Hey there, Legal Tea Listeners –This is your host, Jenny Rozelle! Today’s episode of Legal Tea is a cautionary tale, where we talk about real-life cases with real-life clients with real facts – they’re things me or my office have worked on. On today’s episode, we’re going to talk about a couple that we’re helped for a while now (maybe 10 years or so) and something that has recently happened in their estate plan – that has not only be an UNpleasant surprise, but the consequences (of the issue) are not very … fun, to say the least. There are a few lessons you’ll be able to take away from this episode, so buckle up, my friends!
Let’s call this client, Bob and Sally – they’re a married couple. Lovely couple. Such a pleasure to be around. Well, Bob and Sally are NOT Indiana-born, you see. They actually came to Indiana from another state about 10-15 years ago. So, while they lived in that former state, they had created their initial estate plan – and that estate plan, among other things, consisted of something called an Irrevocable Life Insurance Trust. A lot of professionals call this type of Trust an I-LIT (standing for Irrevocable … I … Life … L …. Insurance …. I … Trust … T). Anyway, this type of Trust was commonly and is commonly done for people who have estate tax issues. I’m going to explain what I mean by that – and if you are a faithful Legal Tea Listener, you know I recently did an episode on estate taxes. So, you can tune out for a second, unless you need a little reminder.
Before we even get started on the specific topic, I think it’s incredibly important to get crystal clear on WHAT the estate tax even is and I say this because so many get the types of taxes confused. Super generally speaking, there are two types of taxes that are pertinent to my little estate world when someone passes away – 1) inheritance tax and 2) estate tax. One of the biggest differences between inheritance tax and estate tax is WHO gets taxed when it’s pertinent? With inheritance tax, the BENEFICIARY receiving the inheritance is “who” is taxed while with estate tax, the ESTATE of the DECEASED PERSON gets taxed BEFORE the distributions are made to the beneficiary.
Now, here in my state of Indiana, like I said, they repealed the inheritance tax, but there are a small number of states that DO still have an inheritance tax according to Nerd Wallet (which the article is linked in the source links for this episode), so be mindful of that if you are any of the following states: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania. To confirm or to clarify, there is no FEDERAL inheritance tax – just state. And interestingly, that number of states (that still has inheritance tax) seems to decrease as time passes.
Shifting to estate tax, again this is the tax that happens on the ESTATE of the DECEASED PERSON before the beneficiary gets their inheritance, there IS a FEDERAL estate tax and even some states have state estate tax. Confusing, right? Well, some cynics may say that’s intentional – the states that have state estate tax is a short list: state of Washington, Oregon, Minnesota, Illinois, New York, Vermont, Connecticut, Massachusetts, Rhode Island, Maryland, and Maine (If you’re paying super close attention to this episode, Maryland is the only state that has a state inheritance tax and state estate tax!) Anyway, so those states have a state estate tax – but there’s also a FEDERAL estate tax that is pertinent to all of us.
Currently, in 2024, the FEDERAL estate tax exclusion amount is $13.61 Million Dollars per person – so as a married couple, you actually get two of those. What does that actually mean? That means that estates that have LESS THAN that amount ($13.61M individual, $27.22 couple), there is not an estate tax imposed on your estate when you die. However, if your estate exceeds that amount, the amount of that EXCEEDs that amount IS taxed at a fairly ungenerous rate. Something to be mindful of, though, is that of those states I named that have state estate tax, if their state exclusion amount is higher or lower, you may be subject to state estate tax and federal estate tax – or just one.
Now, that is all fine and dandy and I’m sure many are thinking to themselves, “Well, those kind of numbers certainly don’t apply to me!’ Not so fast, my friends, because these amounts are supposed to decrease at the end of 2025, unless Congress has something to say about it, to still some pretty high amounts, but slightly more reasonable amounts (that could impact more people than the numbers that they’re currently at). This is a perfect segway to what I want to talk about today because if you look over the last, say, 15 years or so, it’s gradually (and sometimes, exponentially) increased – but even in 2008, 15 years ago, the estate tax threshold was $2 Million – which is WAY easier to go over than what it is today. So, for that reason, a lot of people did, let’s call it, fancier planning than they do today – enter, the Irrevocable Life Insurance Trust (the ILIT). An ILIT was and continues to be a popular estate planning tool for people that have an estate over the threshold.
Back in 2008, Bob and Sally here were DEFINITELY over the $2 Million estate tax threshold, so they did an ILIT … you guessed it, in 2008! Nowadays, Bob and Sally would NOT be over the estate tax threshold, but nonetheless, they have this ILIT as a “just in case.” Well, an ILIT, to work as an estate tax planning tool, has to 1) be setup correctly (insider secret: Bob and Sally cannot be the Trustee) and 2) has to be managed over the lifetime of Bob and Sally correctly. Bob and Sally got it created correctly, but unfortunately, it didn’t get managed correctly –so here we go with the details!
We were recently meeting with Bob and Sally, and like I said, we’ve worked with them for 10 years or so. Well, in a recent meeting, we were reviewing some assets and beneficiary designations because we were making some pretty large changes to their estate plan. They have several life insurance policies and when we asked about beneficiary designations on the policies, they weren’t 100% sure. They were 90% sure, but not 100% so I was like, “Okay, let’s call your insurance agent and have him send over a recap of all active policies, who owns each one, who is the insured on each one, and who is the beneficiary on each one.” Bob called while we were in the room and the agent was like, “Sure thing! I’ll send that over in a few minutes.” We got the email and I started reviewing what they sent over.
Imagine my surprise … I see a policy on there that 1) I didn’t know about and 2) that it’s held in an Irrevocable Life Insurance Trust. We, honest to goodness, didn’t even know they HAD an ILIT – so imagine my surprise! Seriously, after 10 years of working with Bob and Sally, they have never mentioned it. I’m not joking … their level of calmness was unmatched. To this day, I seriously don’t think they thought it was that big of a deal that their estate planning attorney had no idea this Trust and this policy existed “out there.” I tried to remain calm and inquire about the Trust document – they said, “Well, we don’t have a copy of it, but the CPA does, we’re pretty sure.”
I’m not sure if you caught it a second ago, but I said one of the non-negotiables about setting up and creating THIS type of Trust is that Bob and Sally cannot be the Trustee. So, they put their CPA, let’s name her Ashley, as the Trustee. So, what did I do? I contacted Ashley to get a copy. THANKFULLY, Ashley had a copy of it and she sent it to me. Now, not to get super in the weeds of setting up an ILIT, but the Trustee has to do something SUPER SUPER specific every year. It’s like part of every ILIT – fun fact, they are called Crummey Letters. It’s not because they are crummy; it’s because there was a Court case and one of the parties’ names was Crummey. Because of that case, the Trustee has to send, what are called, Crummey Letters to the beneficiaries of the Trust. Well, I asked Ashley the CPA about the status of the Crummey Letters – and she had never sent them to anyone. Ever. They are supposed to be happen EVERY year to EVERY beneficiary. Never sent them.
At this point, the Trust is unfortunately a moot point. They have not been complying with the terms of the Trust – and if the IRS, later down the road, wanted to push the issue, the IRS has the winning argument. This was my gut instinct, but because of how much was on the line (estate tax issues, upset beneficiaries, etc.), I advised the client that we get a second opinion from another attorney. I have actually never seen an ILIT not be followed correctly, so to protect my client, I recruited an attorney friend (from another law firm who does the same type of law I do) to give us a second opinion. Very long story short, after I sent her all the documentation and information, we had a meeting and she said exactly what I anticipated … that the Trustee failed at its duties of doing the Crummey Letters and at this point, they’re basically crap out of luck. Yikes, right?
I think this leads to a final point for this episode about the professionals involved. I saw the letter that the attorney (who actually created the ILIT way back in 2008 – who remember was not us!) put together and it clearly advised the CPA, who was the Trustee, to send the Crummey Letters (and a few other minor duties). The client really, really likes the CPA, so I felt this weird balance of playing “Yeah you may like her, Ashley the CPA, but she also messed up … and now it’s going to cost you money (of unwinding this ILIT), time (of dealing with this nonsense), and potentially some energy (of having to keep the beneficiaries in the loop – which will have to be a thing to unwind it). So yeah, it’s not ideal. At All. I have to wonder if the CPA doesn’t normally serve in this role – and maybe flat didn’t know and understand. Or, perhaps the CPA thought that the client would be sending the Crummey Letters or something (even though they should come from the Trustee). I don’t know – I’m trying to minimize or deter any finger-pointing. I’d rather just get to the issue and get it resolved – and not do any of that stuff. I’m a big person on “facts, not feelings” and the fact of the matter is: We’re going to have to unwind/the ILIT. Which is a bummer.
Alrighty, time is up, my friends! I hope this was an interesting episode for you. Hopefully, it wasn’t too technical…I try to keep things not super technical on here. Let’s shift to a sneak peak of next week, which we’re circling back to the “current trends” topic where we talk about things that are going on currently that impact my estate and elder law world – or maybe, things that I have stumbled upon on the news or social media that is relevant to this podcast. Well, next week, we’re going to talk about a local-to-me (here in Indiana) gentleman that passed away and set up his estate plan to doll out distributions to various charities. It made the news and is super cool and interesting, so check that out next week. Talk to you then, Legal Tea Listeners! Take care and be well!