Planning Your Estate in Connecticut- Part 2

7. An Introduction to the Probate Process

    As the Connecticut Probate Court website aptly describes, “the administration of a decedent’s estate is a legal process by which any outstanding financial obligations of a deceased person are paid, and the person’s property is transferred to those entitled to receive it.” The probate process normally does not take longer than a year, but it can last longer under certain circumstances. Contrary to what most people believe, the probate process is relatively inexpensive unless there is a will contest, unlawful actions taken by the executor, or an ambiguous will. 
    It is important to remember that the probate process only applies to probate property. Probate property is all property directly owned by the decedent for which there is no legally recognized death beneficiary designation. Some examples of probate property include real estate owned outright or by tenancy in common; non-joint bank accounts and bank accounts that do not have payable on death designations; interests in partnerships, corporations, or limited liability companies, and tangible person property like cars, jewelry, and home furnishings. Ray Madoff et al., Practical Guide to Estate Planning, § 2.03 (2014).
    Property that will not qualify for this process is called non-probate property. This property will bypass the probate process and be distributed directly to the designated beneficiaries. Some examples of non-probate property include real estate held in joint tenancy, life insurance, retirement accounts, payable on death accounts, joint bank accounts, and interests in trusts. Many individuals who wish to avoid probate convert their probate assets to non-probate property by placing them into an inter vivos revocable trust that terminates the grantor’s interest at death. The various options for trusts will be discussed in greater detail later in this publication.
    In Connecticut, when a person dies, the probate court serves many purposes. First, the court provides a medium for locating and taking control of a decedent’s assets. The court also ensures that all 25 Maya Murphy, P.C. | Mayalaw.com proper debts, administration expenses, and taxes are paid from the assets of the estate. Once all debts are paid, the court determines how the remaining property should be distributed according to the terms of the will, trust documents, or laws of intestacy. By overseeing the administration of estates, the probate court also provides individuals with a forum to hear and settle any disputes that may arise.
    Much of the probate process involves filing forms and paying fees, but there are many steps to the process. This is a detailed overview of normal estate administration, but there is also a simpler procedure for estates that do not exceed $40,000 in value. If you are interested in that process, there is a form entitled “Affidavit in Lieu of Administration,” or form PC-212, which can be found on the probate court website along with detailed filing instructions.

    i. To Begin: File a Petition With the Probate Court

    For the probate process to begin, one must petition the court where the decedent was domiciled at death. This is usually the responsibility of the executor, but the petition can be filed by any person who wants the estate administered. This petition should be filed within 30 days of the testator’s death and submitted with a certified death certificate, the original will, and any original codicil or trust documents. The application, form PC-200, can be found on the Connecticut probate court website at ctprobate.gov. The form requires information regarding date of death, name of spouse, names of heirs, and intended beneficiaries under the will. 
    Once the petition is received, the court will schedule a hearing to admit the will to probate and appoint an executor of the decedent’s estate. If the decedent died intestate (without a will) the court will have to appoint an administrator for the estate. Before either can be appointed, the court must determine both if there is a will and if the document is the valid last will and testament of the decedent. Once this initial hearing is complete, the court will give the executor or the administrator fiduciary certificates to prove they have authority to act on behalf of the estate. Without such certificates, the executor or administrator would not be able to manage and dispose of the estate assets.

    ii. Appoint a Fiduciary to Handle Administration Duties

    The executor or administrator of an estate is called a fiduciary. This means they hold a position of trust in the handling of another’s property. A fiduciary owes a duty to properly manage and dispense the decedent’s property and can be held liable for certain failures or unlawful acts. Once appointed, the fiduciary will take over the decedent’s assets, determine and pay proper debts, and distribute the remaining property to the decedent’s intended beneficiaries. Naturally, the fiduciary must not commingle the estate assets with their own. Throughout this period, the fiduciary must file all necessary documents such as estate tax forms, gift tax forms, and certificates for land records. The exact duties of a fiduciary are discussed in greater detail below. 

a. File Certificates for Land Records

    If the decedent owned real estate that was devised in his will, the court will provide certificates for land records that the executor or administrator must record at the town clerk’s office to show the executor or administrator has been appointed to manage and dispose of that property. This form, PC- 251, must be filed within two months of appointment as fiduciary. 

b. File Inventory of Estate

    Also within two months of being appointed, the fiduciary must file an inventory of all estate assets. This inventory must include all property the decedent owned in their name such as real estate, bank accounts, retirement accounts, cars, household items, and personal effects. Any property held with a partner, but not with right of survivorship, must also be listed. In addition, if life insurance policies are payable to a decedent’s estate, those must be included in the accounting as well. Once all property is listed, it must be valued according to the fair market value at the decedent’s time of death. This can be completed through getting verified appraisals. 
    Any assets not intended for probate need not be listed, such as property held with right of survivorship, life insurance policies with named beneficiaries, joint bank accounts, and other payable on death accounts.

c. Sell Estate Property to Pay Expenses and Claims
    
    Next, the fiduciary must determine the validity of any claims against the estate and pay all proper debts and taxes. The process of determining valid claims starts with the fiduciary placing a notice in the local paper within 14 days of appointment requesting creditors to present their claims. Once this occurs, creditors have 150 days to present their claims. The proper form, PC-234, can be found on the probate court website. 
    Within 60 days of the conclusion of the 150 day creditor claim period, the fiduciary must file a return of claims and list of notified creditors, form PC-237, with the court. After the 150 days concludes, a fiduciary can, in good faith, distribute all remaining estate assets.
    In addition to settling creditor’s claims, the fiduciary must also pay all administration expenses, fees, and taxes. These expenses include fiduciary fees, attorney’s fees, probate court charges, legal notice charges, and any other expenses relating to the maintenance of the decedent’s property. If there are not enough assets in the estate to settle all debts, the estate is deemed insolvent.

d. File Estate Tax Returns and Pay Taxes

    Within six months of the date of death, an estate tax return must be filed by the executor with the State of Connecticut. This deadline may be extended up to six months upon filing of a request, form CT-706/709. The appropriate tax forms should be filed with the probate court for the district in which the decedent resided at the time of death. If the decedent was a non-resident, the forms may be filed in a probate district where the decedent owned property.  
    Federal estate taxes are due on estates larger than $5.34 million (2014, adjusted for inflation each year). If a decedent’s estate is less than that amount, no federal estate tax is due. The majority of estates, therefore, do not end up owing federal estate taxes.
    As for Connecticut state estate taxes, the exemption amount is $2 million for those passing after January 1, 2011. This figure is drastically less than the $3.5 million exemption that was available in 2010. If the decedent’s estate is less than $2 million, a simplified tax return, form CT-706 NT, should be filed. In cases where the decedent’s assets exceed $2 million, form CT-706/709 must be filed to determine the tax due. If a decedent’s estate is less than $2 million, there will be no federal or state estate taxes due.
    Remember, these are just the exemption amounts for Connecticut and the federal government. There are many ways to decrease or avoid the amount of taxes owed at death. Many of these options are outside of the scope of this publication and highly complex. If you have an estate that is worth more than either of the exemption amounts, you will want to discuss proper estate and financial planning with an experienced attorney. Every estate is different, and there are numerous ways to plan for and reduce estate taxes. Only a specialist can help you decide the best tools for your estate.

e. File Final Financial Report

    Within 12 months of the decedent’s death, a fiduciary must file a financial report with the court when the administration of the estate is complete. There are two forms of this report, a simpler form PC-246, and a more complex form PC-241 or 242. The latter forms will be needed by a fiduciary when there are trusts that disperse income and principal to separate beneficiaries due to more complex tax implications. 
    Once the financial report is submitted, the probate court will hold a hearing to allow beneficiaries to question or object to the accounting or the way the assets were handled. This hearing can be avoided if all parties waive their rights to the hearing through form PC-245. This form states that all parties received a copy of the final accounting and waive their right to such a hearing. This is most common when no one questions the estate and how it was handled.
    If the estate cannot be closed within a year, the fiduciary must file status updates with the court. The first report must be filed within three months of the day the fiduciary was appointed and then annually thereafter. These reports must include detailed financial accounting and the reason why the estate is open longer than the usual year.

f. Distribute Remaining Assets to Beneficiaries

    Once the fiduciary has completed all other tasks and settled all other debts, assets may finally be distributed to beneficiaries.  

g. File Affidavit of Closing Estate

    Finally, to complete their duties, the fiduciary must file form PC-213, the affidavit of closing. This form is used to report receipts and disbursements that occur after the final accounting was submitted. If directed to do so by the court, this form must be submitted within 30 days after the distribution of all assets. 

Probate Process Conclusion

    Although the fiduciary may have many steps to take, the probate process is not as daunting as it may seem. The beneficial oversight the probate court supplies to a decedent’s estate outweighs the probate court fees and process. With proper planning, and a trustworthy executor, most of these costs can be avoided completely. 

8. Gifts

    In addition to bequests through a will or a trust, property may also be gifted during life. Of course there are tax implications to making lifetime gifts, but there is also an annual exclusion individuals can utilize each year to make gifts free of tax. As of 2014, each year an individual may gift up to $14,000 per person, $28,000 if married, to as many individuals as they desire. This is called the annual gift tax exclusion and it is adjusted for inflation each year. In order for the transfer to qualify as a gift, it needs to be a transfer of property for less than full and adequate consideration in money or money’s worth. I.R.C. Reg. § 25.2512-8. 
    Additionally, for the gift to qualify for an annual exclusion amount, it needs to be a gift of a present interest as opposed to a future interest. A future interest is an interest that is limited in use, possession or enjoyment at some future date or time. I.R.C. Reg. § 25-2503-3. Generally, this means that outright gifts of property qualify and interests in trust do not qualify unless specific requirements are met. These specific requirements are called “Crummey” powers because of the famous Crummey v. Commissioner tax case. This case created a rule in which a gift of an otherwise future interest to a trust would qualify as a present interest for gift tax purposes if certain requirements were met. The case requires gifts in trust to be drafted in such a way as to give the beneficiary a right to withdraw the gift principal for a defined period of time, usually 30 days. The withdrawal right of the beneficiary creates the present interest needed to qualify the gift for an annual exclusion free of tax.

9. Estate and Gift Taxes

    The main goal for most individuals is to avoid or minimize estate taxes, which can be done through proper estate planning. It is helpful to know that 99% of Americans do not pay any federal estate tax. That means only 1% of America’s wealthiest individuals, or two out of every 1,000 people who die, owe any federal estate tax. Urban-Brookings Tax Policy Center Table T13-0019. That may seem extraordinarily low, but federal estate taxes are expected to result in $200 billion worth of revenue by 2022 and account for more than $20 billion each year. Id. These figures do not align with state estate taxes, which apply to closer to 30% of individuals in Connecticut. The most important aspect of many estate plans is the appropriate use of the annual gift tax exclusions and the lifetime exemption amount. 

    i. Federal and State Exclusion Amounts

    As of 2014, every U.S. citizen has $5.34 million of estate and gift tax exemption. For married couples, that number doubles (this now includes same sex marriages as well). This lifetime exemption amount can be used during life, at death, or a mixture of the two. Additionally, each year an individual can make gifts of up to $14,000, per individual, to as many individuals as they would like free of any estate, gift, or transfer tax. If married, and an election is made on the gift tax return, this number can double to $28,000 per individual. This is called the annual gift tax exclusion amount and it is adjusted each year for inflation. Every dollar transferred over those exemption amounts results in a flat 40% rate of tax.
    Also, if the transfer is subject to generation-skipping transfer taxes, an additional 40% may be imposed. The generation-skipping transfer tax imposes a tax on transfers in trust or for the benefit of unrelated persons who are more than 37.5 years younger than the donor, or to related persons more than one generation younger than the donor (such as grandchildren). I.R.C. § 2601.
    As of 2014, the Connecticut estate tax exemption is $2 million and applies to gifts during life as well. This amount is completely separate from the federal tax structure and is owed in addition to any federal taxes, or owed despite not owing any federal estate tax. Although Connecticut lowered its exemption amount, it also eliminated its “cliff” structure. Pre-2010, an estate of $2 million paid no estate taxes, but an estate of just one dollar more paid $101,700 in taxes. Connecticut’s estate tax structure caused the state to be listed in the 2013 Forbes Magazine article “Where not to die.” Thankfully, rates are now staggered from 7-12% depending upon total estate value. For example, a $3 million estate is taxed at 7.2%, a $5 million estate is taxed at 8.4%, and a $10 million estate is taxed at 11.4%. This remains much lower than the federal rate of 40% of the entire estate if its value exceeds $5.34 million.
    Even with these tax structures in place, there are three ways to transfer property free of any tax and in an unlimited amount. These are called tax exemptions. The first exemption is the unlimited gift tax exclusion for amounts paid on behalf of an individual for medical or educational expenses. This is often referred to as the “Med-Ed” exclusion. I.R.C. § 2503(e). Any amounts paid directly to a medical or educational provider will transfer free of tax and not count towards an individual’s lifetime exemption amount.
    The next way to transfer property without limitation and without tax is to give it to a spouse. This is called the unlimited gift tax deduction for marital transfers. I.R.C. § 2523. However, in order to qualify for the unlimited transfer amount, the transfer must be in the form of a qualifying interest. Much like the present interest rule for gifts, outright transfers of property will normally qualify for the deduction. But, transfers of less than the entire interest in property must meet the requirements of the terminable interest rule. I.R.C. § 2523(b). This rule denies the marital deduction for transfers of interests that terminate or fail upon the lapse of time or the occurrence or nonoccurrence of an event, if a person other than the spouse will receive the property from the donor after the termination of the spouse’s interest. Id. While this publication will not delve deeper into how to properly gift assets to a spouse, it is helpful to note that exceptions to this rule do exist. The most common exception is the qualified terminable interest property or QTIP trust (discussed in greater detail in Part 3).
    The final method to transfer property free of transfer tax is to gift it to a charity. The gift tax provides an unlimited deduction for property transferred to a qualifying charitable, religious, or governmental organization. I.R.C. § 2522. Much like transferring property to a spouse, outright transfers will generally qualify without issue. But, if someone wants to transfer less than the entire interest in a piece of property, special requirements need to be met. The most common ways of achieving this result would be through charitable remainder trusts (also known as CRATs or CRUTs).
    The above list of exemptions and deductions is not meant to be exhaustive, and proper tax planning is essential if your assets are anywhere near the exemption amounts. Tax planning is essential for everyone because the estate tax exemptions change so frequently. The various methods of proper estate tax planning are highly complex and outside of the scope of this publication. If you are interested in hearing about some of these methods, you should contact the experienced estate planning attorneys of Maya Murphy, P.C., at 203-221-3100 or via email at ask@mayalaw.com.

    ii. Assets Subject to Tax

    The estate tax is imposed on all property owned or controlled by the decedent at death, whether or not the property passes through the probate process but only if the estate exceeds the federal and state thresholds. This means that trust assets can be subject to taxes as well. Also, estate tax is imposed on any property in which the decedent had incidents of ownership at death. Incidents of ownership are generally defined as the ability to control any of the economic benefits of the property. I.R.C. Reg. § 20.2042-1(c)(2). 

    iii. Value of Assets

    Property in a decedent’s gross estate will be taxed according to its fair market value. I.R.C. Reg. § 203.2031-1(b). The fair market value is defined as the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Id. 
    The date for valuing such property in the gross estate is generally the date of death. I.R.C. § 2031(a). This date is used unless the executor of the estate elects for an alternate valuation date. To avoid hardships caused by reductions in market value during administration of an estate, executors may elect to value the decedent’s property as of the date that is six months after the date of death. I.R.C. § 2032. This election may only be used if the election will reduce the value of the gross estate and, accordingly, reduce the total amount of taxes due. I.R.C. § 2032(c).

    iv. Income Tax on Property Received by Gift or Inheritance

    Property received through gift or inheritance is not subject to any income tax. Thus, a recipient can enjoy the full value of property received without worrying about income tax liability. However, if the recipient subsequently sells the property they received, they may be taxed on any gains or losses.  For example, if a gift or inheritance of property like stocks is made, and the recipient chooses to sell it before it increases in value, they might not be taxed on any portion of the sale. 
    The tax liability of selling property received by gift or inheritance is based on the recipient’s basis in the property. Basis is the cost, or value, of the property acquired. This number is usually the value of the item received based on the decedent’s date of death value. For example, if an aunt left a niece ten shares of Disney stock, valued at $100 per share on the date of her death, the niece would have received $1,000 worth of Disney stock. The $1,000 would be the niece’s basis in the property regardless of whether the aunt’s basis would have been ten dollars (the price that she paid when first acquiring the stock). This is called a stepped up basis in property. This stepped up basis allows all of the gain, $90 per share, to go untaxed. Thus, it is often very beneficial for a decedent to leave stock they have a very low basis in, and that appreciated significantly, to a beneficiary in their will.