For years, financial planners and advisors have preached the creed of “avoiding probate.” In their efforts to avoid probate at all costs, planners sometimes overlook key income, gift and estate tax consequences. This article explores some of the problems associated with indiscriminate probate avoidance, and provides guidance in minimizing those problems.
Overuse of joint ownership
Financial planners often inform clients that jointly owned property will pass free from probate. This is true. State statutes recognize that property owned joined with a right of survivorship, or in tenants by the entireties form, will pass to the surviving joint tenant free from probate.
In their efforts to avoid probate, property owners sometimes fail to make full use of the federal estate tax applicable exclusion amount. Individuals with A/B trusts or other estate planning vehicles designed to use the applicable exclusion amount may fail to transfer property into the names of their trusts, preferring to keep joint ownership of property.
While both approaches avoid probate, the joint and survivorship approach prevents the assets from funding a credit shelter trust and making use of the owner’s applicable exclusion amount. The stakes are high. Under current law, failure to use the applicable exclusion amount can add up to $920,000 on the federal estate tax bill.
Avoiding probate without a plan
There are many ways to avoid probate, including use of beneficiary designations, joint and survivorship ownership, and transfer on death designations for real property and autos. When using these tools, it is very important to consider provisions for debts, administrative expenses, and taxes.
A decedent’s liability to creditors, plus the burdens of state and federal estate taxes and administration expenses, stays with that decedent’s estate. The beneficiaries of the probate estate bear the burden of these costs, even when they are generated by assets passing in non-probate form.
In extreme cases, probate avoidance renders an estate insolvent and incapable of paying such administration expenses, debts, and estate taxes. This may cause creditors and governmental agencies to pursue the beneficiaries or surviving joint tenants in an effort to collect on the amounts owed. This is time-consuming and often costly for heirs, as they must now fight over whether or not they are legally obligated to pay such costs.