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FAQ

Can I disinherit relatives I don’t like?

Disinheritance is intentionally depriving someone who would otherwise be a rightful heir from receiving your estate. Typically, your heirs include your spouse, your descendants, and possibly other relatives. Although you may feel you have a good reason for disinheritance, be aware that a majority of non-community-property states provide statutory protection for spouses. That is, most states provide that if a spouse is disinherited under the decedent’s will, he or she may elect to take under the state intestacy laws instead. These laws vary from state to state but generally entitle the spouse to receive from one-third to one-half of the decedent’s estate.

Although only one state provides similar protection for the children of a decedent, simply leaving a child out of the will may not succeed in disinheriting that child. In the absence of any mention in the will, the child can either argue that this was an oversight on the part of the parent or contest the will on other grounds. Moreover, courts are often reluctant, in the absence of evidence to the contrary, to rule against the disinherited child. Therefore, if a child is disinherited, it is best to mention him or her in the will, even if only for a token amount.

Can an UGMA/UTMA account reduce my child’s financial aid for college?

It can, but in the same way that any other asset held by your child can. An UGMA/UTMA account is a custodial account established at a financial institution for a minor child and managed by a parent or other designated custodian. It is established under either a state’s Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA).

Because an UGMA/UTMA account is held in your child’s name, it is considered your child’s asset. The federal government’s financial aid formula treats your child’s assets differently than your assets. Under the current federal formula, children must contribute 20 percent of their assets to college costs each year before becoming eligible for financial aid, while parents must contribute only 5.6 percent of their assets.

For example, $10,000 in your child’s UGMA/UTMA account would result in a $2,000 required contribution from your child. The same $10,000 in your bank account would result in a $560 required contribution from you.

As a result of this formula, any asset that your child holds, including an UGMA/UTMA account, will always translate into a higher monetary contribution to college costs than if the same asset were in your hands. It follows that the more money your family is required to pay up front for college costs, the less financial aid your child will be eligible for. But even though your child will be entitled to less financial aid, that may not be such a bad thing. Remember, the main component of the average financial aid package consists of loans that must be paid back.

Does property owned jointly avoid probate?

It depends. Generally, there are four forms of joint ownership. In legal terms, they are known as (1) joint tenancy with rights of survivorship, (2) tenancy in common, (3) tenancy by the entirety, and (4) community property. Ordinarily, interests in property held as joint tenancy with rights of survivorship, tenancy by the entirety, and community property held under joint tenancy avoid probate. An interest in property held as tenancy in common passes by will and thus does not avoid probate.

Two or more people can hold property as joint tenants with rights of survivorship or tenants in common. Only married couples can hold property as tenants by the entirety, and only married couples who live in community property states can own property as community property.

Although an interest in property held as tenancy in common must pass through probate, it is also freely transferable to anyone. Conversely, interests in property held as joint tenancy with rights of survivorship, tenancy by the entirety, or community property held under joint tenancy pass automatically to the remaining owner(s).

What is an advanced directive for health care, and will it help me avoid court involvement during incapacity?

At some point in your life, perhaps as a result of illness, accident, or advanced age, you may lack the mental capacity to make or communicate responsible decisions about your own health care. Without directions to the contrary, medical professionals are generally compelled to make every effort to save and maintain your life. Depending on your attitude toward various medical treatments and your views on the quality of life, you may want to take steps now to control your future health-care decisions. You can do so by adopting one or more advanced directives for health care. If you do not adopt such a directive for health care, a family member may have to petition the court for the authority to make those decisions for you.

There are three types of advanced directives for health care. Each serves a different function, as described briefly below. Be aware that not all are allowed in every state. Check with your state to find out which one(s) you can consider.

  • Living will: A living will lets you decline certain types of medical care, even if you will die as a result. Generally, a living will can be used only to decline medical treatment that “serves only to postpone the moment of death.”
  • Durable power of attorney for health care, or health-care proxy: A durable power of attorney for health care, or health-care proxy, lets you appoint a representative to make medical decisions on your behalf. It becomes effective only when you’ve become incapacitated. You decide how much power your representative will have.
  • Do Not Resuscitate order (DNR): A DNR is your doctor’s order that tells all other medical personnel not to perform CPR if you go into cardiac arrest. There are two types of DNRs. One is used while you are hospitalized. The other is used while you are outside the hospital.

Are life insurance proceeds income taxable?

In general, life insurance proceeds paid to you because of the death of the insured are not subject to federal income tax. To qualify for such favorable tax treatment, the life insurance contract must meet certain IRS requirements.

However, proceeds may be taxable in limited cases. For instance, if you receive the insurance proceeds in installments and interest is paid, the interest portion of the payment generated after the insured’s death is treated as taxable income. This is taxed at your ordinary income rate. The part of the installment payment that is classified as investment in the contract is not taxable, however.

If a life insurance policy is sold or otherwise transferred for valuable consideration before the insured’s death, the proceeds (except to the extent of that consideration) are generally taxable to the beneficiary, unless an exception applies. This transaction is complicated, so be sure to seek professional assistance before proceeding.

Note: Different federal income tax rules may apply to accelerated death benefits (i.e., due to a terminal or chronic illness) and to other types of life insurance benefits paid before the insured’s death (e.g., cash withdrawals, policy loans, dividends).

How often do I need to review my estate plan?

Although there’s no hard-and-fast rule about when you should review your estate plan, the following suggestions may be of some help:

  • You should review your estate plan immediately after a major life event
  • You’ll probably want to do a quick review each year because changes in the economy and in the tax code often occur on a yearly basis
  • You’ll want to do a more thorough review every five years

Reviewing your estate plan will not only give you peace of mind, but will also alert you to any other changes that need to be addressed.

There will be times when you’ll need to make changes to your plan to ensure that it still meets all of your goals. For example, an executor, trustee, or guardian may change his or her mind about serving in that capacity, and you’ll need to name someone else.

Other reasons you should do a periodic review include:

  • There has been a change in your marital status (many states have laws that revoke part or all of your will if you marry or get divorced) or that of your children or grandchildren
  • There has been an addition to your family through birth, adoption, or marriage (stepchildren)
  • Your spouse or a family member has died, has become ill, or is incapacitated
  • Your spouse, your parents, or other family member has become dependent on you
  • There has been a substantial change in the value of your assets or in your plans for their use
  • You have received a sizable inheritance or gift
  • Your income level or requirements have changed
  • You are retiring
  • You have made a change in your estate plan (e.g., you created a trust or executed a codicil to your will)

How can I determine what my business is worth for estate and gift tax purposes?

Determining the value of your business is something you should not attempt to do on your own, especially because the IRS could challenge your valuation. Even the IRS acknowledges that no one true fair market value (FMV) exists for a closely held business. There are appraisers who specialize in determining the value of businesses. Your CPA may be one of these specialists or know someone who is.

FMV is defined by the federal estate and gift tax regulations as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” It is the sale price that a hypothetical buyer and seller would reach, not necessarily the price that the actual owner would agree to or the price that an actual buyer might be willing to pay.

You may have had your business appraised in the past for another purpose. As tempting as it might be, don’t use an old appraisal for a new transaction. The purpose of the appraisal can affect the valuation assigned, and time can change the factors that go into the appraisal calculation.

Numerous factors might affect the value of a business. However, the IRS has identified a number of relevant considerations:

  • Nature of the business and history of the company
  • Outlook for the economy in general and an industry in particular
  • Book value and financial condition of the company
  • Earnings capacity
  • Dividend-paying capacity
  • Goodwill/intangible value
  • Sales of stock and the size of block to be valued
  • Market value of stock in comparable businesses

A number of different methods exist for determining the FMV for a closely held business. Generally, only an appraiser will know how to analyze these factors to reach a conclusion as to the FMV of your business.

How can I determine what my business is worth for estate and gift tax purposes?

Determining the value of your business is something you should not attempt to do on your own, especially because the IRS could challenge your valuation. Even the IRS acknowledges that no one true fair market value (FMV) exists for a closely held business. There are appraisers who specialize in determining the value of businesses. Your CPA may be one of these specialists or know someone who is.

FMV is defined by the federal estate and gift tax regulations as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” It is the sale price that a hypothetical buyer and seller would reach, not necessarily the price that the actual owner would agree to or the price that an actual buyer might be willing to pay.

You may have had your business appraised in the past for another purpose. As tempting as it might be, don’t use an old appraisal for a new transaction. The purpose of the appraisal can affect the valuation assigned, and time can change the factors that go into the appraisal calculation.

Numerous factors might affect the value of a business. However, the IRS has identified a number of relevant considerations:

  • Nature of the business and history of the company
  • Outlook for the economy in general and an industry in particular
  • Book value and financial condition of the company
  • Earnings capacity
  • Dividend-paying capacity
  • Goodwill/intangible value
  • Sales of stock and the size of block to be valued
  • Market value of stock in comparable businesses

A number of different methods exist for determining the FMV for a closely held business. Generally, only an appraiser will know how to analyze these factors to reach a conclusion as to the FMV of your business.

Can I transfer my business through my will?

Yes, you can use your will to transfer your business interest after your death. You can also use your will to specify a long-term succession plan for your business if, for instance, you want one of your children (who may be currently active in the business) to take over and run it when you’re gone. Without such a clause in your will, your interest could possibly be distributed equally to all of your children, even though you did not intend that result.

A disadvantage of transferring your business through your will is that the full value of your interest will be included in your taxable estate. Unless you have made provisions for additional liquidity (e.g., by using life insurance), your heirs may be forced to sell the company just to pay the estate taxes.

Assets disposed of through a will are subject to probate, the court-supervised process of administering a will. Probate can be expensive and time consuming. It could also result in business interruptions, which in turn could result in a loss of customers and employees if confusion develops over who’s running the business and how it will continue to operate. The probate process is also public, which may allow others to discover details about your estate that you would rather not disclose.

Talk to your lawyer and your financial professional about your business interest and what you would like to happen to it at your death. Transferring your interest through your will is just one method that can be used. Other options (or combinations of options) can also be used to accomplish your wishes. Some methods may allow you to equalize distributions to your heirs without splitting up the business. Some can help you minimize the taxable value of your business interest. A buy-sell agreement can be drafted now to establish a plan for the future succession of your business interest. Trusts may also be used to help accomplish your goals. All of these strategies take time to plan and implement, so the best time to begin planning is now.

Don’t most small businesses fail?

Although it’s true that many new small businesses go under within their first year or two, there are usually reasons that can explain their failure. If you’re aware of the pitfalls associated with the start-up of a new enterprise, you can take steps now to maximize the chances that your business will succeed.

Don’t start a business you know nothing about. If you’re a pastry chef, don’t open an auto-body shop. Your experience, skill, and knowledge of the business you wish to run are key to its success.

You’ll want to conduct extensive market research to determine if the product or service you will offer is currently in demand. Define who you’re marketing to and target your message to them. Also, consider the most favorable time to market your product or service (e.g., toys at Christmas). Of course, another key to your success is location, location, location. Finally, plan your advertising campaign and consider how you will distribute your product or service.

Pay attention to your competition. Be sure your product or service offers your customers something your competitors do not.

Set up a written business plan detailing the design of your business growth. Organize a start-up team of people who have abilities you lack. Determine how you will obtain the capital to finance your project, and be sure you have adequate capital. More importantly, make sure you have enough to live on. Many new businesses do not generate income immediately. Finally, include in your business plan an exit strategy for closing the business should things not work out as you had hoped.