Estate Administration Procedures: Why Each Step Is Important
National Business Institute
December 8, 2009
Thomas J. Murphy
Murphy Law Firm, Inc.
ALERTING THE CLIENT TO THE NATURE OF FIDUCIARY DUTIES
The Personal Representative (“PR”) is a fiduciary
Fiduciaries in Arizona have fiduciary duties to their immediate clients and derivative duties to beneficiaries, creditors and other interested parties, although the full reach and extent of those duties is not entirely clear. Counsel must be very familiar with the holdings of the five main cases that, to the extent they exist, set the parameters of these duties, particularly as they exist to the attorneys representing PRs and other fiduciaries. They are:
Fickett v. Superior Court, 27 Ariz App 793 (CA2, 1976);
Estate of Shano, 177 Ariz 550 (CA1, 1993);
Estate of Fogelman, 197 Ariz 252 (CA1, 2000);
Wetherill v. Basham, 197 Ariz 198 (CA2, 2000);
Capitol Indemnity Corp. v. Fleming, 203 Ariz 589 (CA2, 2002).
While there is considerable discussion as to the practical implications to these decisions, the standards are that the fiduciary and the attorney representing the fiduciary owe a duty to their clients, such a personal representative or a trustee, of ”undeviating and single allegiance” while the duty owed to beneficiaries and other interested parties is that of “fairness and impartiality”. The courts have given practitioners precious little guidance on how to balance these often-competing interests.
However, the recent enactment of Arizona Trust Code also included some statutory changes that appear to take aim at the concept of derivative duties, at least as it relates to the PR’s attorney. The act creates a new ARS 14-5652 that states:
“ABSENT AN EXPRESS AGREEMENT TO THE CONTRARY, THE PERFORMANCE BY AN ATTORNEY OF LEGAL SERVICES FOR A FIDUCIARY, SETTLOR OR TESTATOR DOES NOT BY ITSELF ESTABLISH A DUTY IN CONTRACT OR TORT OR OTHERWISE TO ANY THIRD PARTY. FOR THE PURPOSES OF THIS SUBSECTION, THIRD PARTY DOES NOT APPLY TO THE PERSONAL REPRESENTATIVE, SETTLOR OR TESTATOR.”
This new stature took effect January 1, 2009. In most instances, it will not apply to acts that predate the effective date or to wills and trusts drafted before then.
The duties of a PR
When do the duties begin?
Obviously, a PR’s duties commence upon appointment. ARS 14-3701. But many attorneys do not realize that the statute also recognizes that “the powers of a personal representative relate back in time to give acts by the person appointed which are beneficial to the estate occurring prior to appointment the same effect as those occurring thereafter. Prior to appointment, a person named personal representative in a will may carry out written instructions of the decedent relating to the decedent’s body, funeral and burial arrangements. A personal representative may ratify and accept acts on behalf of the estate done by others where the acts would have been proper for a personal representative.”
What are the duties as set forth in Title 14?
ARS 14-3703(a) sets forth the basic concepts:
“A personal representative is a fiduciary who shall observe the standards of care applicable to trustees as described by section 14-7302 and the duties of accounting applicable to trustees as provided in section 14-7303. A personal representative is under a duty to settle and distribute the estate of the decedent in accordance with the terms of any probated and effective will and this title, and as expeditiously and efficiently as is consistent with the best interests of the estate”.
Once appointed, a PR must prepare an inventory “listing it with reasonable detail, and indicating as to each listed item, its fair market value as of the date of the decedent’s death, its nature as community or separate property and the type and amount of any encumbrance that may exist with reference to any item”.
However, unknown to many probate attorneys, this inventory need not be filed with the court. To preserve privacy, the PR may elect not to file the inventory but “he must deliver or mail a copy of the inventory to each of the heirs in an intestate estate, or to each of the devisees if a will has been probated, and to any other interested persons who request it”. ARS 14-3706(b).
When preparing the inventory, it is important that accurate, defensible appraisals are obtained. These values are presumed to be correct, affording some protection to the PR. ARS 14-3707, In Re Torrey’s Estate, 54 Ariz 369 (1939). But the use of appraisers is subject to the reasonableness standards set forth in ARS 14-3703. The use of unqualified appraisers can cause great problems for a PR. For an extreme example, see Nelson v. Rice, 198 Ariz 563 (CA2, 2000), where paintings worth $1 million were sold by a PR for $60 after the PR obtained the opinion of an appraiser who admitted he did not appraise fine art.
The PR is under a continuing duty to update or supplement an inventory if the initial inventory is “erroneous or misleading”. ARS 14-3708.
Be careful about disclosing account numbers or SSNs since this is now considered confidential information under the new Rule 7 of Probate Procedure. Rather than filing the document as confidential, it is easier to simply use the last four digits of the account number or SSN.
The PR has considerable authority in searching for information on the estate’s assets. If the PR believes that “a person is suspected of having concealed, embezzled, conveyed or disposed of any property of a decedent, or possesses or has knowledge of deeds, bonds, contracts or other writings which contain evidence of or tend to disclose the right, interest or claim of a decedent to any property, or the will of a decedent, the court may cite that person to appear before the court and may examine that person on oath on the complaint”. ARS 14-3709(b).
At such a hearing, “the court may order that person to turn over the documents or disclose knowledge to the personal representative and may commit the person cited to jail until the order is complied with or the person is discharged according to law”. ARS 14-3709(d).
The PR also has the right to sue and be sued on behalf of the estate. ARS 14-3703(c); In Re McCabe’s Estate, 11 Ariz App 402 (CA2, 1970).
Self-dealing by the PR is always a dicey proposition, but it is permitted if it is in conformance with the terms of the will. ARS 14-3713.
Liability dangers to the PR
Many PRs are blissfully unaware that that they are personally liable for “improper” exercise of the PR’s powers. The PR is held to the same standard as a trustee, which the prudent man standard. ARS 14-3712 & -7302. A trial court has authority to impose an interest charge on a PR for unreasonable delay in settling an estate. Matter of Ford’s Estate, 25 Ariz App 115 (CA2, 1975). A PR has the duty to correct mistakes, such as erroneously filing tax returns. Matter of Estes’ Estate, 134 Ariz 70 (CA1, 1982).
Protecting the PR
Given the statutory duties and the judicially recognized derivative duties that a PR faces, how does the probate attorney make sure that the PR is protected from liability? I frequently use two concepts – disclosure and court approval.
The big D
The PRs that I represent get one word drilled into them time and again: disclosure, disclosure, disclosure. When in doubt, disclose. Disclose so much and so often that the beneficiaries become sick of hearing from the PR. “Fair disclosure” can prevent an interested party from later objecting to the disclosed transaction. ARS 14-3713
Petition For Instructions
When a fiduciary is in doubt on the proper course of action, the easiest and best procedure is to file a petition for instructions. ARS 14-3704 and In The Matter of CVR Irrevocable Trust v. Retter, 202 Ariz 174 (CA1, 2002). This is simply a petition setting forth the quandary that the fiduciary is in and seeks guidance or approval from the court for a particular course of action. This author has successfully used this petition many times for authorization for gifting, either for ALTCS or estate tax purposes. Such a petition can avoid the liability exposure suffered by a PR in cases like Downing v. Skluzacek, 61 Ariz 322 (1944) and Graybar Electric Co., v. McClave, 91 Ariz 223 (1962)
Challenging the PR
Challenges to a fiduciary will usually take place in three settings: objections to an accounting, objections to a fee application and a petition for an order to show cause (“OSC”).
Simply stated, this is “put up or shut up” time. The same procedure for submitting an accounting is used for decedent’s estates, conservatorships and trusts. Disputes usually occur in two settings. One is that, in Maricopa County, the accounting guidelines of the court accounting are enforced in excruciatingly strict fashion. Those guidelines, which do not correspond to any GAAP formats, are available online at www.superiorcourt.maricopa.gov/ssc/forms/pdf/pbipf52i.pdf.
One of the most useful functions that practitioners can provide to their clients is scrutinize the accounting before it is submitted to make it “court accountant proof”. This means making sure it is in the proper format. Many accountants are unfamiliar and quizzical about the format of the probate court accountant. Our job is to educate them on what is required since, even if every dime is accounted for, the accounting will be rejected if the format is not strictly adhered to.
In making an accounting “court accountant proof”, the liberal use of footnotes is encouraged. In other words, if there is a large expenditure whose appropriateness is not readily apparent, then the fiduciary needs to explain it. This is best done through the use of footnotes. This is much more likely to result in a recommendation from the court accountant.
The second area of disputes will concern the appropriateness of expenditures. This usually will have one of two aspects. One concerns documentation – what was the expense for? Practitioners must keep in mind that, for a person in declining health, family members or other interested parties are often very unaware of the costs of care or the amount of hours that caregiving entails. Receipts and time logs can go a long way towards minimizing conflicts on these matters and family members serving as fiduciaries cannot be reminded enough of this.
The second aspect will involve disputes regarding the amount of time expended or fee rate charged. Fees must be in a reasonable amount. ARS 14-3719, -5414, –7202 & -7206 It is hard to provide much practical advice in this area since it is usually so fact-intensive and the courts’ rulings are very inconsistent. If a family member is serving as fiduciary and wants to draw a fee, remind them that any fee is taxable income.
The most important consequence of obtaining approval of an accounting is that closure is provided. Absent fraud, a court approval of an accounting forecloses a later challenge to expenditures or other aspects of administration. Estate of Thurston, supra; Estate of Shano, supra; Estrada v. Arizona Bank, 152 Ariz 386 (CA2, 1987); Matter of Estate of Olivas, 132 Ariz 61 (CA2, 1982). Dockery v. Central Arizona Light & Power, 45 Ariz 434 (1935). Failure to obtain that approval leaves the PR at risk of personal liability. Downing v. Skluzacek, 61 Ariz 322 (1944). This is particularly so when a significant claim, such as a wrongful death claim, is settled. Court approval and proper notice (ie, involvement of all beneficiaries) will afford protection to the PR from later attack. Costello v. Cunningham, 16 Ariz 447 (1915) but the key is that all beneficiaries – each and every one – must be given notice and an opportunity to participate in the settlement. ARS 14-3952, Wilmot v. Wilmot, 203 Ariz 565 (2002)
Removal or Surcharge
Removal of the fiduciary may be appropriate if it would be in the best interest of the estate, ARS 14-3611 & –5415 or if waste, embezzlement or mismanagement by a fiduciary is proven, then removal. Barth v. Platt, 52 Ariz 33 (1938). A surcharge may also be sought. ARS 14-3808(d) & -7306(d)
STATUTORY REQUIREMENTS – WHO GETS PAID FIRST?
#1. Homestead allowance – ARS 14-2402
Provides for $18,000.00 to a surviving spouse that takes priority over all claims except administrative expenses. The homestead allowance is chargeable against any benefit or share that passes to the surviving spouse or minor or dependent child by the decedent’s will, by nonprobate transfer pursuant to section 14-6102 or by intestate succession, unless it is otherwise provided by the decedent’s will or by the governing instrument for a nonprobate transfer. To determine the homestead allowance under this section, a survivorship interest in a joint tenancy of real estate is considered a nonprobate transfer pursuant to section 14-6102.
#2. Exempt property allowance – ARS 14-2403
In addition to the homestead allowance, the decedent’s surviving spouse is entitled from the estate to a value that is not more than seven thousand dollars in excess of any security interests in that estate in the following:
- Household furniture.
- Personal effects.
#3.Family allowance – ARS 14-2404
The decedent’s surviving spouse and minor children whom the decedent was obligated to support and children who were in fact being supported by the decedent are entitled to a reasonable allowance in money out of the estate for their maintenance during the period of administration. Prior versions of this statute limited this allowance to $1,000 per month for twelve months. This allowance is payable to the surviving spouse, if living, for the use of the surviving spouse and minor and dependent children. Otherwise this allowance is payable to the children or to persons who have the care and custody of these children.
Notice must be given to all interested parties, defined as “any heir, devisee, child, spouse, creditor, beneficiary and other person who has a property right in or claim against a trust estate or the estate of a decedent, ward or protected person”. ARS 14-1201(26) & -1401. For an informal probate, notice must be given within thirty days of the filing of the application. ARS 14-3306. For a formal proceeding, fourteen day notice must be given before the hearing. This means notice by publication as well as the customary mailing. ARS 14-3403. As to creditors, a personal representative shall publish a notice to creditors once a week for three successive weeks in a newspaper of general circulation in the county where the probate was filed as well as written notice to all known creditors. ARS 14-3801
Creditors get paid before beneficiaries
Never pay a debt of the decedent without first receiving a claim IAW ARS 14-3804. It is amazing how many creditors do not respond to a creditors notice, thereby forgoing their claim.
Never pay a claim before the four month period closes. While family members may be adamant that there are no creditors or that all creditors are known, this may not be so, especially if a long illness preceded death. A large medical bill not covered by insurance or Medicare can wipe out an estate.
Warn non-probate transferees that they take subject to creditors claim. For instance, a payable-on-death beneficiary on a bank or brokerage account can be reached by a creditor of the decedent. ARS 14-6102. One big exception to this is life insurance and annuities that often pass creditor-free. The Arizona Supreme Court held in May v. Ellis, 208 Ariz 229 (2004), that insurance policies are protected from creditors of the deceased insured’s probate estate. Legislation passed in 2005 expressly extends the May holding to life insurance policies and annuities by amending ARS 20-1131 and 33-1126. The former $25,000.00 cap has been eliminated for policies and annuities that are at least two years old and name a family member as beneficiary
Make sure that the payment of all debts is coordinated through the attorney’s office since creditors claim should be mailed to the attorneys’ office. This will insure that the correct amount is paid on a properly presented claim.
Always check the recorder’s website for any liens or judgments. If the person died while receiving AHCCCS benefits, a TEFRA lien may have been filed IAW ARS 36-2935. AHCCCS can assert a claim to recoup the net amount it has paid for services provided by medical contractors, for Medicare premiums and for insurance co-payments or deductibles. The largest of these will be the payments to medical contractors that, for most nursing home residents, will amount to approximately $2,500 per month. According to section 4.17 of AHCCCS’ State Plan, the claim can be asserted against any real estate in which the deceased person had an ownership interest and any other property subject to probate. There are four main exemptions to the estate recovery process. First, federal regulations limit estate recovery to medical services rendered to persons over the age of 55. Second, estate recovery cannot be asserted against a surviving spouse. Third, it cannot be asserted if the deceased person is survived by a child under the age of 21. Finally, it cannot be asserted if the deceased person left a surviving child of any age who is blind or is disabled under the criteria set forth by Social Security. Simply put, AHCCCS can only pursue an estate recovery claim against an unmarried person with no minor or disabled children.
These claims are usually filed with the probate court, either as a demand for notice if no probate has yet been filed or as a creditor’s claim. But, beginning in August 2005, AHCCCS began to issue liens against an AHCCCS’ patient’s residence. Under the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), states were authorized to issue liens on the real property of Medicaid (ie, AHCCCS) patients who were over the age of 55 years and who were residing in a nursing home for at least 90 consecutive days. (Transfers from one care facility to another will not interrupt the 90 day period.) These liens are a means to enforce AHCCCS’ estate recovery claims. They do not create any new basis for claims.
COLLECTING AND MANAGING THE ESTATE ASSETS
One would think that, in this age technology, that locating assets should be a simple matter. Unfortunately, the primitive, time-consuming and age-old methods still prevail. This means a thorough search of the decedent’s residence that must be done by family members, for a number of reasons. Cash and other valuables can be kept in the strangest places and can be easily stolen once located. Items that may seem of no importance to a non-family member made hold untold value to the family. Be particularly wary of others finding the original will that may disinherit certain family members – I have seen these mysteriously disappear.
Collecting financial records is key to determining the assets and debts of a decedent. Cancelled checks, tax returns, deeds and bills will provide leads. Safe deposit boxes can also be a revelation but warn the family that you never know what you may find there, such compromising photographs or letters describing wild and/or embarrassing indiscretions. Have all mail forwarded to the Personal Representative. Compile a list of all advisors, past and present – accountants, financial advisors, insurance agents, etc. – and contact them. Run an unclaimed property check, such as through www.unclaimed.org or www.missingmoney.com, both administered through the National Association of Unclaimed Property Administrators that is a non-profit organization affiliated with the National Association of State Treasurers.
An estate checking account should be established early on, in the name of the Personal Representative. It should read something like “John Smith as Personal Representative of the Estate of James Jones”. This will require submitting a form SS-4 to the IRS to obtain a tax identification number since a bank will not open an account without it. The bank will also require a death certificate and the letters of personal representative. Advise the client at the very outset to order at least 15 to 20 copies of the death certificates. Mortuaries often only order a half-dozen or so, but every bank, brokerage house, insurance company and title company will insist on an original copy although they will often return them later.
All bank and brokerage accounts should be retitled in the name of the Personal Representative. Thought should be given to consolidating the accounts. Explain the Personal Representatives that the step-up in basis should eliminate any taxable gain on the sale.
Make sure homeowner’s insurance is maintained on any residence and automobile insurance is in place on any vehicles.
Within 90 days of appointment, the Personal Representative must either a) file an inventory and send a copy to those interested parties who have requested a copy or 2) not file the inventory but provide copies of the inventory to all heirs and devisees. ARS 14-3706 A revised inventory must be similarly provided or filed if other estate assets are subsequently discovered or a significant change in value has been established. ARS 14-3708.
Appraisers may be hired to establish a value. This must be disclosed in the inventory. ARS 14-3707. The appraisal does have important consequences, such as being the most logical source to establish a step-up in basis.
Questions to ask the client
Be very reluctant to criticize the work of the prior attorney and for several reasons. First, there is often more than one way to address a problem. Simply because the prior attorney did things differently does not make it wrong. Second, circumstances and laws change over time. A large increase in income, a large inheritance, a death or remarriage as well as increases in the estate tax exemption or the enactment of beneficiary deeds can negate many aspects of, what at the time, was a first rate plan. Third, you do not what the prior attorney was told by the client or what advice the client was given but chose to ignore or did not understand. Finally, making other people look bad, such as the prior attorney, is not a good way to make yourself look good.
Citizenship. Often overlooked. While a foreign accent will tip off the attorney to inquire about this, this is not obvious with a Canadian client. Having a non-citizen, either client or spouse, can radically alter the tax consequences, often requiring use of a QDOT trust and other mechanisms.
Length of time in Arizona. Important for determining community property issues although quasi-property rules will normally call for a similar result. ARS 25-318; Sample v.Sample, 135 Ariz 599 (CA1, 1983)
Armed forces veteran. Was the decedent a veteran? If so, was he/she retired military? When did they serve, since service during periods of armed conflict will often result in special treatment? If burial at a Veterans cemetery is desired, the burial is at a nominal cost to the client’s estate. But more important to many clients is that fact they do not have to worry about future endowment problems for the cemetery. In other words, the client often wants to be assured that, twenty-five years from now, the cemetery will not be run down with weeds and overgrown grass. This should not be an issue with the VA. But warn the client that, with the World War II generation dying off quickly, that these cemeteries are filling up. This may require burial at a veterans cemetery that may be a considerable distance (ie, hundreds of miles) away from the client’s home. This is not a problem for those clients seeking burial in the Phoenix area.
Children from current marriage. Ask the client if any child has financial problems, a substance abuse problem or a bad marriage. Always mention if any child or other family member, such as a grandchild or sibling, is disabled or otherwise receiving public benefits. This is more prevalent that one might think. This may give rise to the use of supplemental benefits trusts (aka special needs trusts) that many estate planning attorneys are not proficient or comfortable with. This topic exceeds the parameters of this seminar. For more information on Special Needs Trust, visit my website or read one of the authoritative treatises on the topic. The treatise generally considered the best is Third-Party and Self Created Trusts: Planning for the Elderly and Disabled Client by Clifton B. Kruse, Jr., 3rd edition published by the ABA. Or consider purchasing tapes and materials from the annual SNT conference at Stetson University College of Law, www.law.stetson.edu or 813-228-0226.
Finally, do not ever overlook the existence of loans or gifts to the children, especially if they are in unequal amounts or if not all children are aware of the loans/gifts. In my experience, this is probably the single biggest cause of family discord after the decedent has died. Establish if it is a gift or loan. If a gift, is it an advance of an inheritance? If a loan, is it to be forgiven? If so, is the forgiven amount to be included in the beneficiary’s share of the estate? Obtain whatever documentation exists verifying the gift or loan since these may disappear post-mortem. Has a large expense been undertaken for one child but not another, such as paying for a college education?
Children from prior marriages. Nothing complicates the administration of an estate as quickly as the existence of children, especially adult children, from a prior marriage.
Problem children. Are there children that can be expected to settle scores and cause trouble? The client may want to have these children eliminated from certain decisions, such as health care or end-of-life issues when the client becomes incapacitated.
Inheritances from other family members. Inquire if the estate anticipates or has received an inheritance from a parent or sibling since this could dramatically affect the size of the estate. Many times an income stream from a family asset is indicative of a much larger interest in the underlying asset (ie, the real estate that is the source of the rental check could be worth millions). Or the decedent may inherit real estate or similar interests in another state or states, that can complicate planning (ie, multiple probates, different state estate tax exemption amounts, etc.)
Other advisors. Determine who are the accountants, insurance agents and financial advisors that the decedent had used. These advisors will likely have much useful information, including much that was never written down regarding the decedent’s intentions. Make sure everyone is on the same page and understands the concepts involved. Unfortunately, other advisors may be quick to criticize something they do not understand and, since they have had a much longer relationship with the client, these advisors often have more credibility with the client. The attorney can never be too careful here. The attorney also needs to confirm certain information, such as beneficiary designations.
Pending or anticipated claims or lawsuits. This is something the client may not want to discuss or may think that only the other lawyer needs to know about it.
Retirement plans. Make sure that valid, current beneficiary designations exist. Do not simply assume all is in order since, with the consolidation of many banks and brokerage houses, records are misplaced or lost with increasing frequency. Second, make sure they are current. Be especially vigilant if the client has been divorced since the designations often still reflect the former spouse. The provisions of ARS 14-2804 (where the divorced spouse is disinherited) does NOT apply to 401(k)’s and other ERISA plans. Egelhoff v. Egelhoff, 121 SCt 1322 (2001) and Kennedy v. Plan Administrator for DuPont Savings and Investment Plan, 555 US ____, 129 SCt 865, 2009 WL 160440 (2009). Third, consider obtaining copies of the signature cards for any POD accounts since banks are often sloppy in maintaining these designations. For a horror story on this that cost a client of mine $1 million, see the now-depublished case of Estate of Moore, 435 Ariz Adv Rep 9, 97 P3d 103 (CA1, 2004). Fourth, if a trust is named as beneficiary, make sure the trust will qualify as a “designated beneficiary” under the minimum distribution rules. For a string of recent favorable rulings in the area, see PLRs 200615032, 200616040, 200620025 & 200708084 and Q&A 16 of IRC Notice 2007-07.
Prenuptial agreements. Arizona has adopted the Uniform Premarital Agreements Act that provides for the enforceability of a prenuptial agreement zas long as the factors set forth in ARS 25-202 are met. The primary stumbling block is ARS 25-202(c)(2)(a) that requires “fair and reasonable disclosure” of both parties’ financial matters. Unless otherwise unconscionable, the agreement will be upheld and enforced. Schlaefer v. Financial Management Service, Inc., 196 Ariz 336 (CA1, 2000).
In reviewing pre- and postnuptial agreements, I also review the disclosures and whether both parties were represented by counsel. Then make sure that the terms are consistent with the will, trust and other dispositive designations. Also look for any sunset provisions where the agreement ends if the parties remain married for a certain number of years.
PRACTICAL TIPS FOR VALUING THE ASSETS
The valuation of assets can be a critical issue if, in the months after the decedent’s death, an estate or gift tax return may need to be filed. While all asset valuations are subject to IRS scrutiny, some are more so than others. Hard-to-value assets will get particular attention, three of the foremost being unimproved land, commercial real estate and a family-owned (closely held) business. The filing of these returns can also be important to commence the running of any applicable statute of limitations. IRC 6501. This is usually a three-year statute. But filing the return is not enough. There has been considerable controversy over the adequate disclosure rules set forth in IRC 6501(c)(9) and Treas Reg 301.6501-1. These rules provide that the statute will not begin to run if the taxpayer has not a) identified the parties, b) provide a summary of the applicable provisions in the trust agreement, c) details how the valuation was arrived at and d) provides a recitation of any contrary authority. An appraisal from a qualified expert will normally meet these requirements. Treas Reg 301.6501-1(f)(3)
This means that hiring an expert to conduct an appraisal is not an area to cut corners on. Ask colleagues for recommendations or submit a posting on a reputable listserv or blog. Ask for credentials and make sure that the expert is using the latest studies and other information when rendering the appraisal, such as recent case law or IRS pronouncements. For instance, a business appraiser must be very familiar with Rev Rul 59-60 and should discuss the factors mentioned in it. The IRS has had a great deal of success in the Tax Court attacking the qualifications of the expert when they have used outdated data or ignored prominent articles or studies. Make sure that your expert is comfortable with the possibility that he/she may be deposed or called to the witness stand during a trial if the appraisal is called into question.
A battle with the IRS will most likely occur over the use of discounts when valuing a family business or other entities with multiple members, shareholders and owners. The two most common discounts are the minority discount and the lack of marketability discount.
The minority discount reflects the inability of a shareholder/member to control the management of the entity. In other words, how much power and authority does a 10% member of an LLC really have?
The lack of marketability discounts reflects the inability to sell the interest – there is no readily available market to sell the interest. In other words, who wants to buy a 10% interest in a business where the other 90% is owned by a father and his two children?
In recent years, much of the fight over discounts has taken place in the context of family limited partnerships but is equally applicable to other forms of entities. For a typical and recent case, see McCord v. Commissioner, 461 F3d 614 (5th Cir, 2006).
Another commonly incurred discount is for built-in capital gains. This has also been the subject of much litigation with the pro-taxpayer repeal in 1986 of the General Utilities doctrine. This involves the extent to which a potential purchaser of a closely-held business will consider the tax impact if the business later liquidates while holding highly appreciated assets. Until 1986, the purchaser could avoid incurring the built-in gain because the purchaser’s basis was allocated among each of the business’ assets. After 1986, the corporation itself must recognize the gain or loss as if it had sold the assets at fair market value. The IRS initially fought this approach but, in 1999, it acquiesced in the adverse rulings it was receiving. Eisenberg v. Commissioner, 155 F3d 50 (2nd Cir., 1998), AOD 1999-00; Estate of Dunn v. Commissioner, 301 F3d 339 (5th Cir, 2002). This means that the fight is no longer whether the discount exists but rather the size of the discount.
Even if an estate or gift tax return is not likely to be filed, appraisal of all important assets will need to be obtained to establish a basis for these assets when the beneficiaries later sell them. There is a tendency to downplay these concerns when there is a surviving spouse since, with the marital deduction, there normally will not be any estate tax due at the death of the first spouse to die. Yet, the values set forth in the form 706 will establish at least one-half of the basis for these assets if they are sold during the surviving spouse’s lifetime.
TRANSFERRING ESTATE ASSETS
The book that is generally considered to be the leading authority on the funding of estates and trusts is “The Funding of Living Trusts” by Carla Neeley Freitag, published by the Real Property, Probate and Trust Law section of the American Bar Association.
In Arizona, there is little authority as to what exactly one must do to transfer an asset into an estate or trust. California has a line of cases beginning with Estate of Heggstad, 20 Cal Rptr 2d 433 (CA1, 1993) that concerned a revocable trust that was “self-settled”, meaning it was created by Mr Heggstad to hold title to his property while he was alive. He was both trustee and beneficiary while he was alive. Mr Heggstad owned real estate but he never executed a new deed transferring the land into the name of the trust. The issue before the court was whether the land could be considered trust property.
The court ruled that the land was trust property. It held that there was:
“abundant support for our conclusion that a written declaration of trust by the owner of real property, in which he names himself trustee, is sufficient to create a trust in that property, and that the law does not require a separate deed transferring the property to the trust”.
20 Cal Rptr at 436.
The only other case on point, reaching the same result, is the Kansas Supreme Court’s decision in Taliaferro v. Taliaferro, 921 P2d 803 (Kansas, 1996). That case had similar facts — a written declaration of trust but title to the grantor’s assets (mainly shares of stock and a life insurance policy) was never changed. Citing Heggstad, the court ruled that:
“where the settlor of a trust executes a declaration of trust, no transfer of legal title to the trust property is required to fund the trust”.
921 P2d at 806.
Both cases rely heavily on the Restatement of Trusts, particularly section 17. After these cases were decided, a new draft of the section, now numbered as section 10, has been released. There is no significant change and the precise issue is now covered in subparagraph (c) of section 10 and comment (e), stating that “a trust may be created without a transfer of title to the property”. .
These cases were cited to the Court of Appeals in the case of Estate of Moore, 97 P3d 103, 435 Ariz Adv Rep 9 (CA1, 2004), that adopted the Heggsted rationale but determined that the assets could not be considered trust property for other reasons. Note that this case was ordered depublished by the Arizona Supreme Court so its precedential value is slight.
For real estate in Arizona, the procedure that has recently gained widespread acceptance in the use of a beneficiary deed rather than a warranty deed. See ARS 33-405 and my article “Drafting the New Beneficiary Deed” in the June 2002 edition of Arizona Attorney. The beneficiary deed will not vest until the death of the last grantor to die. This means that no new deed must be issued when a client wants to refinance the home. All too often, the lender requires that the grantor deed the property out of the trust and into the names of the grantors. One would hope that the grantors would know enough to have the property deeded back to the trust after the refinancing was completed but this seldom happens. As a result, an easy and effective solution is to name the trust as the grantee on the beneficiary deed.
For out-of-state deeds, it is always best to employ a local law firm or title company to issue the deed. Many states have their own unique laws, rules and requirements (such as the effect of a quitclaim deed). This is particularly true with oil, gas or mineral interests. Condominiums and housing cooperatives can also create tricky titling issues. Some states, notably Florida, will take an aggressive stance against out-of-state practitioners executing deeds by claiming it is the unauthorized practice of law in that state. Or a new deed may have other local consequences, such as effecting property tax exemptions or assessments.
Mobile homes may or may not be treated as the equivalent of real estate. If a certificate of affixture has been recorded, then the property can be deeded as with real estate. Otherwise, title is passed through the Motor Vehicle Division.
Title to most boats will be kept with a state or local authority. In Arizona, the Arizona Game and Fish Department require an “Application for Certificate of Number” to retitle the boat. If the boat exceeds 26 feet in length or five tons, it must be registered with the United States Coast Guard using an “Application For Initial Use, Exchange or Replacement of Certificate of Documentation”, CG Form 1258.
Savings bonds must be retitled through the Bureau of Public Debt of the US Department of Treasury using the form PDF 1851E. Treasury bills use the form PDF 5178E.
As for marketable securities, the easiest method is having the certificates on deposit with a broker who has established a brokerage account. However, if the stock has been owned for several decades, the decedent will likely hold title in his/her own name, requiring the use of the corporate transfer agent to retitle. This information is on the certificate but is probably dated, requiring a search of the internet or similar measures. This means that the PR must retrieve the original stock certificate and provide it to the transfer agent together with other documents, such as a letter of instruction that must have a medallion signature guarantee.
Shares of closely-held stock can also be a headache. Again, the original share certificate must be obtained. The practitioner must also determine if a shareholder agreement exists that will normally contain transfer restrictions. Almost never will the organization documents or the shareholder agreement address if transferring the shares into a grantor trust is permitted. If not, which is usually the case, then the grantor must obtain permission of the other shareholders to complete the transfer.
If the business is in the form of a Subchapter S corporation, the estate or trust must qualify as a Qualified Subchapter S Trust, or QSST, in accordance with IRC 1361(d). These requirements essentially require that the trust have only one shareholder who is an individual and who must receive all income derived from the corporation.
If life insurance has been transferred into an irrevocable trust, beware that three years from the date of transfer must pass before the proceeds will be excluded from the grantor’s gross estate for estate tax purposes. IRC 2035(a).
GETTING PAID AND CLOSING THE ESTATE
Fiduciaries are entitled to a reasonable fee. ARS 14-3719, 14-5414 & 14-7206. However, fiduciaries need to be reminded that fees are taxable income. This will often dissuade a PR from taking fees. This is a fact-driven determination where the trial court has considerable discretion. The court will look to the amount of time, labor and skill of the PR and attorney. Estate of Wiswall, 11 Ariz App 314, 325 (CA2, 1970). See Estate of Wright, 132 Ariz 555 (CA2, 1982) where fees for the PR and counsel amounted to $72,000 in a $330,000 estate but the estate involved the sale of 66 separate parcels of land.
As long as a PR litigates a matter in good faith, the PR’s attorney is entitled to reasonable fees, even if the PR is unsuccessful or there was no benefit to the estate. Estate of Gordon, 207 Ariz 401 (CA1, 2004); Estate of Killen, 188 Ariz 569 (CA1, 1996). The court is not bound to follow the terms of the fee agreement between the PR and attorney if the fee appears unreasonable. Estate of Smith, 131 Ariz 190 (CA2, 1981); In Re O’Reilly’s Estate, 27 Ariz 222 (1925).
The burden of proof is on the PR and attorney to justify their fees. Matter of Estes’ Estate, 134 Ariz 70 (CA1, 1982); In Re Elerick’s Estate, 11 Ariz App 559 (CA1, 1970)
All probate practitioners are aware of former Local Rule 5.7 of Maricopa County Superior Court that governed the fee application process. This process is now governed by Rule 33 of Probate Procedure that does not substantially change the former Rule 5.7.. This author has noticed several misunderstandings regarding the fee approval process. First, there is no statutory requirement that a fiduciary or the attorney seek court approval. The new Rule 33 specifically says so. The Rule simply sets forth the procedure to be followed if court approval is sought.
Second, the fee application process needs to be placed on the court calendar. This, for some reason, seems to be shrouded in mystery – court staff has frequently mentioned that they are unsure what to do with a fee application. The simplest and best way is to schedule the matter for a non-appearance hearing. In Maricopa County, this is done through court administration.
Third, the fee application is often an educational experience for the beneficiaries, many of whom have never been in court or probate court before. The itemization should be very detailed since clients and families often do not realize the amount of work that has been done outside of their presence. For an extremely helpful book on how to write an invoice, read “How To Draft Bills Clients Rush To Pay” by J. Harris Morgan and Jay G. Foonberg, written by two of the most business savvy lawyers in America and available on the ABA website.
Fourth, if the fees have arisen from a litigated probate, practitioners need to be aware of the recent case of Matter of Estate of Gordon, 207 Ariz 401 (CA1, 2004) in which the Court of Appeals reversed the trial court by emphasizing that the standard for reviewing fiduciary and attorneys fees was of good faith, and not what was in the best interests of the estate. ARS 14-3720.
Finally, a party challenging a fiduciary is generally not entitled to fees. Matter of Estate of Groves, 163 Ariz 394 (CA2, 1990). There is a long line of cases holding that attorneys fees arising from a breach of contract, ARS 12-341.01, do not apply in a probate or trust setting. See, most recently, Matter of Naarden Trust v. Keiber, 195 Ariz 526 (CA1, 1999). In a guardianship proceeding, practitioners need to advise their clients that, in a contested matter, the losing party will liable to the alleged ward for fees. ARS 14-5314.