Introduction of the concept of rules for wealth transfers between generations.
These rules change slowly and have very deep roots, which in the US trace back to England in the Middle Ages. Often, the reason why something is as it is can only be explained historically.

1. The common transfer devices: Wills

FAQ about Wills: Nolo Press

A will can be thought of as a "letter to a judge", to get court decree carrying out its terms

Needed because documents of title don't automatically change ownership when someone dies

The formalities of Wills

Probate Code Sec. 6100: Wills dispose of property

Individual over 18, of sound mind

Formalities of signing and witnessing

PC 6110: Writing, signed, 2 witnesses
Holographic will: signature and material provisions handwritten
If interested witness, presumption of duress/ undue influence

Intestacy Marian Ford, "Estate Planning Terms"

Community property to surviving spouse PC Sec. 6400 ff.

Separate property:

• if 2+ children, 1/3 to spouse
• if 1 child, or parents or parents issue:1/2
• otherwise, all to spouse

Other property

to issue, then parents, then parents issue, then g'parent's issue: then next of kin then to State of California: escheat

Joint tenancy and its variants

Civil Code Sec. 683

Both own with equal control rights while alive

decedent's interest cut off at death
by the "ripening" interest of survivor
so no probate needed

transfer by filing death certificate and affidavit

in land records or w/ transfer agent, etc.

ability of either JT to sever by inconsistent act

Variants

for bank accounts, "Pay on death" accounts
or multiple signature accounts
"Totten trusts"

Living trusts

legal fiction: X to X as trustee FBO X"

Change documents of title to show trustee as owner
trusteeship is an office , not an individual
so successor trustee can manage and convey

Gifts while alive

Civil Code Sec. 1146, 1147
voluntary transfer of personalty w/o consideration
verbal gift not valid w/o delivery (real or symbolic)
grant of Realty takes effect on delivery

2. Estate Administration

What is "Probate"? article by Mark Welch, Esq.

legal procedure for carrying out will and intestacy transfer, and for supervising trusts
 

Probate court: a department of each county's superior court
 
Probate as the residue of the role of equity courts re wills
In 20th century, merger of law and equity functions, generally
Still- no jury trial in equity matters
enforcement in equity/ fairness of fiduciary duties

 The process of administration

D dies. Now what?

before authorization, only pay for funeral and protect estate

Obtain letters of administration

a "representative" under general supervision of court
done by "Petition for probate", file will with court
"executor", "administrator", public administrator

notices to potential heirs and by publication

actual and publication to creditors
largely a game of forms and waiting
court supervision, but approval routine if no objection
Independent Administration usually a good idea
so is a waiver of bond

Inventory and appraise the estate

Cal has probate referees (a leftover form Cal inheritance taxes)
File info on real estate with court / assessor
Pay routine expenses to protect the estate
family allowances and preliminary distributions

Settle the estate

review and approve creditor claims
file the 706 if needed (personal liability problem)
Sell property if appropriate ($ needed, or heirs not want)
probate sale: public overbidding

Prepare and file a plan of distribution

accounting for interim estate transactions
at this time, fees awarded: statutory and extraordinary
    Probate Fee Schedule

3. Fiduciary Financial Accounting

What is a fiduciary?

"faithful one": manages trust, estate (ptr to other ptrs, etc.)

 Variety of legal "duties"

keep the manager honest and diligent

duty to administer trust in accord with terms PC Sec. 16000
duty to make trust property productive: PC 16007

duty of loyalty

PC Sec. 16002: solely in interest of B's
issues of self-dealing: PC 16004

fiduciary standard of care: PC 16040

"prudent person familiar with such matters"
duty to report: 16062: annual accounting to B's
Contents: Sec. 16063

How Does Fiduciary Accounting Work?

like fund accounting only simpler
prime concern is to prevent the fiduciary from stealing
technically: verify compliance with duties

Charged with opening assets and income

cash method, generally
for books, Principal and Income control accounts

eg. Dr FMV of property at inception, CR Principal
eg. Dr Cash for interest received, Cr Income

Credited with closing assets and expenses

The Corpus-income distinction

reason is the use of fiduciaries to structure interests over time

 Revised Uniform Principal and Income Act

PC Sec. 16300: for other funds, Civ Code Sec. 731
Due regard for current and future beneficiaries
follow trust doc; if not, law, if not due care

Income and principal defined: Sec. 16303

differ from income tax

eg. cap gains and losses to principal
corp liquidation to principal
depreciation allowance belongs to principal

Charges against principal and income

PC Sec. 16312 (b)(1), (b)(5); (d)(1)
 

4. The Income Taxation of Fiduciaries:

The Big Picture:

Trusts and estates treated as "conduits"

Tax reporting passes through to someone else
Other conduits: P'ships, S-Corps, RIC's

811 looks at "what is income" - here we assume we know, and look to "who will be taxed"?

Choice of person to tax on income:

• Y taxed to grantor if certain retained powers (discuss later in course)
• to Bene to extent currently distrib
•  to Trust to extent retained

Reporting: Form 1041 and Schedule K-1

Prepared by the fiduciary
In general, character of Y items flow thru
losses flow thru in termination year

Tax Code Provisions for Non-Grantor trusts

Secs. 641-667 ( Subchapter J)

Importance of the Sec 1 rate structure

Tax reform changes

• Until 1986, Tr rates like individual: a long bracket ride
• 1986 Tax Reform saw drastic compression: even more in 1993 Act
• Now, 1997: trusts and estates hit the top taxable rate (39.6%) on all income over $8,100

Implications for Trust/Estate operations

• Invest in muni bonds (income tax free)
• seek cap gains (20% maximum now)
• distribute the income to the lower taxed benes
• have it treated as grantor trust to lower bracket grantor

Many trust rules now block nonexistent loopholes

Peculiar form of obsolesence throughout
Before 1986/93: Incentive to fragment among multiple trusts to double up on the bracket ride

Many rules attacked this (multiple trust, grantor trust, throwback, etc.)

IRS hoist by its own petard: had attacked trusts used for bracket ride by treating others as income earners. Now Tp's use these cases against IRS, and IRS has to attack its own victories

1997 change to reflect the new, compressed brackets

Major simplification law change in 1997 regarding distributions of previously taxed Y

Formerly, No tx if B was child/unborn.
Otherwise tax it again, w/ credit for tax already paid
In practice, elaborate "throwback" averaging procedure

Trusts and Estates as "Modified Conduits"

Fiduciary files 1041 to  reports income and deductions

Accounting periods

Trust uses calendar year; estate may use fiscal year. Sec. 645
Trusts (and estates after 2 years) must pay estimated tax
trusts can pass estimated tax thru to benes: 643(g)

Concepts of income: 643(b)

The problem:

Fiduciary income and taxable income are different concepts with different objectives, so the results aren't the same

Fiduciary income ( see above)

Question is what belongs to current benes, as opposed to what is to be preserved for future, remainder benes

EG. capital gains as part of corpus, exempt income is still income, allocation of fees between income and corpus, charitable and individual beneficiaries

Taxable income

Like an individual: Sec. 641(b)

Distributable Net Income ("DNI")

The elegant theoretical solution to the taxabl/fiduciary difference
643(a) -- circular definition

Not all the taxable income may be distributable under fiduciary standards, and at the same time there may be distributions from corpus that are non-income gifts

DNI has iimilar function to corporate "E&P" : tests distributions for taxability and deductibility by the payor estate or trust

How the DNI calculation works

Distributions from trust to beneficiary "carry" income with them to the extent of the trust's DNI

Whether called income or corpus under the fiduciary rules

Fiduciary deducts amounts distributed to the extent they are not tax-free income (like muni bond interrest) Schedule B

" Simple", Sec. 651 trusts

All fiduciary income is "required to be distributed currently": Sec. 651(a)
Trust deducts, up to the taxable portion of DNI

"Complex", Sec. 661 trusts, and all estates

Deduct income and any other amount paid out
But not to exceed the taxable portion of DNI: Sec. 661(c)

Corpus or income distribs carry out DNI
But not gifts or specific bequests of specific sum or specific property: 663(a)(1)

Beneficiary includes amounts deducted by trust/estate in income

SS. 652 and 662
Character flows through: Sec. 652(b) and 662(b)
Operationally, a K-1 report
Again, not to exceed DNI

Special Rules

"Tiering"

For complex trusts/estates, "tier" required income distributions and other distributions

DNI allocated 1st proportionately among first tier -- the mandatory income recipients. If excess, allocate proportionately among second tier -- the discretionary recipients: Sec. 662(a)(2)

Sale of gifted property w/in 2 years: Sec. 644 tax at grantor's rates

Distributions in kind: Sec. 643(e)

Treat as carrying out DNI=Basis (or FMV if less), and no stepup
If elected, recognize gain or loss, and use FMV as DNI carryout and as basis

Depreciation follows the income: Sec. 642(e)

No double estate tax and Y tax deduction: Sec. 642(g) waiver

Unused loss CF and excess deductions jump to bene in final year: 642(h)