Your Trusted Advisor, Spring 2007

April 1, 2007

Ethical Wills: Leaving a Personal Legacy

As you sit down with your estate planning and tax attorney to make decisions about who should receive your assets upon your death, consider an opportunity that could impact your children, grandchildren and great grandchildren for generations. Consider creating an ethical will that does not leave assets, but rather passes along your wisdom, values and ideas. An ethical will creates a thoughtful, memorable and documented legacy for your family.

Initially a Jewish tradition, ethical wills are ancient in their origin, dating back thousands of years. In today’s hurried society, rarely do older generations have the opportunity nor do they take the time to record their personal beliefs, values, dreams and their hopes for the loved ones they leave behind.

Thank, Encourage, Motivate for Generations

An ethical will is a wonderful legacy to leave your family, and can include any or all of the following: thoughts of gratitude and thanks:

• Favorite memories or moments with each family member
• Life lessons learned
• Personal values/spiritual beliefs
• Hopes and dreams for loved ones
• Encouragement and recognition
• Forgiveness or apologies

Avoid being negative or judgmental. The true purpose of an ethical will is to offer a loving and teaching legacy. Because ethical wills are personal documents, there is no required format. They can be handwritten or typed, audio or video. However they are created, ethical wills leave a personal legacy that will live for generations to come.

Let someone you trust know that the ethical will exists and where to find it when you are gone. And finally, be sure not to use an ethical will to alter your estate plan by attempting to gift or to dispose of any assets in your ethical will.

For more information or suggestions on ethical wills, go to www.ethicalwill.com.

Will Your Family Pay Inheritance Tax?

Much has been said about the possible repeal of the federal estate tax, with little attention given to the inheritance tax imposed by individual states. For Texans, the inheritance tax has traditionally been tied to the amount of federal taxes paid—if no federal tax was owed, no Texas inheritance tax was due.

Prior to 2005, any tax paid to the State was deducted from the federal estate tax bill, so families paid no additional tax; they simply wrote two checks—one to the IRS and one to the State. In 2005, a little publicized change in the way the federal government computes the credit for state death taxes changed. One effect of this change is that the Texas inheritance tax was repealed. For most Texans, all of the tax now goes to the IRS.

The same cannot be said in other states. At least 20 states have adopted legislation that “decouples” or separates their inheritance tax from the federal system.

In those states, inheritance tax may be due even if the estate is below the federal estate tax exemption.

Inheritance Taxes Can Follow the Property

We Texans may think that the rules in other states do not concern us, especially since there appears to be no effort to reinstate an inheritance tax here. For the most part, Texas law applies to our estates. But inheritance taxes in other states may apply if you own real property in those states.

For tax purposes, real property includes not only land or a vacation home, but also oil and gas royalties or mineral interests. If you have a vacation property in Minnesota, an interest in a family farm in Kansas, or oil and gas leases in Oklahoma,each state’s inheritance tax may apply when you pass away.

With proper estate planning in place, the laws of these states often permit deferral or avoidance of state inheritance taxes.

Please contact us to learn how these rules may apply to your specific situation.

States That Have a “decoupled” Inheritance Tax Currently Include:

• Connecticut
• District of Columbia
• Illinois
• Kansas
• Maine
• Maryland
• Massachusetts
• Minnesota
• Nebraska
• New Jersey
• New York
• North Carolina
• Ohio
• Oklahoma
• Oregon
• Rhode Island
• Tennessee
• Vermont
• Virginia
• Washington
• Wisconsin

Help Your Family Administer Your Final Wishes

When you pass away, your family, in the midst of dealing with a loss, will be faced with many decisions about your funeral and financial arrangements at a very sensitive time, unless you plan ahead. You can relieve your family of some of this burden, and ensure that your wishes are carried out by preparing a document that clearly expresses your wishes.

The document should set out your burial or cremation preference and any other funeral arrangements that you want.

In Texas you can appoint an agent to control the disposition of your remains and provide written directions that specify what you want. Section 711.002 of the Texas Health and Safety Code contains the general wording that should be included in this document. You can customize the document to provide specific instructions to your agent. Put the document into effect by signing and having it notarized.

If you do not execute a document appointing an agent and providing specific funeral and disposition instructions, Texas law determines who will make these decisions in the following order:

1. Your spouse
2. Any one of your surviving adult children
3. Either of your surviving parents
4. Any one of your adult siblings
5. An adult person in the next degree of kinship

Since your surviving family members may not be privy to all of the personal information that they will need to properly handle your affairs, you should also prepare a financial summary document. It should contain the names, addresses and phone numbers of your family members; a list of your advisors; a summary of your assets; the location of important documents such as your personal papers, your current will, and your financial records and deeds to real estate. Provide a copy of this summary document to a trusted family member or advisor. It will be of great help, and relief, to your surviving family members as they begin the process of administering your estate once you are gone.

Taking some time now to think about what you want to happen when you pass away will ensure your wishes are carried out and that your family members have the information they need to properly administer your estate.

Lessen Gift and Estate Tax with a GRAT

Owners of rapidly appreciating assets often consider giving them to their children or other loved-ones to remove the asset appreciation from their estates for federal estate tax purposes. A major obstacle is the gift tax that must be paid when the asset is given away. Using a form of trust expressly authorized by Congress called a “Grantor Retained Annuity Trust,” or GRAT, can often avoid this gift tax exposure.

To create a GRAT, the donor establishes a trust for his or her intended beneficiaries, but retains the right to receive payments from the trust for a fixed period of time, possibly two or three years. Since the trustee holds the property until all of the payments are made to the donor, the gift to the beneficiaries does not actually occur until some future date.

A common form of rapidly appreciating property is stock in a closely held business that is likely to be sold in the foreseeable future. If the stock that is given to the GRAT is not publicly traded, and if it represents a minority (non-controlling) interest in the company, business appraisers will often assign a fairly low value to the stock. If the company is later sold, the net sales proceeds received by the GRAT may greatly exceed the appraised value of the contributed stock. Family limited partnership interests are another popular asset to convey to a GRAT.

Current Year Valuation Can Mean Major Savings

A key to the GRAT’s effectiveness is that the future gift to the beneficiaries must be valued in the year the gift is made. The IRS computes the value by measuring the property’s current value, less the present value of the payments retained by the donor, assuming that all assets appreciate at a rate tied to the interest rate on

government securities. (For example, the rate for gifts made in April, 2007 is 5.6 percent). If assets appreciate more rapidly than the rate assumed by IRS, the excess growth passes to the beneficiaries free of gift tax.

Example: Mr. Smith owns an asset currently worth $1 million, which he expects may be worth $2 million in a few years. Mr. Smith places the asset into a trust, with a provision that requires the trustee to pay Mr. Smith $378,000 per year over three years. When the IRS computes the value of the gift, it assumes that the asset will grow at the 2007 rate of 5.6 percent each year, making the present value of the three payments to Mr. Smith $998,979. Since the current value of the property is $1 million, but the value of the interest Mr. Smith retains is $998,979, the amount of his gift is only $1,021 ($1,000,000 minus $998,979).

If in fact, the asset grows not at 5.6 percent each year, but actually doubles in value as Mr. Smith expects, the beneficiaries of the trust will receive nearly $1 million in future growth, despite the fact that the IRS computed the gift to be worth only $1,021. The IRS cannot review the trust at the end of the term to see whether the growth was more or less than their prediction. Instead, the gift tax computations are fixed in the year the gift is made.

Timing is Critical

Because of the way the computations are made, the trust can be structured with either a long term and small payments to the grantor, or with a short term and large payments to the grantor.

Sometimes donors opt to establish a very long term for the GRAT, to give the property a long time to grow. But there is a catch here. If the donor dies during the time that they are to receive payments, a portion of the trust property may be subjected to estate tax in the donor’s estate, thereby defeating the goal of the GRAT. As a result, most donors opt for a shorter term, knowing that property can be placed into a second or third GRAT if continued rapid appreciation is expected.

To get more information on whether a GRAT is the right option for you, contact Bracewell & Giuliani’s Wealth Management Practice at 713.221.1154.

Love Your Pet? Endow a Trust to Ensure Their Care

The concept of including a pet in an estate plan is certainly not new. Animal lovers often use their wills to select a caretaker and to clarify their wishes regarding assets to be used for the care of their pets. However, istorically, Texas law did not recognize the validity of a trust created for a non-human beneficiary.

Recognizing the deep love and attachment that some people have for their animals, the Texas legislature rvised the Texas Trust Code, effective Jan. 1, 2006. The updated statute allows pet owners to endow a trust for continuous care for their pets, at their death, or should they become disabled.

Prior to the code revision a will could provide for a conditional gift of money to a friend if, and only if, the friend agreed to take care of a pet. Or, an honorary trust with a human beneficiary would allow (or require) distributions from the trust to take care of the pet. Because Texas law technically treated animals as personal property, these provisions were sometimes difficult to enforce because the pet could not be the official beneficiary of these gifts.

Under Trust Code Section 112.037, creating a trust for your pet can be an easy and inexpensive solution to ensure your pet’s care during both your lifetime and after your death. While a will takes effect at death, a trust can be effective during the owner’s lifetime, and may be invaluable in the event that the owner becomes disabled physically or mentally. Pet owners may also use a power of attorney to specify when the appointment of a caretaker becomes effective.

The trust terminates on the death of the animal, or if the trust is created for more than one animal, on the death of the last surviving animal. According to the statute, the trust may be enforced by a person appointed in the trust, or, if no person is appointed, the court will appoint a caretaker. As a safeguard, a family member or friend with an interest in the welfare of an animal may request the court to appoint a person to enforce the trust or to remove an appointed person.

Finding a suitable home with a person willing and able to adopt our pets when we can no longer care for them can be problematic. Often the people our clients deem worthy of assuming this responsibility are already overextended with their own animals. Other times, a friend or family member who would be willing might not be in a position for financial reasons or as a result of unsuitable living conditions. Our clients who wish to provide for their pets in a will or with a trust often have very high standards for their animals. The monetary incentives of a pet trust or will provision can alleviate many of the problems, and may be a good way to thank a kind-hearted individual for adopting their pets.

Bracewell & Giuliani LLP is among the nation’s most prominent law firms. With 400 lawyers in New York, Texas, Washington, D.C., Kazakhstan and London, we are distinctively positioned to serve clients concentrated in the energy and financial services sectors worldwide. In 2005, former New York City mayor Rudolph W. Giuliani joined the firm as a senior partner. His international reputation for leadership and problem solving is a unique asset for our clients, which include Fortune 500 companies, major financial institutions, leading private investment funds, governmental entities and individuals. For more information about Bracewell & Giuliani, visit www.bgllp.com.