Use of Trusts in Estate Planning, 2011

The new tax law signed by President Obama prompted a sigh of relief from a lot of people because it increased the estate tax deduction to $5 million, instead of lowering it to $1 million as many feared, which is where it would have gone had Congress not acted before December 31. Now many people are predicting the end of testamentary trusts because there is no need to create a Family Trust to take advantage of marital deductions. Some are going so far as to say that testamentary trusts will disappear altogether.

This is probably a short-sighted view. While testamentary trusts may no longer be useful as estate TAX planning tools, they remain invaluable estate planning devices, especially where minor children or incapacitated individuals are involved. Where such individuals are among those to whom bequests would be left, use of a trust provides flexibility, professional management and peace of mind to the maker of the trust.

Don't assume that a trust has no place in your estate planning toolbox simply because the estate is under $5 million and no tax consequences will attach.

Credit Scores and Bankruptcy

When you file bankruptcy of any kind, your credit score (sometimes called a FICO score) will immediately take a nosedive. Even if it was low to begin with, it will go lower. A credit score is supposed to be a prediction of whether or not you will pay back debt in the future. However, since no one, not even the big three credit reporting agencies, can predict the future, what a credit score really measures is the likelihood you will pay back existing debts. Since, once you file bankruptcy, you will most likely NEVER repay any existing debt, your credit score drops to reflect that.

If you think about it, someone filing bankruptcy is probably a better credit risk than another person with the same income and the same amount of debt, but who didn't file. That's because the person who filed has (1) gotten rid of a bunch of debt; and (2) now cannot file bankruptcy for several years (eight years if you filed Chapter 7 and receive a discharge). Car loan companies know this. That's why they have people who do nothing but see who has filed bankruptcy and then send them offers of credit if they buy a new car. The lenders are so sophisticated that they tailor their solicitations based on your ZIP code. If you live in an affluent ZIP code, you might get offers for a Lexus or a Corvette. If you live in a lower-income ZIP code, the offers might be for lower-end Fords or Hyundais. But one thing you can count on, besides the hit your credit score will take, is that you will get solicited to buy a new car. Three words about that: DON'T DO IT. More on that topic later.

Simple Wills and Living Wills

Do you need a simple will or a living will?

Probably you need both. One is effective before you die, the other after death. A "simple willl" is a generic name given to a will that has only a few dispositive provisions. The typical simple will leaves everything to the surviving spouse, or, if the spouse does not survive, to certain specified beneficiaries, such as children. It's called a simple will because it is simple, meaning it isn't a complicated document. A simple will takes effect upon death.

A "living will," on the other hand, becomes effective during life; hence the word "living." A living will is designed to set forth your wishes and desires about certain end-of-life matters, such as the extent to which your family and medical personnel should go to keep you alive. Many people do not want to remain alive if they are in a permanent vegetative state, unresponsive, comatose and unable to care for themselves in any way. A living will directs that if you are in such a state, you want life support (such as food or breathing assistance) to be removed, and you want to be allowed to die. In Utah a living will has a formal name: Advance Medical Directive, and state law specifies exactly what needs to be in the Directive to make it legal.

Regardless of whether you have a simple (or other) will or a living will, both need to be executed with certain formalities, and either can be changed at any time before death.

Having Your Cake and Eating It Too

No, you really can't have your cake and eat it too, but that's exactly what a lot of people want and even expect from bankruptcy. They look on bankruptcy as a magic potion that will solve all of their financial problems and let them live the lifestyle they dream of (and were probably living in the first place). Bankruptcy is a serious step and requires serious effort. It is possible, even likely, that when someone files bankruptcy they will lose their house, their car, their boat, and a lot of other things that they financed. The reason is, if they can't make the payments before filing, they won't be able to make the payments after filing.

Instead of focusing on what they lose by filing bankruptcy, they should look at what they gain: Freedom from debt collectors. Freedom from robbing Peter to pay Paul. Freedom from working two or three jobs to make ends meet. Freedom to spend more time with family and friends. The chance to start over.

Bankruptcy is intended as a second chance. The "fresh start" concept is central to bankruptcy. But a fresh start doesn't mean going back and doing the same things over again, making the same mistakes, incurring the same debt. It means starting over and doing it better this time. This probably means living within your means, absolutely, positively not buying anything you don't need and setting priorities among what you do buy. It's hard, but bankruptcy wasn't meant to be a simple solution. And in the end, it's worth it.

Deficit Commission Report Fails

My Facebook page has been alive with comments from Realtors and those in the real estate profession about the Deficit Commission Report that proposes, among other things, to eliminate the mortgage interest deduction (MID) for taxpayers. As the tax code now reads, interest paid on mortgage loans is deductible from income in calculating income tax. Real estate professionals are afraid that, if the MID is eliminated, the real estate industry will crumble.

Fears that the sky is falling are premature. The report failed to gain enough votes from the Congressional committee to advance to Congress as a whole. It received 11 votes, three shy of the 14 needed for advancement. While any of the proposals in the report could be considered piecemeal, its rejection assures that the entire report will not be voted on.

In addition to eliminating the MID, the report also called for changes to Medicare, freezes on federal salaries, an increase in the federal gas tax and raising the retirement age for Social Security. If France is any indication, the last will be wildly unpopular.

Credit Cards or Retirement?

One of the best reasons to file bankruptcy may be to plan for your retirement. If you're paying the minimum amount each month on credit card debt, you can't be saving for retirment. If you want to retire in any form, you have to start saving now.

Suppose you have $20,000 in credit card debt and all you're paying is the minimum amount each month. Under most credit card agreements, the minimum varies, based on the outstanding balance, and is often something like 1.5% of the balance. Paid at $300/month that $20,000 will take nearly 37.5 years to be paid in full at an 18% interest rate, which is pretty cheap for a credit card.

Now suppose that instead of paying the debt, you file bankruptcy and get a discharge. Then you pay $300/month into an IRA that earns 6% a year. At the end of 37.5 years, you will have over $500,000 in a retirement account.

Lots of people feel they are being irresponsible if they don't pay their debts. Being responsible also means that you have made adequate provision for retirement so you are not a burden to your family or society. Bankruptcy may be the responsible choice.

Last Minute Tax Planning

This is the time of year that many people start last-minute tax planning. This year, because the estate tax was repealed for 2010 and the gift tax was reduced to 35%, last minute planning is even more important, and may really be last minute. There is a lot of uncertainty about whether Congress will retroactively reinstate the estate tax for 2010 and retroactively increase the gift tax to the scheduled 55% that will be imposed on January 1, 2011. While we don't recommend that anyone die before December 31 just to take advantage of the lack of an estate tax in 2010, gift planning should be considered.

Everyone can give up to $13,000 tax free to any other person, and the number of people to whom you can give $13,000 is not limited. Beyond that, if you want to give more to a single person, you have a $1 million lifetime exemption that was formerly tied to the estate tax exemption. To the extent you use the lifetime exemption for gifts, it isn't available to reduce the estate tax. If you choose not to use the lifetime exemption, gifts in excess of $13,000 are taxed at 35%. However, if the gift tax bumps up to 55% as scheduled on January 1, and especially if the estate tax exemption is lowered to $1 million, also as scheduled, it might make sense to give gifts this year and pay the 35% tax as opposed to using any part of the lifetime exemption or paying the 55% tax rate next year.

The prudent thing seems to be to plan for some gifts, but not actually make them until late December when Congress has adjourned for the year and any retroactive legislation might be a little clearer. Then consult with your tax professional.

Estate Tax Status

We are fast approaching the end of 2010, and the end of the no-death-tax year. The estate tax went away on December 31, 2009, and hasn't been in effect since then. It is scheduled to return in 2011, with a higher rate and a lower exemption. Most observers don't believe that will happen, but Congressional gridlock might rule the day.

According to the Wall Street Journal, the most likely scenario is that Congress will enact a stop-gap measure that will reinstate the estate tax at 2009 levels. That means $3.5 million in exemption and a top rate of 45%, rather than the $1 million exemption and 55% rate now scheduled if Congress doesn't act. One thing that does seem certain is the estate tax will be back in 2011 in one form or another.

Debt Settlement Companies Prohibited from Collecting Advance Fees

Under amendments to the Telemarketing Sales Act that took effect October 27, 2010, debt settlement agencies that offer to renegotiate or settle consumer debts for a fee are now prohibited from collecting advance fees from consumers. Before such an agency can collect a fee, three things must happen:

The company has settled, reduced, renegotiated or otherwise changed at least one of the consumer's debts.
There is a written agreement between the consumer and the debt settlement agency.
The consumer has made at least one payment under the terms of the negotiated or changed agreement with her creditor.

This law applies to credit card or other unsecured debt, and is not applicable to companies that claim to renegotiate mortgage loans.

What is Elder Law?

Elder law is a special area of the law that deals with the needs of the elderly or disabled. It encompasses several areas of law, including estate planning (wills, trusts, etc.); so-called "end of life" issues such as living wills, durable powers of attorney and guardianships; estate and gift tax planning; Medicare and Medicaid; nursing home abuse; fraud against the elderly; long term care financing; retirement benefits; age discrimination; and disability planning and insurance, among others. Elder law attorneys are not specialists in all of these areas, but generally focus on two or three of the areas. Typically elder law attorneys approach a client from a holistic viewpoint, addressing legal, medical, social, financial and family needs at once.

Lindsay Lohan Settles E-Trade Lawsuit

Lindsay Lohan sued E-Trade, an online brokerage company, over a Super Bowl ad that featured talking babies. In the ad, one of the babies, a male, apologizes to a female baby for not calling her the night before. Suspicious, the female asks if he had been with that "milkaholic Lindsay."

Ms. Lohan claimed that she had attained "one name recognition" like Madonna or Oprah, and that the use of the name Lindsay in the E-Trade ad used her celebrity status for its own profit. E-Trade responded that Lindsay is a popular name and happened to be the name of one of the ad team's members. It moved to dismiss the lawsuit as meritless.

Under the terms of the settlement, which is confidential, Ms. Lohan dismissed her lawsuit with prejudice. The settlement of the $100 million action came the same day a judge issued a bench warrant for her arrest. Settlement leaves her free to focus on her other legal problems, including the current probation-violation claim for failing multiple drug tests.

Bankruptcies Reach 5-Year High

With data through the second quarter of 2010, bankruptcies have reached highs not seen since the fourth quarter of 2005, just before the dreaded BAPCPA, which was designed to halt a perceived flood of bankruptcies, became effective.

In the three month period ended June 30, there were over 422,000 filings in the United States, the highest since the October-December, 2005, period when 667,431 bankruptcies were filed. For the fiscal year ended June 30, 2010, consumer bankruptcies were up 20% while business bankruptcies rose 9% over 2008-2009 levels.

The obvious reasons are the prolonged financial crises, poor job market, rising mortgage foreclosures and ever-present medical emergencies, according to Deborah Thorne, an associate professor of sociology at Ohio State University. Until the economy improves, she expects bankruptcies to continue to rise.

For the year ended June 30, 2010, Utah ranks 12th in the nation, with 6.12 filings per 1,000 people. Nevada is first with 11.74 filings per 1,000 people.

Unbundled Legal Services

The term "unbundled legal services" or "limited scope representation" as it's sometimes called is one of the hot new buzzwords in the legal profession. Simply put, unbundled legal services means that a client hires an attorney for a specific task and pays only for those services. For example, rather than retain an attorney to prosecute a lawsuit all the way from start to finish, the attorney might be retained only to draft the complaint. Later on, the client might ask the attorney for help with a procedural matter, or for some legal research. In between, the litigation is solely under the direction and control of the client, not the lawyer.

With the costs of litigation so high these days that only where hundreds of thousands of dollars are at stake, unbundled legal services might make sense. In Utah, the rules of civil procedure specifically allow for limited scope representation, so if your attorney tells you he ethically can't only represent you in part of a case, look for another lawyer.

Beware Short Sales

We hear a lot about short sales these days. A "short sale" is a term that generally means a lender accepts less than what is owed on a mortgage loan and in return releases its mortgage. There's a lot of confusion about the effect of a short sale. Is the borrower free and clear after a short sale, or can the mortgage company still sue her for what wasn't paid in the short sale?

To understand this, you have to know there are two parts to a mortgage loan. The first part is the promissory note. That evidences the debt that was created when the borrower borrowed money from the bank. The second part is the mortgage, or lien (pronounced "lean") on the borrower's house. That is the security for the loan and is what lets the bank foreclose and sell the house if the borrower doesn't pay.

Most borrowers think that when the bank releases its mortgage, which is the point of a short sale, the underlying debt is fully paid. In some cases this is true. But it is possible for the bank to agree to release its collateral (the house) without considering the loan to be fully paid. In that case, the borrower remains liable for the unpaid balance and can be sued.

The lesson is, if you're considering a short sale, make sure that the bank will accept the proceeds of the sale in full satisfaction of the loan.

Blockbuster Headed to Bankruptcy?

The Los Angeles Times reports that Blockbuster, the movie rental giant for the last decade, will file a "pre-planned" Chapter 11 as early as next month.

A pre-planned bankruptcy is one in which most, if not all, of a debtor's creditors agree to the reorganization plan before filing. The debtor is in and out of bankruptcy relatively quickly. In Blockbuster's case, it hopes this will be about five months. The presumed major benefit to Blockbuster will be the ability to shed its most burdensome store leases, those where the retail outlets aren't performing but the company remains saddled with long term leases with landlords. In a Chapter 11, a debtor can reject any unexpired leases, meaning it simply cancels the remaining term. The landlord has an unsecured claim for unpaid and future rents, but since most unsecured creditors receive very little in a reorganization, this is small consoloation to the landlords affected.

Beaten down by changing consumer tastes, Blockbuster, which once the the undisputed leader in DVD rentals, has seen its stock delisted by the New York Stock Exchange. The stock now trades on the OTC (over the counter) market and recently traded at 11 cents/share.

Is the U.S. Housing Market Headed for Collapse?

There are some, and their numbers are growing, who feel the U.S. housing market is headed for collapse. Here are some of the reasons they cite:

• New home sales are at an all-time low.
• Because of this, construction of new homes has all but come to a standstill
• The Mortgage Bankers' Association reports home loan applications are at a 13-year low
• Foreclosures continue to rise. The glut of bank-owned properties further depresses real estate values.
• Because of the number of foreclosures and bank losses, banks are tightening their credit standards to those last seen in the early 1970s, which will further depress the market.
• Home prices are still far above 90% of Americans' ability to purchase a house. The law of supply and demand dictates prices will fall until demand matches supply.
• People need jobs in order to buy houses, and with unemployment near 10%, that isn't happening.
• Bankruptcies continue to rise, up 32% in 2009 over 2008.
• The giant tax credit that artificially pumped up the housing market last year is gone, and the government can't continue to fund it.
• Fannie Mae and Freddie Mac, the "twin pillars" of the housing market, are in total shambles. It's estimated it could take another $5 TRILLION to fix them. But Fannie, Freddie and the VA back over 90% of mortgages.
• The overall U.S. economy is drowning in debt. Consumer, government and business debt is in the neighborhood of 360% of gross domestic product (GDP). This debt bubble is about to burst.

Any way you look at it, the forecast isn't good for the housing industry.

$85 Million in Legal Fees

Chrysler's bankruptcy, which started in April, 2009, has generated nearly $85 million in legal fees and costs, most of it going to its lead attorneys, who billed an average of $500/hour.

Chrysler filed a Chapter 11 reorganization. This same chapter is available to small businesses and even individuals. However, because Chapter 11 has to be able to accommodate the likes of Chrysler and other huge corporations, filing a Chapter 11 isn't a viable option for most people or companies. While it's true that most debtors wouldn't incur $85 million in legal fees, the sheer size of that number for a year's work should demonstrate that bankruptcy isn't cheap.

Second (or Third or Fourth) Marriages Complicate Estate Planning

It's human nature not to be alone. That's why the majority of people who lose a spouse, either through divorce or death, remarry. Second and subsequent marriages complicate estate planning in ways most people never consider before they say "I do." Here are a few of the problems:

Age difference. When one party is significantly older or younger, by 10 or more years, the problems are compounded because of the strong likelihood one party will outlive the other for a significant time period. This is espcially true if the husband is older, since women tend to live longer than men anyway.

Health issues. Many older people suffer significant health issues that have to be addressed as part of the overall estate plan.

Children from prior marriages. This is the one issue most people catch. The possibilities are endless. Husband has children; wife doesn't. Wife has children, husband doesn't. Both have children. The children get along (not only as between parents, but among themselves). The children don't get along. There are minor children. There are children with special needs. You get the picture.

Children vs. new spouse. This is the million dollar question. In virtually every second or subsequent marriage where there are children from a prior marriage there will be a conflict between the new spouse and the children of the prior marriage. The parent's loyalties are divided between his/her new spouse and his/her children.

Pre-Nuptial Agreements. While technically not part of "estate planning" as it is commonly understood, the existence or absence of a pre-nuptial agreement in a second marriage can have a significant estate planning impact. In most states, a surviving spouse has certain rights, called the spouse's pre-emptive share, that may allow her to reject the provisions under a will and claim what she is entitled to under intestacy laws. A properly drafted pre-nuptial agreement can go a long way toward avoiding this.

Attorney Fee Only Plan Not in Good Faith

An attorney and his client came up with a novel, but ultimately unsuccessful, way to file immediately and pay attorneys' fees -- and nothing else.

In In re Buck, 2010 WL 2746217 (Bky.D.Mass. July 9, 2010), the problem for the Bucks was they couldn't pay the attorneys' fee of $2,000 for a Chapter 7 bankruptcy. They wanted immediate relief from the harrassing collection efforts they were subject to, but, understandably, their attorney wouldn't file for them until they paid his fee. So they agreed to file a Chapter 13, which cost $4,000, but those fees would be paid through the plan, at $130/month. This allowed them to file immediately. Sounded like a good plan.

That was until the bankruptcy court determined that the plan was not filed in good faith. It turns out that all of the Bucks' property was exempt and all of their debts were dischargeable in Chapter 7. As a result, no one other than the attorney would have received a distribution under the plan. The bankruptcy judge said that this was not a "good faith" plan, it exposed the debtors to 36 months of payments and delayed their discharge by that same time. As a result, he refused to confirm the plan. The Bucks converted to Chapter 7 and the court ordered that the attorney could not receive fees for either the Chapter 13 or the Chapter 7.

Steinbrenner 1, IRS 0

George Steinbrenner, the bombastic boss of the New York Yankees, died this week. Many people only know George Steinbrenner from Seinfeld episodes, but to many baseball fans, he was the undisputed face of the Yankees from 1973 until his death. Steinbrenner was famous for hiring, firing and then re-hiring managers and meddling in their day-to-day operations.

By dying in 2010, Steinbrenner (actually his heirs) gets to keep an estimated $632 million from his reported $1.15 billion estate that otherwise would have gone to estate taxes. As Kelly Phillips Erb, a/k/a The Taxgirl, writes on her blog, that sum is enough to pay the entire budget of the Small Business Administration for all of 2009.

Congratulations George, you won another one.

Providing for Pets

Many people have pets that become a part of the family. To some, a pet might be the only family they have. What can be done to provide for pets upon the owner's death?

Contrary to what TV might show, most states don't allow a person to leave money or property directly to a pet. However, there is nothing wrong with making provision for a pet in a trust and leaving money to the trust.

If a pet is to be provided for in a will, there are a couple of documents that, at a minimum, are necessary. First, obvioulsy there has to be a will that makes provision for the pet. Remember that you can't leave anything directly to the pet, so if there is a fund established for the pet, it will have to be given to a trust. And the will should provide for someone to take the pet. Make sure that person is willing to accept and care for the pet. Money given directly to an individual with instructions to use it for the pet is probably not enforceable. So you might want to consider establishing a trust. Finally, there should be a durable power of attorney that specifies that the attorney in fact named has the ability to decide what to do with the pet. Everyone should have a durable power of attorney in case they become incapacitated, anyway.

Is Bankruptcy Moral?

A lot of people struggle with this question. Most people are fundamentally honest and the idea of not paying their just debts doesn't sit right with their upbringing. There is a lot of guilt associated with filing bankruptcy.

Bankruptcy goes back at least to the 14th century. The term "bankruptcy" probably comes from the Italian banco rotta, which means "broken bench." It was the custom to break the bench of a merchant who could not pay his creditors. "Bankruptcy" is also figuratively description of a ruptured bank, with a resulting loss of money. England has had a formal bankruptcy law since 1542.

Even earlier, the law of Moses in the Old Testament called for the sabbath year, a year occurring every seven years when debts were forgiven.

In America, bankruptcy is one of the few laws specifically mentioned in the United States Constitution, which provides that Congress shall have power to make and enforce a uniform law regarding bankruptcy.

The purpose of this historical review is to show that throughout history, humankind has found that a process by which debtors could be released from their debts and given a fresh start has a salutary effect. Bankruptcy is legal and while filing bankruptcy may not be the most desirable outcome, there is nothing immoral about it.

Estate Tax Update

2010 is nearly half over and Congress still hasn't done anything about the estate tax. It expired on December 31, 2009, leaving the United States without an estate tax for the first time since 1916. It's scheduled to be resurrected in 2011 at levels unseen since the Clinton administration.

For now, someone like Dan Duncan, who died earlier this year leaving an estate worth an estimated $9 billion, can pass his estate free of any tax to his heirs. Had Mr. Duncan died in 2009, the estate would have been taxed at 45%, meaning just over $4 billion would have gone to the IRS. Had he survived until next year, when the estate tax is scheduled to come back at 55%, his heirs would have lost nearly $5 billion.

But the real losers in the estate tax mess are the merely rich, those with estates between $1 million and $3.5 million. In 2009, the estate tax exemption was $3.5 million, meaning estates under that amount didn't pay any tax. In 2011 the exemption will drop to $1 million and the 55% rate will kick in. Many of those people have set up their estate plans under 2009 rules on the assumption they would owe no tax. If they don't act quickly, they could end up losing a bundle.

Help! I don't qualify for Chapter 7 OR Chapter 13

More people are being caught between the rock of the means test under Chapter 7 and the hard place of the debt limitations under Chapter 13, finding that they can't qualify for either.

The means test under Chapter 7 says, basically, if you make above a certain income (the state median income for a family of your size), you can't file Chapter 7. There are exceptions and other tests, but the bulk of Chapter 7s are filed by people who "pass the means test" by having income under the state median, or whose debts are not primarily consumer debts, in which case the means test doesn't apply. The means test was designed to force more people into Chapter 13 so they repaid at least some of their debt.

Less known are the debt limitations of Chapter 13. Under section 109 of the Bankruptcy Code, if a debtor (and spouse, if filing jointly) owes more than $360,475 in unsecured debt, or more than $1,081,400 in secured debt, they do not qualify for Chapter 13. What this means is that for a high debt, high income debtor, she cannot file for either Chapter 7 or Chapter 13.

Consider a debtor earning $100,000/year, single, who bought a house in 2007, at the height of the real estate market. In today's market that house is worth $400,000 and she owes $750,000. Since the house is only worth $400,000, $350,000 of that debt is unsecured. If she has in excess of $10,475 in other unsecured debt, such as credit cards, doctor bills, student loans, etc. this person doesn't qualify for Chapter 13. But due to her income, she can't file Chapter 7, either (and she might not want to for various reasons). Her only option is to file a consumer Chapter 11, a very expensive and time consuming proposition.

Family Meetings in Estate Planning

One often overlooked tool of estate planning is to hold a family meeting. There are several good reasons for doing this, and a few reasons why many people don't hold a family meeting.

A family meeting first and foremost should be an opportunity to make wishes and desires known and acknowledged and documented so they are carried out. This last item, documentation, may require the services of a qualified attorney. Simply writing down that mom and dad want the house to go to a certain person might not be enough. Everyone might agree that is what mom and dad wanted, but unless there is a will or other legally effective device, it might not happen.

Another reason for a family meeting is to ease anxieties about what will happen. It's a time to discuss last wishes such as funeral arrangements, burial/cremation, etc. While this is hard to do, afterward everyone feels a sense of relief.

At a family meeting, tax advantageous strategies for passing wealth can be discussed, such as family trusts, limited liability companies, life insurance policies to provide cash flow to continue a business and the like.

A very important function, and one often overlooked, is to preserve family harmony. At a family meeting, everyone's viewpoints can be aired. While it is the prerogative of those whose estates are in issue to decide where and to whom they leave things, by getting everyone together to discuss things, when the will is finally read there should be no big surprises.

Don't overlook a family meeting as part of your estate plan.

Adversary Proceedings in Bankruptcy

You may hear the term "adversary proceeding" and wonder what that is all about. An adversary proceeding is a lawsuit within a bankruptcy. Most of bankruptcy is an administrative matter. The trustee administers the assets by converting them to cash, usually by selling them, and then determining who is owed what and making a distribution of the cash she has to those claimants.

Sometimes there is a matter that needs to be litigated before the bankruptcy judge. An example might be if a creditor believes a debt was incurred fraudulently and wants to object to the discharge of that debt. The creditor would file an adversary proceeding by filing a complaint in the bankruptcy court. The adversary proceeding proceeds just like a lawsuit, with the debtor then filing an answer, discovery taking place, motions, and, ultimately, a trial.

Adversary proceedings are rare. In most cases, if an adversary proceeding is filed, the fee that you paid to your attorney for the bankruptcy will not cover the costs of defending the adversary proceeding.

Another reason to see a lawyer about a will

Several posts back, I questioned the wisdom of using online will and trust forms, or the celebrity will and trust devices (like the Suze Orman documents). Here's a story out of New York in case you're still convinced that you don't need a lawyer to prepare your will.

Harry Wu served as one of two witnesses to his sister's will. Though he was not named as a beneficiary under the will, he was named as a beneficiary under a life insurance policy that his sister had. The will had a common clause that said that taxes, such as estate taxes, should be paid out of the "residuary estate," and not apportioned among those receiving property under the will. Despite this clause, the executor of the will challenged Harry's right not to have to share in payment of estate taxes because of a New York law that prohibits a witness of a will from benefitting from a distribution under the will. The court in New York agreed with the executor and Harry had to pay a share of the estate taxes on the $3 million estate.

It's little things like this New York law that the average person doesn't know about that make using an online form or one you got on a CD that comes with a book so dangerous. Yes, paying a lawyer to draw up your will is much more expensive than $29.95 for a book or a form you download from the Internet, but ask Harry Wu about hidden traps.

Family Limited Partnerships

You may have heard of a family limited partnership, or FLP, as an estate planning device. A FLP is just a limited partnership formed for the benefit of family members. Limited partnerships have several benefits over general partnerships, the greatest of which is that limited partners are shielded from liability beyond the extent of their investment or contribution to the limited partnership. In addition, because a separate legal entity, the FLP, owns the assets that are transferred to it, those assets are out of the estate of the individuals, and need not pass through probate, nor be subjected to an estate tax, upon death. For these reasons, FLPs have gained popularity in recent years.

However, as an estate planning tool, FLPs are only for the wealthy. They require expertise to create, involve complex issues of valuation of property that is contributed, and they must be managed as long as they are in existence. In short, unless there are assets of around $1 million that can be put into the FLP, their cost and effort do not justify the benefits. For most people, a FLP is neither necessary nor desirable.

Debt Settlement Agencies

You hear it on the radio or even late-night TV informercials: "Don't file bankruptcy; settle your debt for pennies on the dollar. Call us -- we know the secrets the credit card companies don't want you to know." Some of them even tell you that you have the "right" to settle for less. Do these work?

I can't speak for every such agency. Some are non-profit organizations that really do help SOME people. But most are nothing more than scams. They want you to send them money up front, and then they'll contact your creditors and work their magic. It almost never works. In the meantime, you stop paying your bills, your interest rates go up because you're in default, you start getting calls (if you weren't already), and eventually you get sued and your wages are garnished. Finally the debt settlement agency tells you they tried, it just didn't work.

Does this mean you should never try to work something out with your creditors? Absolutely not. By all means, if you can work out a settlement, do so. But before you pay someone to do it for you, look into it closely.

Creditors Should Read Their Mail

On March 23 the Supreme Court of the United States issued an opinion in a bankruptcy case that, in essence, says creditors need to read their mail. The case is United Student Aid Funds, Inc. v. Espinosa. Justice Thomas delivered a unanimous opinion.

The facts are fairly simple. Espinosa had several student loans that totalled $13,000. In his Chapter 13 plan he proposed to pay principal only, no interest, which resulted in a discharge of the interest. Normally, any discharge of any part of a student loan requires an adversary proceeding and a finding of a "hardship discharge." In this case, neither the creditor nor the trustee objected to Espinosa's plan. Espinosa completed his plan and received a discharge.

Several years later, United Student Aid Funds attempted to collect by garnishing Espinosa's tax refund. Espinosa responded by reopening his bankruptcy case to obtain an order prohibiting United Student Aid Funds from trying to collect. The case eventually worked its way to the Supreme Court. There were several complicated legal issues involved in the case, but the bottom line is, where a creditor admittedly received a copy of the plan and failed to object, it can't come back years later and ask the court to fix its mistake.

Automobile Claims and Bankruptcy

Toyota has recalled thousands of vehicles for accelerator problems. Now Honda has recalled over 400,000 vehicles for brake problems. With all of those recalls, it's certain that some owners of the recalled cars are contemplating filing or have filed bankruptcy.

In the case of Toyota, a few lawsuits seeking class action status for those involved in accidents allegedly caused by the defects have already been filed. Such lawsuits may be filed by Honda owners. If you are among those affected by these recalls and are in or considering bankruptcy, beware. You might have a claim against the manufacturer. If so, that claim is probably property of your bankruptcy estate and you are obligated to disclose it to the trustee, who may or may not decide to pursue it. Be sure to let your bankruptcy attorney know that you own a car covered by the recalls so he can investigate whether to list a potential lawsuit or participation in a class action in your bankruptcy filing.

Why is the Estate Tax So Controversial?

Taxes are a fact of life, whether they are income tax, sales tax, property tax, or a tax on gasoline. We grumble about paying taxes, but accept them. Why, then, is the estate tax so controversial?

For starters, because Congress waffles back and forth about eliminating it. The estate tax was scheduled, in 2001, to disappear permanently in 2010. It has disappeared, but is slated to return in 2011. Like a bad penny, it keeps turning up.

But probably the biggest reason for controversy is over who (or what) the estate tax hits and how much it actually contributes to public revenue. By some estimates the estate tax only provies 1% or less of all public revenue. By contrast, it impacts to the point of destroying some small family businesses. When a small business owner dies his business may be asset-rich but cash-poor. The business may have inventory, equipment, land and other assets that give it a value, on paper, in excess of the exemption amount ($3.5 million the last time there was an estate tax). But there may be very little cash with which to pay the tax. So in many cases, the business has to be sold to pay the tax, leaving a pittance to heirs, compared to the value they would have received had the business been passed on intact.

A similar concern is the fact that the estate tax is one last gouge at a lifetime of savings. Consider, for example, an estate that consists of stocks and bonds that have paid dividends and interest. The money with which those stocks and bonds were purchased was taxed with an income tax before they were even bought. Then the income from the stocks and bonds (the dividends or interest payments) were taxed again as income. The dividends had already been taxed at the corporate level before they were paid. Finally, on death, there is an estate tax levied. That's up to four separate taxes imposed. To a lot of people, that's at least one tax too many.

Bankruptcy and Taxes

If you thought death and taxes were bad, wait until you try bankruptcy and taxes. When you file bankruptcy, there is an estate created, which consists of all your property and all your debts at the instant you file. Included in that is taxes that you might later owe for income earned up to the point of filing, and refunds to which you might be entitled for overpayments through withholding as of the same date. A little known provision in the Internal Revenue Code allows you to create two taxable years. One for the part of the year prior to your bankruptcy filing date, which is the portion that is in your estate; and one for the remainder of the year. Whether or not to make this election depends on a number of things. So in addition to talking to a bankruptcy attorney before you file bankruptcy, talk to an accountant or tax attorney as well.

Review Your Estate Planning Documents

In the last estate planning post, I noted that Congress had failed to extend the estate tax, and this was creating all sorts of uncertainty for planners in 2010. The uncertainty doesn't end with what might be done in the future. The repeal of the estate tax could throw a monkey wrench into existing estate plans.

This is because many plans were writtent to take advantage of the spousal exemption. Under the Internal Revenue Code, a certain amount of the estate was exempt if passed to a surviving spouse. As a result, many estate plans provided for a division of the estate, with a portion equal to the spouse's exemption going to the spouse, the rest going into a trust or somewhere else. With the repeal of the estate tax, these plans could be read such that the surviving spouse gets nothing, i.e., since there is no estate tax, there is no spousal exemption. Thus, everything goes into the trust or elsewhere, where the spouse can't get at it. This is clearly not what most people would want for a surviving spouse, but it might be exactly what happens.

Review your estate planning documents.

The Best Time to File Bankruptcy

Since the passage of the Bankruptcy Abuse and Consumer Protection Act in 2005, timing a bankruptcy filing has become more important than ever. First is the means test, which we have discussed previously. The means test looks at a debtor's income over the past six months, so if you received a big bonus in the past six months, you might want to wait a month or two so that bonus isn't included in the calculation of average income. Secondly, if you're facing foreclosure or having wages garnished, you probably want to file as soon as possible, like yesterday. Thirdly, if you have some cash on hand or other assets that are subject to being taken by the bankruptcy trustee, you may want to delay filing while you engage in some exemption planning. There is nothing wrong with using non-exempt assets (such as cash or selling stocks) to acquire exempt assets (such as clothes, food, a new washer/dryer or refrigerator). All of these considerations have to be weighed to determine when is the best time for you to file.

Death and Taxes

Nothing is certain but death and taxes, goes the old saying. But combine the two and nothing is certain but uncertainty. The new year came without Congress extending the estate tax (the House voted to extend the tax, but the Senate didn't act), so for 2010 it is gone. It's scheduled to revive at a higher rate (55% vs. 45% in 2009) and lower exemption ($1 million vs. $3.5 million in 2009). Most commentators expected Congress to extend the tax in 2010. Most commentators were wrong.

2010 marks the first year since 1916 that a person can die without an estate tax. That is making for a lot of macabre jokes about doing in a rich relative. The truth, though, is 2010 might not be such a great year to die anyway. In the Internal Revenue Code there is a provision for "stepped up basis," which means that when property passed by inheritance, the basis (amount at which the property was acquired) was stepped up to the date of death. That meant, for example, if Uncle Harry owned real estate that he purchased in 1950 for $10,000 and it is today worth $750,000, the basis to the heirs became $750,000, saving a bundle in capital gains taxes. But this provision went away with the estate tax. So now the heirs are looking at a capital gain tax on $740,000, the difference between the 1950 basis of $10,000, and today's value of $750,000 should they sell. Assuming values continue upward, that taxable gain will only get bigger.

What is the Meeting of Creditors?

The meeting of creditors, also called a 341 meeting, because it is held pursuant to section 341 of the Bankruptcy Code, is often the only appearance that a debtor makes in his bankruptcy. The meeting is conducted by the bankruptcy trustee appointed to the case, not the bankruptcy judge. The purpose of the meeting is for the trustee to question the debtor under oath about the debtor's schedules and statement of affairs, and to allow creditors to question the debtor. In most cases, creditors don't appear at the meeting. This is because their appearance is useless in most cases, especially where the debt is unsecured. Occasionally a secured creditor will appear and ask about insurance, condition of the collateral or what the debtor intends to do (surrender, redeem or reaffirm the debt). In Utah, trustees hold meetings every hour with 10-12 debtors appearing each hour. This means the trustees allocate 5-6 minutes per case.