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What to know about tax exemption

The Tax Cut and Jobs Act of 2017 doubled the federal tax exemption amount for estates from $5.49 million in 2017 to $11.2 million in 2018.

The change means that whether you have or lack a will, you can now leave more untaxed funds to your beneficiaries. The change has drastically altered how estate planning attorneys are working with clients.

The federal estate tax on the taxable portion of a decedent’s estate is 40 percent. California does not require an additional state inheritance tax.

“Before, we tried to bring the value of assets down to reduce the amount of the estate. We wanted the value of the estate to be low to fit within that $5.49 million exemption. We created limited liability companies and did gifting, creating fractional share interests. (We) used other estate planning tools to make that happen. Now we’re trying to maximize the value of the estate to get as close to full value, but within the applicable estate tax exemption. (This) increase(s) the ‘step-up’ in capital gains basis for the estate assets,” said Mark Gladden, a Healdsburg-based estate planning attorney with Passalacqua, Mazzoni, Gladden, Lopez & Maraviglia, LLP.

Beneficiaries also receive an advantage because of the step-up basis loophole.

When a person dies, the value of certain assets, including qualified stocks, real estate, and other capital assets, changes to the asset’s fair-market value on the day that the decedent passed.

For example, say a decedent bought a house for $50,000. The house is now worth $650,000. The person inheriting the house can value the house at $650,000. This practice minimizes the beneficiary’s capital gains tax on the asset. Capital gains tax is a tax on the profits from specific types of assets.

A beneficiary would be taxed on the profit they received from the sale of the $650,000 house.

Aretha Franklin’s death on Aug. 16 and the passing of Prince in April 2016 turned up one thing the entertainers shared in common.

Both died without a will.

According to experts, dying without a will creates mystery.

“In my experience, the most common thing that happens when someone dies without a will (or trust) is nothing. No one really knows what to do,” said Anthony Celaya, a Napa-based estate-planning attorney.

As a result, your children, partner and relatives have to spend time, money and energy working to convince a court-appointed probate administrator what you wanted done with your property and other assets.

The most common way to avoid confusion is to create a living trust and a “pour-over” will. A pour-over will states that assets that have not been placed in the living trust should go there when you pass. Creating a trust that contains all of the assets allows you to avoid the costs and time of probate.

A living trust is a written legal document that places your assets into a trust for your benefit during your life. When you pass, the assets are distributed by your chosen representative, or successor trustee, to your beneficiaries.

What happens first?

California state law allows the court to initiate a probate case when there is no will and there are assets requiring the opening of a probate, such as real estate in the decedent’s name. The court typically appoints a close relative, the decedent’s spouse, child, or grandchild, in that order, as an administrator.

That person settles the decedent’s outstanding debts, including their final federal and state income taxes. All debts are deducted from the assets of the estate. Then the administrator distributes the remaining assets to the decedent’s heirs. The distribution occurs pursuant to California’s intestacy statutes. The term “intestacy” refers to dying without a will.

If a decedent is survived by children but no spouse, the children inherit everything in equal shares. If a decedent is survived by a spouse, their assets are handled differently depending on whether the assets are community or separate property. Community property is property acquired during the marriage, such as income earned during the marriage.

Separate property is property a spouse owned before marriage or after separation. It is also property that a spouse inherits or receives as a gift before, during, or after marriage.

An asset can change status from community to separate property and vice versa. There are many ways an asset can change status, such as if two or more assets are commingled, the spouses form a written agreement, or the spouses improve separate property, like a house, with community property, such as income earned during the marriage.

After a decedent passes, the spouse gets all of the community property. When a decedent is survived by a spouse but the decedent leaves no children, grandchildren, parents, siblings, nieces, or nephews, then the spouse inherits all the separate property as well.

When a decedent is survived by a spouse and one child, the spouse receives one half of the separate property. The decedent’s child receives the other half of the separate property.

When a decedent survived by a spouse and two or more children, the spouse receives one third of the separate property. The children receive the remaining two thirds of the separate property, divided up into equal shares.

What to know about tax exemption

The Tax Cut and Jobs Act of 2017 doubled the federal tax exemption amount for estates from $5.49 million in 2017 to $11.2 million in 2018.

The change means that whether you have or lack a will, you can now leave more untaxed funds to your beneficiaries. The change has drastically altered how estate planning attorneys are working with clients.

The federal estate tax on the taxable portion of a decedent’s estate is 40 percent. California does not require an additional state inheritance tax.

“Before, we tried to bring the value of assets down to reduce the amount of the estate. We wanted the value of the estate to be low to fit within that $5.49 million exemption. We created limited liability companies and did gifting, creating fractional share interests. (We) used other estate planning tools to make that happen. Now we’re trying to maximize the value of the estate to get as close to full value, but within the applicable estate tax exemption. (This) increase(s) the ‘step-up’ in capital gains basis for the estate assets,” said Mark Gladden, a Healdsburg-based estate planning attorney with Passalacqua, Mazzoni, Gladden, Lopez & Maraviglia, LLP.

Beneficiaries also receive an advantage because of the step-up basis loophole.

When a person dies, the value of certain assets, including qualified stocks, real estate, and other capital assets, changes to the asset’s fair-market value on the day that the decedent passed.

For example, say a decedent bought a house for $50,000. The house is now worth $650,000. The person inheriting the house can value the house at $650,000. This practice minimizes the beneficiary’s capital gains tax on the asset. Capital gains tax is a tax on the profits from specific types of assets.

A beneficiary would be taxed on the profit they received from the sale of the $650,000 house.

What it costs

The probate process starts with the filing of a probate petition in the county in which the decedent lived. Fees vary between counties. The fee for filing the initial petition is $435 in three North Bay counties: Marin, Napa and Sonoma.

The petitioner must also pay a court reporter fee and a fee for publishing the notice of probate with a local newspaper. The court appoints a probate referee to appraise the estate assets. As to the appraisal, there is at least one fee but there can be more fees. The probate process closes with the filing of a petition for final distribution of the estate assets. This action has its own fee.

In addition, the probate court will charge fees for filing other petitions, the probate notice, compensating the probate referee, if needed, and certified copies of court documents. When there is no will, the court requires the administrator to get a probate bond. The exception is when there is a waiver of a bond for the administrator. The reason there is an exception is that the beneficiaries have waived the need for an instrument to protect them in case of a loss.

The bond protects the beneficiaries and creditors in case the administrator does not do his or her job properly. The amount of the bond depends on the value of the estate. A bond for $100,000 may be about $500, or 0.05 percent of the estate.

A matter typically takes six months to two years to be resolved in probate court. Small estates with certain assets of $150,000 or less can be settled without formal probate proceedings, using simple transfer procedures.

Estates of value greater than $150,000 must go through probate court. Administrators and attorneys get paid for their ordinary duties out of the estate. In 2018, the allowed fees for each are four percent, or $4,000, for the first $100,000 value of the estate, three percent of the next $100,000, two percent of the next $800,000, one percent of the next $9 million, and one-half percent of the next $15 million.

The fees are charged on the gross estate. If the estate only contained a house worth $1 million that owed a debt of $600,000 on its mortgage, the administrator’s and attorney’s fees would be based on the $ million value. The attorney and administrator can charge further fees for handling “extraordinary” matters such as lawsuits and tax-related concerns.

If the decedent left property in another state, the administrator must file a separate petition in the appropriate probate court in the state in which that property lies. Probate courts in other states may have different fees and costs than those in the North Bay region of California.

Probate courts are similar, but attorneys aren’t

Throughout California, probate courts operate in relatively the same way. In Marin, Napa, and Sonoma counties, fees amounts and minor timing and scheduling issues are the only appreciable differences.

“Some local rules can serve as an impediment to things getting done more quickly. Also, probate examiners tend to examine a case with different degrees of specificity,” said Timothy Barteau, an estate attorney who often practices in Marin County. Barteau works at the San Francisco-based Keystone Law Group and typically deals with litigation following the administration of an estate.

A skilled attorney can help beneficiaries showcase the decedent’s intent when a formal will does not exist.

“A will is a somewhat loose term. The document doesn’t have to have all the formal requirements, such as being signed by…the decedent with two witnesses present at the time that the (decedent) signs. A document written by the (decedent) in his or her handwriting which is intended to act as a will and that is signed and dated by the testator, even without witnesses, can be a will. A letter could end up being a will. It is best not to leave this issue to chance.” said Mark Gladden, a Healdsburg-based estate-planning attorney with Passalacqua, Mazzoni, Gladden, Lopez & Maraviglia, LLP.

Gladden said an attorney can also assist a spouse with filing a spousal property petition, which transfers assets from the decedent to the surviving spouse. This is a simplified probate process that costs less than a full probate. Further, if an asset, including a piece of real property, is excluded from a trust, an attorney can also help a beneficiary file a Heggstad petition. The court will then consider bringing the excluded asset into the trust.

An attorney can also ease real property transfers, said Frank Bailey III, a Santa Rosa-based estate-planning attorney.

“An attorney working with spouses before one passes can ask how the spouses hold title to their house. Spouses primarily build up value in a house. If the spouses hold title as “community property with right of survivorship,” the surviving spouse will automatically own the house after the decedent passes. Probate will not be necessary to transfer the house. The surviving spouse then does not have to do a real estate assessment,” said Bailey.

Children, more important than money

One of the best reasons to make a will is to name the guardian of minor children. If the other natural or adoptive parent is alive, they become the guardian. If both parents have passed and the decedent died without a will, the decedent has given up their right to name a guardian.

In this event, the court appoints a guardian, using information about the children, the family circumstances, and the decedent’s wishes. The court is required to act in the best interests of the children.

“Everybody should at least talk to an attorney, even if they don’t think they have enough money,” said Gladden.

Barteau said a guardian should not be nominated in a trust. A trust is a private document that is not admitted to probate.

“You put that information in a will. You can also use a will to dictate how money will be held for minors after you pass. If there is no will or trust, the money for minor children technically belongs to the kids. It could go into a blocked account, which will only earn minimal interest,” said Barteau.

Other ways to inherit

A will or lack of one does not govern the distribution of all of a decedent’s assets. Other instruments can distribute money or property to heirs and avoid probate. For example, a person named as a beneficiary of a life insurance policy or an IRA or 401(k) plan can receive a disbursement without a will.

Bank accounts can also have pay-on-death clauses. In California, a real property owner can name one or more beneficiaries in a Transfer on Death deed to receive the property when the owner dies. Individuals unsure about whether a certain asset becomes part of the estate should talk to a qualified estate and trusts attorney.