The primary estate planning benefit of a FLP is to reduce the value of assets held in a taxable estate by transferring the assets into the FLP.  The assets may receive a valuation discount for lack of marketability, lack of control, and real property can receive capital gain discounts.   The assets may receive a discount for lack of marketability because a third party will require a discount as they will not own the entire asset and are forced into a partnership with the other owners.  The assets may receive a discount for lack of control because the limited partner of a partnership does not have the ability to make partnership decisions; they only have the right to review the books.  Real property with a low tax basis may receive a built in capital gain discount because under partnership tax laws the partner is responsible for the future tax on the gain of the sale of the real property because the tax will flow through the partnership to the partner.

The above discounts can reduce the value of the assets transferred to the FLP by an estimated thirty percent.  An appraiser will need to be retained to appraise the value of the original assets and also to appraise the assets after they are transferred into the FLP.  The amount of the discount will depend upon the appraiser’s analysis of the type of assets, amount and frequency of distributions, the size of the interest, and other factors.  The appraisals are necessary to validate the discount to the IRS.

The FLP should have a legitimate business purpose in addition to the avoidance of taxes.  Asset protection by limiting liability, managing control over the assets, creating an efficient manner to manage assets, and restricting the rights of others from gaining interests in family assets are all legitimate business purposes.  The FLP partners must treat the FLP as a business.  The FLP must be validly created under state law and comply with all formalities.  The FLP must have its own bank account, tax identification number, and must file separate tax returns.  The FLP must not simply distribute all its income because businesses will generally retain some income.

The client creating the FLP must retain enough assets outside of the FLP to support their lifestyle because people do not invest all of their assets into a single business.  A personal residence should not be transferred into a FLP because businesses generally do not own residences unless they are being rented.  Also, the transfer of a personal residence into a FLP will cause the owner to lose their Internal Revenue Code Section 121 capital gain exclusion.  FLPs are an excellent estate planning tool to use upon the death of the first spouse because the assets will have received a full step-up in basis upon the first spouse’s death.

FLPs require careful planning and drafting because the Internal Revenue Service has been attacking FLPs using two arguments under Internal Revenue Code section 2036.  The FLP must be constructed so that the party transferring the assets into the FLP receives fair and adequate consideration for those assets to overcome the argument that there was an implied agreement that the decedent was able to use the property.  Also, the IRS attacks FLPs where all a person’s assets are transferred into the FLP and deems such a transaction to create a life estate.

Property taxes are another important consideration when creating a FLP.  The parent-child reassessment exclusion will not apply to the transfer into the FLP because the shares in the FLP are the transfer of a personal property interest, not a transfer of real property.  Also, the real property will be reassessed once more than fifty-one percent of the property is transferred into the FLP.  It is also important to realize that FLPs can be expensive to establish because appraisals are required and the FLP must be maintained as a business which requires annual tax returns and state partnership filings.

FLPs can be great vehicles to transfer property out of a taxable estate at a large discount which may greatly reduce or eliminate the amount of estate taxes due upon death.  It is important to remember that they need to be drafted carefully and maintained as a business in order to survive an attack by the IRS.

Daniel T. Quane, Esq. is an attorney with the Family Trusts and Estates Law Group, Danville, California. Our vision brings together a team of highly experienced and distinguished family, trust and estate attorneys all of whom deliver specialized knowledge, strategic insight and tactical planning.  Since 1984 we have dedicated ourselves to this mission.  We are very proud of our five attorneys and our talented support team which includes California State Bar Certified Family Law Specialists, brilliant staff attorneys, and committed and experienced Certified Paralegals and technical staff.   We practice our profession with integrity, strength and commitment to our clients.

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The gift tax is exclusive while the estate tax is inclusive.  To demonstrate, assume a person would like to make a taxable gift of $150,000 but is unsure of whether to make the gift during their life or upon their death.  For simplicity, assume the gift and estate tax rate is fifty percent rather than the current forty-five percent.  If the gift is made during life $100,000 would go the donee and $50,000 would be paid in gift tax.  If the gift was made upon death, $75,000 would go to the donee and $75,000 would be paid in estate taxes.

Every person is also allowed to make annual gifts up to the annual exclusion amount which will not count against the $5,000,000 gift tax exemption.  The annual exclusion is set at $13,000 for 2010 and is per donee.

A married couple is also allowed to combine their exclusions so that they may gift $26,000 per year to a child with no gift tax consequences.  Since the annual exclusion is per donee, a married couple could make annual gifts of $52,000 to a child and the child’s spouse.  Also, the payment of tuition and medical expenses of another person is not considered a transfer for gift tax purposes and is an easy way to reduce a taxable estate.

Daniel T. Quane, Esq. is an attorney with the Doyle Golde Quane Family Trusts and Estates Law Group, Danville, California. Our vision brings together a team of highly experienced and distinguished family, trust and estate attorneys all of whom deliver specialized knowledge, strategic insight and tactical planning.  Since 1984, we have dedicated ourselves to this mission.  We are very proud of our five attorneys and our talented support team which includes California State Bar Certified Family Law Specialists, brilliant staff attorneys, and committed and experienced Certified Paralegals and technical staff.   We practice our profession with integrity, strength and commitment to our clients.

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The two most common ways for the ILIT to become the owner of a life insurance policy is for the ILIT to purchase a policy on the settlor’s life or for the settlor to gift a policy to the ILIT. The preferred method is for the ILIT to purchase the policy because if the settlor dies within three years of making a gift of the policy to the ILIT, the insurance proceeds are includable in the settlor’s estate. One common solution is to obtain a three year term policy to protect against this contingency.

An ILIT is an irrevocable trust and the settlor must be careful to not retain any incidents of ownership. This means that the settlor cannot change the beneficiaries of the trust nor change the beneficiary of the policy, borrow against cash value or participate in any decision affecting the policy. All decisions regarding the administration of the ILIT are to be made by the trustee without the settlor’s input. However, the ILIT is set up as a grantor trust which means that any income earned by the trust during the settlor’s lifetime is taxable to the settlor and must be included on the settlor’s income tax return.

The settlor should make a cash donation to the trust along with the gift of the life insurance policy. I recommend that this gift be an amount in excess of the first year’s premium payment. The trustee will need to continue to make future contributions in order for the trust to have funds sufficient to pay the premiums on the policy. These future contributions should not be in the exact amount of the premium payments and not made only when the premium payments are due. Additionally, the settlor must be careful that the payments due not include directions or notations that could be interpreted as a direction to the trustee to use these funds to pay the insurance premiums. It is important to follow these rules to avoid the IRS claiming that the trustee was merely the settlor’s agent which may lead to the proceeds of the policy being included in the settlor’s estate.

The contributions from the settlor to the ILIT are taxable gifts. Every person is allowed to make annual gifts up to the annual exclusion amount which will not count against the $5,000,000 gift tax exemption. The annual exclusion is set at $13,000 for 2011 and is per donee. However, in order for the gift to qualify for the annual exclusion it must be presently available to the beneficiary. The trustee must advise the beneficiaries of each contribution from the settlor to the ILIT and allow the beneficiary the opportunity to withdraw the contribution. The power of withdrawal is known as a Crummey power and is necessary for the contribution to qualify for the annual exclusion.

A quick listing of additional instructions to serve as the trustee of an ILIT follows below:

(1) All decisions and actions regarding the ILIT must be made by the trustee, not the settlor;

(2) When acting as trustee, make sure you make it clear you are acting in the role by identifying yourself as trustee and adding “as trustee” to your signature;

(3) Do not commingle funds of the ILIT account and your personal funds;

(4) Do not make payments for ILIT expenses from your personal funds;

(5) Keep records of all ILIT transactions and copies of all ILIT bank accounts;

(6) Use the EIN number, not your social security number, when acting on behalf of the ILIT;

(7) Maintain sufficient funds in the ILIT to pay the beneficiaries in the event they exercise their right to withdrawal; and

(8) Give notice to the beneficiaries when contributions are made to the ILIT.

The above is only a partial listing of guidelines for the trustee to follow. It is imperative that the trustee seek and receive assistance from an estate planning attorney if any questions arise.

Daniel T. Quane, Esq. is an attorney with the Family Trusts and Estates Law Group, Danville, California. Our vision brings together a team of highly experienced and distinguished family, trust and estate attorneys all of whom deliver specialized knowledge, strategic insight and tactical planning.  Since 1984 we have dedicated ourselves to this mission.  We are very proud of our five attorneys and our talented support team which includes California State Bar Certified Family Law Specialists, brilliant staff attorneys, and committed and experienced Certified Paralegals and technical staff.   We practice our profession with integrity, strength and commitment to our clients.

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The Mechanics of 412(e)(3) Plans.

A 412(e)(3) Plan is a defined benefit plan funded with either annuities or life insurance and annuities.  The corporation purchases the life insurance and annuities and is entitled to a deduction for this payment.  The employee plan participant is not currently taxed on the receipt of the annuities and life insurance and the plan values will grow tax-deferred.  The employee plan participant will have to pay ordinary income tax once the employee begins receiving distributions from the plan upon reaching retirement age.  The retirement income to the employee is guaranteed by the annuities and life insurance and will not increase or decrease with the market.

The Benefits of 412(e)(3) Plans.

412(e)(3) Plans offer  larger tax-deductible contributions for the employer than other deferred compensation plans which increase the ability of the corporation and highly compensated employees from currently recognizing tax.  The large contributions result because the plans are premised upon the guarantees of the annuities and life insurance which have low assumed rates of return so the amount the employer is required to contribute is large. In addition to allowing for the deferral of large amounts of income, 412(e)(3) Plans are simple to administrate post set-up and an actuary is not needed for annual valuation or certification.

The Negatives of 412(e)(3) Plans.

Sound investing should focus on the growth of deferred compensation plans rather than simply the amount that can be deducted.  No net economic benefit is received if the plan allows larger amounts of income to be deferred but only at the cost of lost growth on the income deferred.  If the investment returns exceed the assumed rate of return upon which the plan was premised, the amount of retirement income will not increase.  The extra investment returns simply reduce the employer’s future contributions to the plan.  With other deferred compensation plans, such as a 401(k), the employee’s retirement benefit increases as the performance of the plan investments exceed expectations.  The 412(e)(3) Plans are locked into a set rate of return so participants will not receive the benefit of a bull market.

In addition to being conservative investment vehicles, 412(e)(3) Plans have some other negative attributes.  412(e)(3) Plans must meet with the same coverage and nondiscrimination rules that all qualified plans must meet.  412(e)(3) Plans cannot make loans and the company cannot skip a year of funding after establishing the plan. Most importantly, 412(e)(3) Plans are not appropriate deferred compensation plans for individuals with a taxable estate because the death benefit will be part of the decedent’s gross taxable estate.

The Ideal Candidate to Participate in a 412(e)(3) Plan.

The ideal candidate to participate in a 412(e)(3) plan is a small business owner approximately age 50 or older with few employees.  The business must be economically stable with consistent annual income in order to make the annual payments the plan will require.  The payments cannot be forgiven or deferred for a year in the event the business profits are not as expected.  The ideal candidate will be operating a successful small business which can benefit from the deferral of substantial amounts of income.  412(e)(3) Plans are more appropriate for people age 50 or older as the plan will require larger contributions because the annuity will be for a shorter length of time since the employee is nearer to retirement.  412(e)(3) Plans are also good plans for investors who desire a guaranteed return as they will not be affected by the stock market.

Daniel T. Quane, Esq. is an attorney with the Doyle Golde Grossman Family Trusts and Estates Law Group, Danville, California. Our vision brings together a team of highly experienced and distinguished family, trust and estate attorneys all of whom deliver specialized knowledge, strategic insight and tactical planning.  Since 1984 we have dedicated ourselves to this mission.  We are very proud of our five attorneys and our talented support team which includes California State Bar Certified Family Law Specialists, brilliant staff attorneys, and committed and experienced Certified Paralegals and technical staff.   We practice our profession with integrity, strength and commitment to our clients.

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There are three types of grantor trusts.  Grantor retained annuity trusts (GRATS), grantor retained uni trusts (GRUTS), and grantor retained income trusts (GRITS).  This article focuses on the use of GRATS in conjunction with the use of tax-free gifts to reduce the taxable estate.  A GRAT is an irrevocable trust created by the grantor for a specified time period.  The grantor pays the gift tax on the value of the remainder interest when the trust is established.  The assets are deposited into the trust and an annuity payment is made each year to the grantor.  When the trust expires the beneficiary receives the remaining assets tax-free.

A wealthy individual or couple should first determine the amount of money they will require to comfortably support their lifestyle until their death.  The assets that exceed this amount can be transferred during life to the later generations to avoid estate taxes upon their death.  A wealthy individual can make annual exclusion gifts in the amount of $13,000.00 per recipient for the year 2011 and can gift up to $5,000,000.00 using his or her lifetime gift tax exclusion with no gift tax payment.  A married couple can make annual gifts of $26,000.00 per recipient and gift up to $10,000,000.00 using their combined lifetime gift tax exclusions with no gift tax payment.

The benefit of these tax free gifts can be greatly increased by making the gifts to a grantor trust rather than directly to the individual.  The income produced by the grantor trust will be taxable to the grantor while the assets of the grantor trust will not be included in the grantor’s gross estate.  The grantor is responsible for paying the income tax on the income of the grantor trust so the payment of this tax is not included in the amount of the gift.  By paying the income tax on the grantor trust income, the grantor further reduces the value of his or her estate.  This allows the assets in the grantor trust to increase in value without the beneficiaries having to pay any tax on the income.

The $13,000.00 annual exclusion and $5,000,000.00 lifetime gift tax exclusion can allow the grantor to transfer a surprisingly large amount of money out of his or her estate through grantor trusts.  By making the annual exclusion gift to a single grantor trust annually for twenty years, it is estimated that the grantor will transfer more than $400,000.00 in inflation adjusted dollars.  A grantor will transfer an estimated $3,000,000.00 over twenty years by transferring $1,000,000.00 of their lifetime gift tax exclusion to a grantor trust.  These amounts can be greatly increased by creating separate grantor trusts for the grantor’s children and the children’s spouses, and for each grandchild.  A dynasty trust for the grantor’s descendants can also be created to transfer additional wealth from the grantor’s estate.

The above strategy can be applied to reduce the taxable estate of moderately wealthy individuals but for extremely wealthy individuals another dimension may be added to increase the amount of wealth transferred from the grantor’s estate.  The additional dimension is to use a series of rolling GRATS.  A rolling GRAT works by the grantor applying the annuity he or she receives from a GRAT and using it to establish a new GRAT.  The use of a rolling GRAT system maintains all the assets the grantor is attempting to transfer out of his or her estate in the GRAT transfer.  The use of simply a single GRAT will result in the annuity payments paid out of the GRAT being brought back into the grantor’s estate.  A system of short term rolling GRATS also protects against the chance of a good investment year being offset by a poor investment year because rolling GRATS are usually of short duration.

A system of rolling GRATS can transfer substantial assets from very wealthy estates and leave the grantors with the amount of capital they calculate necessary to live out the remainder of their lives at the lifestyle they choose.  Rolling GRATS are of short duration, as short as two years, so they offer the grantor the ability to adjust the flow of assets out of his or her estate at a rate comfortable to the grantor even in volatile markets.  The grantor can cease creating new GRATS and stop making annual gifts in order to reduce the flow of assets out of his or her estate.

A wealthy individual or couple can reduce their taxable estate by transferring assets during their lifetime to their beneficiaries using the annual gift tax exclusion and lifetime gift tax exclusion.  This transfer process is made more effective by transferring the assets to GRATS rather than directly to the individual because this allows for the beneficiaries to receive the income of the transferred assets tax-free as the grantor is responsible for payment of the income tax.  The system of rolling GRATS can be used to increase the scale of transfer resulting from the use of gifts combined with conventional GRATS where the amount of wealth to be transferred is substantial or must be accomplished in a short time period.

Daniel T. Quane, Esq. is an attorney with the Family Trusts and Estates Law Group, Danville, California. Our vision brings together a team of highly experienced and distinguished family, trust and estate attorneys all of whom deliver specialized knowledge, strategic insight and tactical planning.  Since 1984 we have dedicated ourselves to this mission.  We are very proud of our five attorneys and our talented support team which includes California State Bar Certified Family Law Specialists, brilliant staff attorneys, and committed and experienced Certified Paralegals and technical staff.   We practice our profession with integrity, strength and commitment to our clients.

FamilyTrustsandEstates.com

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Homeowners with mortgages exceeding their home’s value have two primary options to dispose of their house.  The homeowner can work with the mortgage lenders to sell their residence for a price which is less than the outstanding balance of their loan.  This is commonly referred to as a short sale.  In order to effectuate a short sale, the homeowner will generally first have to complete paperwork establishing a hardship prior to the lender possibly accepting the sale at a value less than the outstanding balance.  If the lender refuses to allow a short sale, the homeowner’s second option is to allow the home to enter foreclosure.   Alternatively, the lender may contact the bank to determine whether the bank is willing to accept a deed in lieu of foreclosure.  A deed in lieu of foreclose will return legal title to the bank without the formal requirements of foreclosure.

The homeowner disposing of their residence through short sale, foreclosure, or deed in lieu of foreclosure will have his or her credit negatively impacted.  Many homeowners’ desire to dispose of their residence through the short sale process as it results in a less negative impact on their credit rating than foreclosure.

There are concerns beyond the negative credit impact that the homeowner must consider if disposing of their home through short sale or foreclosure.  Homeowners should also determine whether they may be found personally liable for the balance remaining on their mortgage after the home is sold through either a short sale or a foreclosure sale.  Additionally, a homeowner may be charged with taxable income for the forgiveness of the mortgage debt which exceeds the amount for which the home is sole.

Personal Liability:

When a person disposes of their home through short sale or foreclosure, the proceeds that the lender(s) receives from the sale are less than the balance of the mortgage(s).  The lender(s) may seek to obtain a deficiency judgment holding the homeowner personally liable for the balance.  Homeowners entering into a short sale must first obtain the lender’s agreement to not pursue a deficiency following the short sale.  Homeowners suffering a foreclosure may find some protection in California’s antideficiency laws which may prevent the lender from obtaining a deficiency judgment.

California Code of Civil Procedure (CCP) Section 580(b) provides that a deficiency judgment cannot be obtained against the principal obligor after foreclosure under a “purchase money” loan.  A loan is a purchase money loan so long as (i) the loan proceeds are used to purchase a residential dwelling of four units or less; and (ii) at least one of the units is owner occupied.  Many Californians are not protected by CCP 580(b) because they refinanced their residence or took second loans or home equity lines, the proceeds of which were not used to purchase their residence.

California Code of Civil Procedure Section 580(d) may offer protection from deficiency judgments for homeowners who do not qualify under CCP 580(b).  CCP 580(d) provides that, the lender loses the right to recover any “deficiency” judgment against the borrower if the lender pursues a trustee’s sale.  Many lenders chose to simply sell the residence upon foreclosure rather than seek a judicial foreclosure.  If the lender exercises their right to simply sell the residence, they cannot later sue the homeowner in an attempt to collect a deficiency judgment.

However, CCP 580(d) does not protect the homeowner from the sold out junior lien holder.  Many homeowners have a first and second mortgage.  If the lender of the first decides to dispose of the residence by a trustee’s sale, the proceeds are generally insufficient to pay off the second lender.  The second lender may then pursue a deficiency action against the homeowner.  The doctrine of merger may apply where the holder of the first and second mortgage are the same lender.

Cancellation of Debt Income:

When a lender receives less than the outstanding balance of the mortgage through a short sale or foreclosure and does not obtain a deficiency judgment, the remainder of the debt is forgiven.  Although, the homeowner will not have to pay this difference, the cancellation of the debt may be considered taxable income to the homeowner.  Cancellation of debt income is considered ordinary taxable income under both federal and California tax law.

Congress enacted legislation relieving some homeowners from incurring federal cancellation of debt income following the housing market crisis.  California followed suit shortly thereafter relieving some homeowner’s from state income tax for the cancellation of mortgage debt.  Although the California law closely resembles the federal law, there are sufficient disparities such that a separate analysis is required to determine whether the homeowner qualifies under each law.

The Mortgage Forgiveness Debt Relief Act of 2007 (P.L. 110 142) and Emergency Economic Stabilization Act of 2008 (P.L. 110-343) allow some homeowners to exclude from their federal taxable income the discharge of debt on their qualified principal residence.  The federal law applies to cancellation of debt incurring in 2007 through 2012.  The amount of indebtedness is limited to $2,000,000 ($1,000,000 if married filing separate) but the amount of debt relief is unlimited.  The new acts only apply to a homeowner’s personal residence.

Many homeowners purchased vacation or rental properties during housing market boom.  Cancellation of debt income resulting from the short sale or foreclosure of these properties is not excluded pursuant to the recent legislation.  Cancellation of debt income from properties other than the primary residence may be excluded if (i) the owner was bankrupt when the discharge occurred (Title 11 discharge); (ii) the owner was insolvent (limited to level of insolvency); (iii) qualified farm indebtedness was canceled; or (iv) qualified real property business indebtedness.

On April 12, 2010, California enacted SB 401, the Conformity Act of 2010.  California now excludes cancellation of debt income from state taxation for the homeowner’s primary residence with some qualifications.   The amount of qualified principal residence indebtedness is limited to $800,000 ($400,000 for taxpayers who file as married filing separately).  The amount of debt relief is limited to $500,000 ($250,000 for taxpayers who file as married filing separately).

A homeowner considering a short sale or faced with a foreclosure is highly advised to first meet with an attorney to determine their potential liability for a deficiency judgment or the incursion of cancellation of debt income.

Daniel T. Quane, Esq. is an attorney with the Family Trusts and Estates Law Group, Danville, California. Our vision brings together a team of highly experienced and distinguished family, trust and estate attorneys all of whom deliver specialized knowledge, strategic insight and tactical planning.  Since 1984 we have dedicated ourselves to this mission.  We are very proud of our five attorneys and our talented support team which includes California State Bar Certified Family Law Specialists, brilliant staff attorneys, and committed and experienced Certified Paralegals and technical staff.   We practice our profession with integrity, strength and commitment to our clients.

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Edward and Joette Masry created a revocable living trust (Family Trust).  The property transferred to the trust was community property as it was acquired during marriage.  The trust named Edward and Joette each as a trustor (settlor) and trustee of the trust and reserved the right of each to revoke the trust “by written direction delivered to the other Trustor and to the Trustee.”

Edward executed a Notice of Revocation of Trust shortly before his death but did not inform Joette.  Edward created a separate trust naming his children from a prior marriage as successor co-trustees and planned on transferring his assets into his new trust.

Joette learned of Edward’s new trust shortly after his death and filed a petition claiming that the revocation of the Family Trust was invalid because Edward did not provide notice of the revocation to her.  The trial court found that Edward’s revocation to himself as trustee was effective because the Family Trust did not explicitly require delivery of a revocation to Joette as the exclusive method of revocation.  Joette appealed.

Prob Code Section 15401(a)(2) states that a revocable trust may be revoked by compliance with the revocation method in the trust instrument or by a writing signed by the settlor and delivered to the trustee while the settlor is still alive, unless the method in the trust instrument is explicitly designated as the exclusive method of revocation.  Probate Code Section 15401(b) states that a trust created by more than one settlor may be revoked by any settlor as to the portion that that settlor contributed, except as provided under Family Code Section 761.  Family Code Section 761 grants either spouse the ability to act alone to revoke his or her community property share of trust assets unless the trust expressly provides otherwise.

The appellate court found that the Family Trust did not “directly and unambiguously” make the revocation method it provided the exclusive method of revocation.  Therefore, Edward was allowed to revoke the Family Trust for the portion he contributed by using the method provided by Probate Code Section 15401(a)(2).  Edward satisfied the requirements of Probate Code Section 15401(a)(2) by delivering from himself as settlor to himself as trustee the Notice of Revocation of Trust he created shortly before his death.  The appellate court confirmed the trial court’s ruling that Edward was allowed to dispose of his one-half of the community property in the Family Trust without notice to Joette.

Daniel T. Quane, Esq. is an attorney with the Family Trusts and Estates Law Group, Danville, California. Our vision brings together a team of highly experienced and distinguished family, trust and estate attorneys all of whom deliver specialized knowledge, strategic insight and tactical planning.  Since 1984 we have dedicated ourselves to this mission.  We are very proud of our five attorneys and our talented support team which includes California State Bar Certified Family Law Specialists, brilliant staff attorneys, and committed and experienced Certified Paralegals and technical staff.   We practice our profession with integrity, strength and commitment to our clients.

FamilyTrustsandEstates.com

925-314-2335

When an Existing Client Becomes Possibly Incapacitated.

The attorney encounters a difficult predicament when a client becomes incapacitated and no longer capable of protecting his or her interests.  On the one hand it is the role of the attorney to protect the client’s interests.  On the other hand the attorney owes the client the duty of confidentiality and the duty of loyalty.  The attorney may desire to inform a third party of the client’s incapacity and inability to act in the client’s best interests or even institute a conservatorship proceeding to have a conservator appointed to act on behalf of the client.

There is no case law or rule in California directing the attorney to the correct manner in which to proceed.  The State Bar Standing Committee on Professional Responsibility and Conduct (COPRAC) addressed the issue in Formal Opinion No. 1989-112.  COPRAC stated that an attorney for a possibly incapacitated client may not institute conservatorship proceedings for the client without the client’s consent.  The attorney would breach the duty of confidentiality and violate Section 6068(e) by disclosing the client’s secrets.

The attorney would also possibly violate California Evidence Code Section 952 which prohibits an attorney from disclosing communications protected by the attorney-client privilege.  Additionally, the attorney would be taking a position adverse to that of the client’s by initiating conservatorship proceedings and violate CRPC Rule 3-310.  In California, the only option available to the attorney faced with a possibly incapacitated client is to withdraw from representing the client.  However, the attorney is likely one of the few people advocating for the client’s best interests and the client will lose the protection provided by the attorney.

The American Bar Association (ABA) view allows the attorney to initiate conservatorship proceedings on behalf of a client where the attorney reasonably believes the client cannot adequately act in the client’s own interest.  The ABA rule is followed in the majority of states.  The Trusts and Estates Section of the California State Bar sponsored legislation allowing for an attorney to act if the attorney believes that the client has become incapacitated.  The proposed legislation provides that if an attorney reasonably believes that the client has significantly impaired capacity and as a result thereof (1) is at risk of substantial physical, financial or other harm unless action is taken, and (2) cannot adequately act in the client’s own interest, the attorney may, but is not required to, notify those individuals or entities that have the ability to take action to protect the client.

There is precedent in California for an exception to the duty of confidentiality.  In 2003, Business & Professions Code Section 6068(e) was amended to allow an attorney to disclose confidential information to the extent the attorney reasonably believes is necessary to prevent a criminal act that the attorney reasonably believes is likely to result in death or substantial bodily harm.

When A Potential Client is Possibly Incapacitated.

In order to execute a testamentary document, at the time the document is executed the person must (1) understand the nature of the testamentary act; (2) understand and recollect the nature and situation of his or her property; and (3) remember and understand his or her relationship to living descendants, spouse, and parents, and those whose interests are affected by the will.

A person possessing the three attributes above generally will be found to have the capacity necessary to create, modify or revoke an estate plan.  However, a person may lack capacity when at the time the document was executed, the person suffered from a mental disorder including delusions or hallucinations, which resulted in leaving his or her property in a way which he or she would not have done without the delusions or hallucinations. California Probate Code Section 6100.5(a)(2); see  Estate of Perkins (1925) 195 Cal. 699, 703-704.  Goodman v. Zimmerman (1994) 25 Cal.App.4th 1667, 1678-1679.

An attorney should not prepare an estate plan for a client who the lawyer reasonably believes does not possess the required capacity.  However, the American College of Trust and Estate Counsel (ACTEC) states that, “because of the importance of testamentary freedom, the lawyer may properly assist clients whose testamentary capacity appears to be borderline.”  ACTEC Commentary on MRPC 1.14 at 132.  ACTEC also advises that if the attorney has doubts regarding the client’s capacity, the attorney should preserve evidence of the client’s competency.

An attorney should inquire into a client’s capacity if the attorney believes that the client may lack the required capacity to create an estate plan in order to fulfill the duty of loyalty owed to the client.  The attorney should proceed with preparing the estate plan if the attorney determines the client possesses the necessary capacity.  However, the attorney has no duty to investigate the client’s capacity as the attorney cannot be liable of malpractice for preparing an estate plan for an incompetent person.  Additionally, the attorney has no duty to beneficiaries or heirs to investigate the client’s capacity.  Moore v. Anderson Keigler Disharoon Gallagher & Gray (2003) 109 Cal.App.4th 1287.

There are procedures for preparing an estate plan for a person who currently lacks the competency necessary to enter into an estate plan.  If the person executed a Power of Attorney appointing an agent or attorney in fact and granted the agent the ability to conduct estate planning, then the agent could create, modify or revoke an estate plan for the incapacity person on their behalf.  However, if the incapacitated person did not execute a Power of Attorney while competent, a conservatorship proceeding will need to be filed to appoint a conservator of the incapacitated person.  The conservator will be able to create, modify or revoke an estate plan for the incapacitated person pursuant to a substituted judgment proceeding.

Daniel T. Quane, Esq. is an attorney with the Family Trusts and Estates Law Group, Danville, California. Our vision brings together a team of highly experienced and distinguished family, trust and estate attorneys all of whom deliver specialized knowledge, strategic insight and tactical planning.  Since 1984 we have dedicated ourselves to this mission.  We are very proud of our five attorneys and our talented support team which includes California State Bar Certified Family Law Specialists, brilliant staff attorneys, and committed and experienced Certified Paralegals and technical staff.   We practice our profession with integrity, strength and commitment to our clients.

FamilyTrustsandEstates.com

925-314-2335