometimes referred to as the “Clifford Trust.” The trust property in a reversionary trust reverts to the trustor (settlor) of the trust after a stated period of time. Under this type of trust the property and/or securities are placed in the care of a trustee for a period of not less than ten years. At the end of the ten-year period, the property would revert back to the original owners. Normally the objective of creating a reversionary trust is to reduce income taxes. However, the 1986 Tax Reform Act removed the ability to reduce income taxes by using a Clifford trust. Note that if all the income is paid to the beneficiary(s), the tax return is filed by the beneficiary(s). If the funds are accumulated, the tax return is filed by the trust; note that a trust required to distribute all of its income currently is allowed a personal exemption of $300. All other trusts are allowed $100.

(I.R.C. Sec. 642.) • Life insurance trusts are used widely in estate planning. The trusts may be either funded or unfunded. If the policies are on the lives of persons other than the creator of the trust, the income from trust funds used to pay the premiums will be taxed to the trust. Thus an income tax saving may result. There are many variations of the insurance trusts for which insurance advisors should be consulted.

• Power of Appointment Trust. A general power to appoint during life is the equivalent of outright ownership since the capital is available for the asking. Most authorities prefer to restrict the power to one exercisable by will only.

This is enough to qualify the bequest for the marital deduction and preserve the property for future generations.

Some of the advantages of a power of appointment trust are as follows:

• There is a good chance the property will pass according to the wishes of the first spouse to die, because of the usual clause designating how the capital will be distributed at the surviving spouse’s death in the event he or she fails to exercise the power.

• There will be savings in administration fees and attorney fees since the trust assets will form no part of the surviving spouse’s probate estate.

• It relieves the surviving spouse of investment and management problems.

• Flexibility may be introduced, allowing the surviving spouse limited invasion privileges during life and by authorizing the trustee to pay additional capital sums to the surviving spouse at any time or times.

Other Uses of Trusts

Some additional conditions and uses for which a trust should be considered are as follows:

• When the beneficiaries are minors.

• When dependents are incapacitated.

• When a beneficiary is a spendthrift or incapable of managing the business.

• When the beneficiary is a person who does not desire to worry or be bothered with the business responsibilities.

Many professional trustees, such as banks and trust companies, have special arrangements for handling farm trusts.

Generally banks charge 1/2 to 1 percent of the trust principal per year. This charge may vary depending on size and nature of the trust. On the other hand, a relative or a person having management experience and qualifications and trusted by the family could be named as a trustee.

Probate Proceedings The process of settling an estate is usually referred to as probate. The primary purpose of probate is to fix the rights of the persons who are to receive the property of the decedent. When these rights are established by the probate court, questions will not likely arise later as to ownership of the property.

The steps in probating an estate of a deceased person are similar whether the decedent died testate (with a will) or intestate (without a will). A petition is filed in the District Court setting out the time and place the decedent died, together with facts showing that the Court has jurisdiction over the estate. Such facts may be that the decedent died or owned property within that county, or was a resident thereof when he died; in addition the petition shows the name of the executor (the person named by the decedent in his will to be his personal representative) and whether he is willing to serve, the names, ages, and residences of known heirs, and the probable value and character of estate property. The petition may be filed by any person interested in the estate including creditors of decedent.

Whether the decedent died testate or intestate, a hearing will be held. A legal notice must be published at least one time in a newspaper within the county. The publication must appear at least ten days before the date set by the court for hearing the petition; also the notice must be mailed to every known heir, legatee, and devisee of decedent.

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