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Top Mistakes In Administering Clients' Estates: How to Identify and Avoid Them

Top Mistakes In Administering Clients' Estates: How to Identify and Avoid Them

Posted on October 16, 2019

Originally published in October 2019

Introduction: Mistakes Happen

As in life generally, when an estate is being administered, sometimes mistakes just happen. They can happen for any number of different reasons. Sometimes the reasons are quite simple. Sometimes the mistakes arise out of fairly complicated circumstances. Sometimes they’re easily avoided. Sometimes they are not.

Why It Matters. All professional advisors have clients who (like their advisors) are going to die someday. In many instances, the clients will die during the advisor’s working career, and so the advisor – whether they be an attorney, accountant, investment counselor or other type of advisor – will need (or want) to know how they can best address the needs of the deceased client’s family. That will serve the interests of the clients, but it will also typically serve the interests of the advisor by (1) limiting the advisor’s exposure to liability and also (2) ensuring greater likelihood of client retention.

How and Why Mistakes Happen. Mistakes can occur in an estate administration for a variety of different reasons.

Circumstances leading up to the Decedent’s death. Sometimes mistakes are more likely to occur or matter because of a particular set of circumstances giving rise to the person’s death. Examples include: When a decedent dies at a relatively young age or dies suddenly; When a decedent’s Will was poorly drafted; When a decedent revised his or her Will numerous times; When a decedent named different persons as fiduciaries, like naming one person as Agent under Power of Attorney, and another person as Executor; or naming one person as Executor under a Will and another person as Trustee of a (Revocable) Trust.
Composition of the Decedent’s Estate. Sometimes it’s the composition of a decedent’s estate that makes it more likely that mistakes will be made. Certain types of assets are more likely to give rise to problems than others. For example, an estate where the decedent died owning a controlling interest in a small business is more likely to give rise to problems than an estate in which the decedent’s only assets consisted of a series of bank accounts.
The Estate Beneficiaries. Sometimes mistakes in estate administration arise or are exacerbated by the types of persons who are beneficiaries. Not all beneficiaries are “equal” in the eyes of their advisors. For example, an estate where all of the beneficiaries get along really well and trust one another is far less likely to cause problems than one where various factions of beneficiaries are “at each other’s throats”.
The Executor(s). Perhaps the biggest prognosticator of difficulties in an estate administration is the person administering the estate, i.e., the “Executor”. Who is that person and what is he/she like? Is the Executor a generally capable person? What is the Executor’s personality like? Is there more than one Executor? If so, then how do the Executors get along? Are any (or perhaps all) of the Executors local or do they live out of town?

The Mistakes: Mistake #1 - Failure to Prepay Inheritance Tax

One of the very simplest mistakes in administering an estate for a person in Pennsylvania is failing to prepay the Inheritance Tax within the first three (3) months. This is an issue that pertains principally to the Executor, but to the extent that financial advisors are involved, they too should also at be at least aware of the issue. For example, the Executor may need to liquidate certain estate assets, including financial assets, in order to make the early payment. If that’s the case, the Executor may need the assistance of their financial advisor in order to make the early payment.

Background – the PA Inheritance Tax. Many states do not have a death tax at the state level. And of the states that do have a state death tax, many have exemption thresholds that make the tax inapplicable to most decedent’s estates. Pennsylvania is one of the relatively few states that has a death tax that is broadly applicable to most decedent’s estates.

Discount for Early Payment. One potential benefit under the Pennsylvania system of taxing decedent’s estate is that if the inheritance tax is paid within the first three (3) months of the decedent’s death, then the estate will get a small (five percent) discount from the inheritance tax.

Example: Decedent dies with $220,000 of assets. The estate administration costs total $20,000, and the Will gives all of the decedent’s assets to his children. The Inheritance tax = 4.5% x ($200,000 - $20,000) = $9,000. The discount = 5% x $9,000 = $450.00.

Strict Adherence to the 3 Month Requirement. If the estate is even a day later than 3 months in paying the inheritance, then the discount is lost altogether.

How the Mistake can occur. Failing to prepay inheritance tax within the 3 month deadline is actually a pretty easy mistake to avoid, but it is, by the same token, a mistake that can easily be made. How? Well, keep in mind that the client often controls the checkbook. So it could happen in a number of ways:

Attorney forgets to mention it to the client
Client was told about it but forgets to make the payment
Client waits until the last second to make the payment
Client issues the check for payment but makes it payable to the wrong payee (The check should be made payable to “Register of Wills, Agent”)
Client sends payment to the wrong place

Is it always a Mistake to Fail to Prepay the Inheritance Tax? No. In some cases, an estate may lack the liquidity to make it possible or practical to pay the tax early. In other cases, clients might just want to keep more money in the estate to cover potential expenses and debts or possibly to allow for an advance of funds to needy beneficiaries.

Does it Always Matter? No. How much the early payment matters will almost invariably depend on the size of the estate. In smaller estates, the savings in actual dollars is going to be less, and so some clients might not care as much about qualifying for the discount. In larger estates, the dollar savings will obviously be greater and therefore qualifying for the discount is likely to have more importance. However, even in smaller and medium-sized estates, clients may view a five percent (5%) discount earned on the early tax payment as an attractive return on investment, particularly in an environment where interest rates are very low.

How to Avoid the Mistake

The best way to avoid missing the early payment is to set up a system in which clients are given detailed written instructions:

Telling the Client whom to make the check payable to
Specifying the suggested payment amount and how that amount was determined
Indicating the deadline for the discount and suggesting an earlier date for payment
Directing the client to give the check to the law firm that will then arrange for payment

Mistake #2 - Improper Investment of Estate Funds

Another type of mistake that is commonly made in connection with estate administration relates to the manner in which the estate funds are invested. This is technically the province of the investment advisor or asset manager. However, financial advisors are not always aware (or perhaps simply forget) that estate funds need to be invested differently than monies held by clients who are still living.

Executor’s Obligation. The Executor’s obligation is to preserve and maintain – and not necessarily to grow – the estate’s assets.

Appropriate Investments. One will often hear that you should not invest in the stock market any money that you will need to use in the next five to ten years. So it stands to reason that estate assets should ordinarily not be invested in the stock market or, for that matter, even in other types of “safer” assets like bonds, which can go down in value. Instead, an Executor’s obligation is to invest the estate assets much more conservatively in other types of assets that do not decrease in value, such as bank accounts, money market accounts, and/or certificates of deposit.

Inappropriate Investments:

Stocks
Bonds
Commodities (Gold and other precious metals)
Real Estate

Reasons why Riskier Investments are Inappropriate:

Length of Investment Horizon. Most estate administrations are concluded much more quickly than 5 years. Therefore, there is insufficient time for the investment to “bounce back” if it happens to drop in value.
Executors’ and Advisors’ Potential Legal Exposure. In addition, Executors and their advisors do not always appreciate that they can be held personally liable for the beneficiaries’ losses if those losses occurred on their watch.

Mistake #3 - Failure to Liquidate the Estate Assets in a Timely Manner

Closely related to the second category of mistake is the failure to liquidate an estate in a timely manner. The point made earlier is that certain assets that living persons hold all the time are nevertheless not appropriate assets to hold in an estate. However, while it might be obvious to some financial advisors that an estate should not be affirmatively investing new funds in risky assets such as most types of investment securities or commodities, what some advisors overlook is the Executor’s obligation to proactively divest such assets even if they were initially acquired when the client was still living. In other words, even though it may have been perfectly prudent and appropriate for the client to hold certain assets during his/her lifetime, once that client is deceased, it may no longer be prudent for an estate to continue to hold on to those assets.

Duty to Liquidate Assets. In many cases, a decedent’s estate may hold multiples classes of assets, including a mixture of stocks, bonds and/or real estate holding. Sometimes an estate may hold other even riskier types of assets such as small business interests, commodities and/or precious metals. In such cases, best practice ordinarily dictates that such assets be liquidated in order to minimize potential loss in asset value and therefore exposure for the Executor.

Exceptions – Is it ever okay for an estate to retain riskier assets? The need to liquidate estate assets will be less acute if the risky assets make up a very small part of the estate, particularly if the beneficiaries all get along well and are in agreement as to how the estate funds should be invested. In that case, it might make sense to document the beneficiaries’ agreement with respect to investment in writing. It is also the case that certain risky assets are more difficult to divest than others. Another exception would be if the risky assets are specifically bequeathed or devised to particular beneficiaries.

“Red Flags” – When to be especially careful:

When beneficiaries do not get along well
When there is poor communication between the Executor and beneficiaries
When the particular assets are especially risky in nature
When the risky assets comprise a significant part of the estate
When the beneficiaries are institutions (e.g., charities, corporate trustees, etc.)

Examples (“war stories” taken from “real life” cases):

Example #1 – Executor’s failure to liquidate stockholdings in an estate with charitable beneficiaries.
Example #2 – Executor’s failure to liquidate/distribute gold bars that the decedent owned at the time of her death.

Mistake #4 - Failure to Safeguard Estate Assets

Although not an issue in most estates, an issue that can be of supreme importance in those estates where it arises is that of securing and/or safeguarding estate assets. This is an issue that can pertain to any number of different assets, including both real estate and personal assets. The issue is probably best understood through examples.

Scenario #1 – Money in the House. By far, the easiest asset in an estate for someone to abscond with is cash. That “someone” could be a beneficiary or it could be a child or other relative of the beneficiary who was not included in the decedent’s Will. One would think that in most cases where clients have money in their homes, they would keep the money in a safe. However, hard as it may be to believe, in some cases clients actually leave cash lying around in their homes. In such cases, it is incumbent on the Executor to secure the home and marshal all of the cash before it mysteriously disappears.

Example – Elderly Client from Deep South. A real life example of this involved an elderly African American woman who had migrated to Erie many years ago from the Deep South. She had lived in Mississippi in the pre-Civil Rights era, and had endured all manner of discrimination from supposedly respectable business persons in neat suits. So she had little, if any, faith in banks or, for that matter, lawyers. This woman had over $20,000 in places spread out throughout her home, including under the mattress, in her Bible and other books.

Scenario #2 – Personal Assets in the Decedent’s Home. Although personal assets in many instances make up a very small part of the value of a decedent’s estate, sometimes that is not the case. Sometimes a decedent will have kept very valuable personal assets. In other instances, a decedent’s personal assets might have modest monetary value, but might be highly prized by the beneficiaries for purely personal reasons. In such instances, safeguarding those personal assets will be important.

Example – Assets left by Multiple Beneficiaries in Decedent’s Home. In another “real life” case, the decedent, an elderly woman, had allowed each of her three (3) children to store some of their own personal assets in her garage. So in the garage were the decedent’s own personal assets, some of her son’s personal assets, and some of each of her two daughters’ personal assets. The assets included things as normal as jewelry and furniture and (allegedly) things as unusual as a grenade launcher. (The decedent’s husband had been a war veteran.) The son and daughters did not get along at all. To compound matters, the decedent provided unequally for the children. (What could possibly go wrong, right?) Following the decedent’s death, the sons and daughters had different opinions as to which assets belonged to whom. To make matters worse, certain of the decedent’s assets were “missing” and each of the beneficiaries alleged that the others took it.

NOTE: Immediately cordoning off the home after the decedent’s death would not have prevented all of the problems in that particular estate. However, it might have at least lessened some of the acrimony and cross-recriminations.

Scenario #3 – Protecting and Insuring the Home. In many estates, the decedent’s home is one of the main assets (if not the main asset). In such cases, the Executor is responsible for safeguarding the home and maintain its value. That may mean:

Securing the Home, so that it’s not vandalized
Maintaining the condition of the Home – i.e., through repairs and maintenance, and normal upkeep
Maintaining Homeowner’s Insurance on the Home
Minimizing liability to third parties (Eliminating any attractive nuisance like an unfenced pool; Pruning overhanging tree branches; and Maintaining liability insurance)
Getting the Home Sold - For fair value and within a reasonable time frame.

Mistake #5 - Failure to Take Steps to Minimize Potential Liabilities to Others

In addition to protecting and maintaining the value of assets that are part of the decedent’s estate, an Executor will also sometimes need to take steps to proactively prevent estate assets from being used in ways that could cause harm to others.

Scenario #1 – the Decedent’s Automobile. An obvious example of an Executor’s need to minimize legal liability to an estate involves the use of a decedent’s automobile. Suppose that the decedent owned an automobile at the time of his/her death, which is now part of the decedent’s estate. That can raise a number of issues related to the use and/or ownership of the automobile:

Who has the right to use the automobile?
If a driver injures or kills someone, who is liable?
If someone drives the automobile before it’s titled over to them, is that driver covered by the auto policy?

Recommended Practice:

Do not let anyone drive the automobile until it has been titled over to them.
Title the auto over to the intended recipient as quickly as possible.

Scenario #2 – Firearms. Another instance in which an Executor needs to be keenly aware of an estate’s liability to outside parties arises where a decedent owned firearms during his/her lifetime. If firearms are part of a decedent’s estate, then there may be a range of different issues that need to be addressed. For example, depending upon the particular type of firearms involved and the person’s relationship to the decedent, a background check may be necessary. But at a bare minimum, the need to be careful in distributing firearms and the need to secure any firearms during the period of the estate administration is fairly obvious.

Mistake #6 - Incorrect Determining a Beneficiary's Share of the Estate

Another commonly made mistake is to incorrectly calculate a beneficiary’s share of the estate. To understand how this is possible, it’s important to distinguish between two (2) different types of beneficiaries – “specific” beneficiaries vs. “residual” beneficiaries.

Specific Beneficiaries. A “specific” beneficiary is entitled to specific assets or to a specific dollar amount from the estate. So, in other words, a specific beneficiary’s share of the estate is easily identified – it’s a specific item or dollar amount. The other important thing to understand about a specific bequest (gift of personal property) or devise (gift of real property) is that it is paid out of the estate ahead of residuary bequests or devises.

Residuary Beneficiaries. Residuary beneficiaries are entitled to a stated percentage of the remaining estate assets (after payment of expenses and after satisfaction of specific bequests and devises). So, by definition, a beneficiary’s share of the estate residue cannot be determined until after all estate expenses and all specifically gifted items and amounts have been provided for.

Satisfaction of a Specific Bequest or Devise. Because a specifically bequeathed item or amount is easily determined, there is typically little harm in paying it out early, provided there are sufficient funds in the estate to provide for the estate’s obligations and expenses. In fact, there are provisions in the Probate Code that encourage Executors to pay such items within a stated time after the estate has been opened.

Satisfaction of a Residuary Bequest. Because a beneficiary’s share of the estate residue is a percentage share of the estate’s net assets, an advance of a beneficiary’s share of the residue is inherently riskier. Typically, an Executor will not know the estate expenses with certainty until the end of the estate administration.

How the Mistake Can Happen

Legal and financial advisors frequently feel pressure (real or imagined) to satisfy clients’ expectations. Clients commonly expect estate administrations to conclude much more quickly than they normally do, and they often want their money sooner rather than later. That encourages advisors to distribute assets early. Sometimes, advisors will distribute assets before all of the estate expenses have been determined and they end up over-distributing to certain beneficiaries. Sometimes, advisors are not even aware of the need to take estate obligations and expenses into account in determining a beneficiary’s residual share.

Example – Advance to Decedent’s Second Wife. One real life example where this occurred involved a doctor who was re-married prior to the time of his death. The decedent (the doctor) had three (3) adult children from his first wife, who predeceased him. The decedent re-married later in life, and was survived by all of his children and by his second wife (who was not the mother of the children). The decedent’s Will provided that the (second) spouse was entitled to roughly one-third (1/3) of the decedent’s estate assets, and that the remaining two-thirds (2/3) of the estate passed in equal shares to the decedent’s three (3) adult children. The financial advisor wanted to appease the decedent’s spouse (and perhaps also retain her as a client), and so very early on in the administration, the advisor advanced roughly one-third of the value in the decedent’s brokerage account to the spouse. In this particular case, the advisor made the advance “in kind” with investment securities. What problems occurred?

Problem #1 – The advisor made the advance based on roughly one-third (1/3) of the total account value. So he never even considered that the spouse’s share of the estate was one-third of the net estate after subtracting expense.
Problem #2 – The advisor’s mistake was compounded by the fact he advanced assets (investment securities) that rise and fall in value. So the increase in the value of the securities (following the distribution to the spouse) made the disparity even greater. Worse still, the spouse sold some of the securities, which made unscrambling the situation that much more difficult.
Problem #3 – the problem was compounded by the fact that the advance was made to a beneficiary (a second spouse) whose interests were at least potentially adverse to that of the other beneficiaries (decedent’s children from a prior marriage).

Mistake #7 - Estate Advances: Too Much, Too Soon?

How the Mistake Can Happen

Problem #1 – The advisor made the advance based on roughly one-third (1/3) of the total account value. So he never even considered that the spouse’s share of the estate was one-third of the net estate after subtracting expense.
Problem #2 – The advisor’s mistake was compounded by the fact he advanced assets (investment securities) that rise and fall in value. So the increase in the value of the securities (following the distribution to the spouse) made the disparity even greater. Worse still, the spouse sold some of the securities, which made unscrambling the situation that much more difficult.
Problem #3 – the problem was compounded by the fact that the advance was made to a beneficiary (a second spouse) whose interests were at least potentially adverse to that of the other beneficiaries (decedent’s children from a prior marriage).

Mistake #7 - Estate Advances: Too Much, Too Soon?

Closely related to the mistake of miscalculating a beneficiary’s share is the mistake of advancing too much money (or other assets) from the estate to a beneficiary. Sometimes the mistake is one of miscalculation (advancing too much), and sometimes it’s one of timing (advancing too soon). Sometimes it’s a little bit (or perhaps a lot) of both.

How it happens. This is a very easy mistake for Executors to make, especially ones that are easygoing or generous by nature. There can be any number of reasons why the Executor might want to advance funds to a beneficiary early in the process, including:

Beneficiaries may be financially strapped
Beneficiaries may have an exigent need for cash for any number of different reasons, including To purchase a home; To pay for a wedding; or To put a child through college
Executor may just want to be generous at or near the Holiday season
An Executor may want to divest certain estate assets (e.g., specifically devised real estate) in order to minimize expenditure of estate funds or potential exposure to the estate.

Why it Matters. The reason it matters is because an Executor is “on the hook” (i.e., personally liable) for any shortfall to the estate’s creditors and beneficiaries. Although it may seem intuitive, not all Executor necessarily understand that if they over-distribute money to a beneficiary, they as Executor are responsible to make up any difference owed to creditors or to other beneficiaries.

Executor’s Obligation to Creditors and Beneficiaries. One of the Executor’s primary responsibilities is to make sure that creditors and beneficiaries of the estate get what is owed to them.

Obligation to Creditors. Debts owed to creditors must be satisfied before any money can be distributed from the estate to beneficiaries. So if a beneficiary receives funds from the estate while an estate creditor is unsatisfied, the distribution to the beneficiary is “at risk” – meaning that the Executor remains responsible for satisfying the obligation, even if the funds to satisfy the obligation have to come out of the Executor’s own pocket.
Obligations to Tax Authorities and Government Agencies. Tax authorities and other government agencies (such as, for example, the PA Department of Human Services) also have a higher claim to estate assets than beneficiaries. So, as is the case with other types of creditors, an Executor is accountable to government creditors if a claim is unpaid due to an excessive advance to a beneficiary.
Obligations to Other Beneficiaries. As previously noted, an Executor is also responsible for making sure that each of the various beneficiaries get the share of the estate that they’re entitled to. As between (or among) beneficiaries, there are different levels of priority. For example, specific legatees have priority over residuary legatees. So, an improper advance could cause an Executor to be liable to Specific Beneficiaries; Pecuniary Beneficiaries; or Other Residuary Beneficiaries.

How Mistakes Can Occur

An advance can turn out to be excessive due to:

Unanticipated Expenses (e.g., hidden creditors);
Unforeseen Liabilities (e.g., an unexpected lawsuit)
Overstated Assets (e.g., decedent’s home sells for less than expected)
Decline in Asset Values (e.g., a stock market decline)

Premature Advances. An Executor can potentially be liable for advances not only because they are excessive in amount, but also because they were made prematurely. Executors do not always understand “time value of money” principles, and so they sometimes fail to appreciate that if they make distributions to some beneficiaries at an earlier point in times than to others, then the early recipients have effectively received more, even if the amounts are nominally the same. If the amounts involved are big enough, the later recipients could conceivably have recourse against the Executor for not having received their share earlier.

In Kind Advances. Sometimes there are very good reasons for making “in kind” advances. For example, the decedent’s home was specifically devised to a particular beneficiary, and the Executor wants to get the home out of the estate, so that the beneficiary will start to use his own funds to pay for expenses related to the home. But if the asset was not specifically given, Executors should generally be careful about advancing them in kind, particularly if it’s early in the estate administration and if an advanced asset suffers a significant decrease in value, then it will be more difficult to cure the overage. The reason is because even the retrieval of the asset (which is by that time worth less) would be insufficient to make up the difference between the beneficiary’s share and what was distributed to him/her.

A Word of Caution about Advances to “Spenders”. Although beneficiaries with financial need are exactly the type of persons whose circumstances cry out for assistance, Executors should be especially careful about advancing money to them, because they are precisely the kind of beneficiaries that may need to expend the money and may therefore not be in a position to pay back the estate if it is later determined that the advance to them was excessive.

Mistake #8 - Selling Assets for Less than Fair Value

In many cases, an Executor may be a family member, and they may therefore not fully appreciate the fact that they are legally obligated to use their best efforts to maximize value received for estate assets. This issue happens recurrently in a couple of fairly common contexts:

Sale of the Decedent’s Home. Probably the most common example involves the sale of the decedent’s home.

Sale to a Family Member. When the decedent’s home is sold to a family member (e.g., one of the Executor’s siblings), an Executor will commonly want to transfer the home to the family member for a price that is less than what the home might sell for on the open market. That is okay, provided that all of the other beneficiaries are also on board with the under-valued transfer. However, sometimes Executors act precipitously and fail to communicate their intended actions to other beneficiaries, either because they do not think to do so or because they see no need to do so. Under such circumstances, an Executor would be well advised to have some objective measure of the property’s value, and to document the beneficiaries’ consent to the under-compensated asset transfer.

Sale to an Unrelated Third Party. If the home is sold to an unrelated third party, then the Executor is going to enjoy a presumption of good faith that will not necessarily apply if the property is sold to a person who is related to the Executor (such as, for example, a child). However, if the difference between the home’s objectively measured value (whether based on an appraisal or a tax assessment) and the price received is significant enough, it will behoove an Executor to keep some documentation of his/her efforts to obtain a higher price.

Sale to the Executor. If the Executor wishes to purchase the home from the estate, the transfer will draw extra scrutiny and will ordinarily require court approval.

Steps to Avoid Trouble

Objectively determine the property’s value
Document the efforts to objectively determine value. Tools include an independent appraisal; use of a Realtor to market the property; keeping record of the length time in between price reductions; documenting other beneficiaries’ agreement to the price reduction
Communication & Transparency with Other Beneficiaries
Document the Other Beneficiaries’ Consent (if their consent can be obtained)

Transfer of the Decedent’s Automobile. Executors will commonly want to transfer a decedent’s automobile to a younger family member (e.g., a sibling or child of a sibling) for less than fair value. In such cases, the automobile should be objectively valued, the decision should be openly discussed with the other beneficiaries, and the other beneficiaries’ consent to the arrangement should be documented. If the automobile is older and not especially valuable, the issue may be less important. If the Executor is also an estate beneficiary and if the auto is transferred to his/her own child without receiving any supporting consideration, then the remedy may be to treat the transfer as an advance against the Executor’s share of the residue.

Mistake #9 - Failure to Elect Portability

Another mistake that Executors frequently make involves the failure to elect to “port” a decedent’s Applicable Exclusion Amount (i.e. federal estate tax exemption) over to his or her spouse. In small estates, the portability election will often be unimportant or possibly even completely unnecessary. But, in medium-sized to larger-sized estates, it can be very important.

What is Portability?

Portability refers to the ability of an Executor to transfer the un-utilized portion of a decedent’s federal estate tax exemption to the decedent’s surviving spouse. So this is a mistake that applies only to married persons.

History. Prior to 2010 (the year in which the portability concept was first enacted), when a decedent died, it was critical that his/her estate have sufficient assets in order to fully utilize his/her federal estate tax exemption. If the federal estate tax exemption was not fully utilized at the death of the first spouse to die, then the un-utilized part of the exemption amount was lost forever. If the decedent’s assets were bequeathed to his/her spouse, that made it much more likely that those assets would be subject to federal estate tax when the decedent’s spouse died. That made it important for estate planners to incorporate testamentary trusts into their married clients’ estate plans and also to try to equalize the estates of married persons in order to utilize each married person’s exemption to the fullest extent possible.

Effect of Portability. Nowadays, in the wake of estate tax portability, if one spouse’s estate is under-funded or over-funded, it generally does not matter as much, because the unused part of the exemption from the first spouse to die can effectively be “ported” (moved over) to the surviving spouse, where it can then be used to shelter the survivor’s assets from federal estate tax when they die.

How the Election is made. The Portability Election is made by filing a federal estate tax return for the first spouse to die.

How the Mistake is Made

If a federal estate tax return is not filed for a decedent’s estate, then generally the election to port the decedent’s exemption will be considered waived. That’s an easy mistake for many practitioners and fiduciaries to make, because often times clients will want to have an estate administered as cost effectively as possible and they very frequently do not appreciate the value of paying for the extra work to prepare and file a federal estate tax return for a decedent whose assets are under the filing threshold. But the problem comes home to roost when the second spouse dies.

Should Portability always be elected? No. Electing portability is a judgment call. There are some estates that are so small that there’s a very small likelihood that federal estate tax will ever have to be paid under any circumstances. In those instances, it probably does not make sense to go through the time and expense of preparing and filing a federal estate tax return.

Why Portability currently has low visibility. Currently, the threshold for filing a federal estate tax return is very high. In year 2019, the federal estate tax “Applicable Exclusion Amount” (i.e., exemption) is $11.4 Million. So very few estates are required to file federal estate returns under current law.

Why Portability is Likely to Matter More in the Future. Although the Applicable Exclusion Amount is very high at present, the desirability of making a portability election may in the future increase for a couple of different reasons:

The current Applicable Exclusion Amount will automatically “sunset” effective January 1, 2026, at which time it will reduce to $5,000,000, indexed for inflation.
Future legislation could (and probably at some point will) reduce the Applicable Exclusion Amount in a much more significant way.

Example. Taxpayer H’s wife, W, dies in 2011 – i.e., when the federal estate tax exemption threshold was $5 Million. At the time of her death, W had approximately $1 Million of assets in her name and H had approximately $7 Million of assets in his name. Because W’s assets were well below the filing threshold ($5 Million), the Executor of W’s estate never filed a federal estate tax return, and thereby waived the right to elect portability. The problem was that H’s estate was significantly larger than W’s estate. H’s estate was estimated at the time to be worth approximately $7 Million. So the concern was that H’s estate may have to pay federal estate tax when H dies. That could have been avoided if W’s Executor would have elected to “port” W’s un-used federal estate tax exemption (approximately $4 Million) over to H. Then H would have a combined exemption of over $9 Million ($5 million plus the $4 Million from W) at the time of his death. That combined estate tax exemption amount ($9 Million) following the portability election would have more than exceeded the value of assets in H’s estate ($7 Million), thus avoiding any estate tax at H’s death.

Mistake #10 - Overlooking a Spouse's Elective Share Rights

Another mistake that is easily made in connection with a decedent’s estate is to overlook the statutory elective share rights of a surviving spouse. If that happens, then the spouse could hold the Executor liable for any monies or other assets that should rightly have been paid to him/her.

Typical Fact Pattern. This type of mistake most often arises in connection with a second marriage. The typical situation involves a decedent who, prior to death, gets re-married to a new spouse who is not a parent of the decedent’s children. (Decedent has children from an earlier marriage and then re-marries a man or woman who is not the father or mother of his or her children.) If the decedent and the new spouse marry later in life, it’s not uncommon for the decedent and the new spouse to provide in each of their respective Wills only for the children from their earlier marriages – in other words, to intentionally omit each other (the spouses) from any dispositive provisions in the Wills. The primary reason for omitting the spouses is typically to protect each of the children’s inheritances; but the spouses might also want to demonstrate to each other that they are marrying for love and not for money. In such circumstances, unless advised otherwise by legal counsel, an Executor might be inclined to follow the literal wording of the Wills, and distribute the estate assets accordingly. However, unless the spouse has affirmatively waived their rights, he/she has a statutory right to a share of a decedent’s estate assets.

Spouse’s Elective Share Rights under Applicable PA Law. Under Pennsylvania law, if a married person domiciled in Pennsylvania dies, then his (or her) surviving spouse has a statutory right to an elective share of one-third (1/3) of the assets included in the decedent’s estate. The elective share right also extends to certain other assets outside the estate, including property over which the decedent had a lifetime right to income or use of the property, property held through a revocable trust, property conveyed within a year of the decedent’s death, etc. [20 Pa.C.S. §2203(a).]

Exceptions to Spouse’s Statutory Elective Share Rights. There are a number of exceptions to a spouse’s elective share rights. Those exceptions include the following:

Property Not Subject to Election. Under the PA statute, certain types of interests are not subject to the spouse’s election, including a decedent’s interest in any broad-based pension, profit-sharing or other company retirement plan; and Life insurance proceeds issued on an insurance policy insuring the decedent’s life. [20 Pa.C.S. §2203(b).]
Waiver of Elective Share Rights. A surviving spouse’s elective share rights can be waived before or after the marriage and before or after the decedent’s death. [20 Pa.C.S. §2207.]

How the Election is made. A surviving spouse’s election to take (or not take) his or her elective share must be made in writing, and it must be signed by the spouse, and filed with the Clerk of the Orphans Court Division of the County where the decedent was domiciled at the time of his/her death. [20 Pa.C.S. §2210(a).]

Time Limit for Making the Election. The election must be filed with the Clerk of Records within six (6) months of the date that the decedent’s Will was probated or the date on which the decedent died (whichever is later). If the spouse fails to file the election within the required time limit, the spouse will be considered to have waived his/her election rights. [20 Pa.C.S. §2210(b).]

Example: H is a retired physician. He has four (4) children from a previous marriage. W has two (2) children of her own from a previous relationship. H and W decide to get married later in life. H is 65 years, and W is 60 years old. H has significantly more assets than W, but each of them are concerned about protecting and preserving assets for their children. Accordingly, each of their Wills provides that all of their assets are to be left to their respective children (spouse gets nothing). After they get married, H suddenly dies shortly after their honeymoon. At the time of his death, H has the following assets: a home valued at $300,000, an investment account valued at $1,200,000, a 401(k) valued at $2,000,000, and a life insurance policy with a $1,000,000 face value. H’s executor is unaware of W’s statutory elective share rights and distributes H’s entire estate to his children. W decides to exercise her elective share rights. What is the executor’s legal exposure? Answer: 1/3 x ($300,000 + $1,200,000) = $500,000.

Mistake #11 - Failure to Properly Provide for the Needs of Disabled Beneficiaries

Another commonly made mistake in administering an estate pertains to the way that disabled beneficiaries are treated (or not treated).

Needs Based Public Benefits. Disabled beneficiaries commonly (though not always) qualify for certain types of public benefits that are “needs-based” – meaning that the beneficiary’s ability to qualify for such public benefits is conditioned on meeting certain financial requirements that show a demonstrated need for the benefits. Typically, there are limits on how much income and/or assets the beneficiary can have and still qualify for such benefits. If a disabled beneficiary receives funds (or other countable assets) from an estate, the beneficiary’s receipt of such funds (or other assets) may disqualify him or her from the needs-based benefits they are receiving.

How the Mistake Can Happen

The “mistake” can occur due to insufficient estate planning or because of missteps in the estate administration.

Mistakes in Planning. In many cases, the mistake occurs in the planning of the decedent’s estate. The advisor fails to discuss the proper methods for providing for the needs of a disabled beneficiary; or perhaps the advisor does not even know about the beneficiary’s disability. Consequently, money is left to the disabled beneficiary, outright and free of trust, when it could have been left to benefit the beneficiary through a (third party) special needs trust or possibly given to another person to apply for the care for the beneficiary.
Mistakes in Administration. However, even if money is mistakenly given to a disabled beneficiary in the decedent’s Will, there are still certain things that can be done to minimize the problem.

Possible Solutions

Possible solutions might include creation and funding of an ABLE Account, or funding a self-settled special needs trust (payback trust or pooled trust).

Pros and Cons. Each of the potential solutions has pros and cons.

ABLE Account – limited to $15,000 annually, N/A if disability arose after age 26
Payback Trust – subject to greater government scrutiny but the entrusted funds could potentially go to non-disabled family members if any balance remains when the disabled individual dies.
Pooled Trust – More flexible and subject to less government scrutiny, but any funds remaining at the disabled beneficiary’s death cannot be passed on to other family members. Any remaining funds stay in the pool for the benefit of other disabled persons.

Mistake #12 – Failure to Pay Creditors in Order of Priority (Insolvent Estates)

Another easily made mistake is to pay creditors out of priority – in other words, to pay off one creditor when there is another estate creditor of higher priority who remains unpaid. That can expose an Executor to liability to the higher priority creditor for the unpaid amount.

How the Problem Typically Arises

The problem typically arises when an estate is insolvent because in such cases, there is, by definition, not enough money to “go around”, i.e., pay all creditors what they are owed in full.

Executor’s Responsibility to Sort out Priorities. An Executor’s responsibilities include making sure that everyone gets paid out of the estate assets in the proper order of priority. To properly fulfill that obligation, an Executor needs to understand that:

Creditors always have priority over beneficiaries
Certain creditors have priority over other creditors – e.g., secured creditors generally have priority over unsecured creditors
Certain beneficiaries have priority over other beneficiaries – e.g., specific beneficiaries come before residuary beneficiaries

Creditors’ Claims – Statutory Order of Priorities. When an estate is insolvent, there is a statutorily mandated order in which creditors’ claims must be paid by an Executor. The statute provides the following “pecking order” for creditors’ claims:

Costs of Administration (attorney fees, court costs, filing fees, etc.)
Family Exemption Amount ($3,500) – available to certain family members living in the home at the time of the decedent’s death
Costs of Funeral and Burial, Medical Services provided within six (6) months of death, and Services performed by Employees within six (6) months of death
Costs of a Grave marker
Rent owed for occupancy in the decedent’s residence for six (6) months immediately prior to the decedent’s death
Claims by the Commonwealth
All Other Claims. [20 PA.C.S. §3392)

The “Classic” Executor Mistake (Early Payment of the Funeral Bill). When a person dies, the decedent’s family typically wants to make sure that the funeral services are paid in timely fashion. Often, it’s the bill that the family is most concerned about satisfying. If the estate has sufficient funds to pay all of the creditors and service providers, then there is normally no harm in paying the funeral bill as soon as it comes. However, if the estate is (or may be) insolvent, then an Executor needs to be especially careful about paying any creditors – including the funeral home – out of sequence. The reason is because if a higher priority creditor is not paid because the Executor already used the remaining estate funds to pay a lower priority creditor, then the Executor could be on the hook to make up the difference to the higher priority creditor.

NOTE: That is one of the reasons that the funeral homes are often quick to encourage clients to pay the funeral bill by assigning insurance policy proceeds.

Example: D (decedent) dies with following assets: a home worth $100,000, a bank account with a $3,000 balance, stocks held through an investment account worth $12,000, and an IRA worth $20,000. D has the following debts and expenses: D’s home has an $85,000 mortgage. The realtor’s commission and other costs to sell the home total $15,000. The attorney fee and other estate settlement costs total $10,000. D owes $12,000 to the nursing home for the last month’s boarding and medical costs. The cost of the funeral bill was $12,000. Finally, D has an unpaid credit card balance totaling $15,000.

Question: Based on the above, who should get paid what?

Answer: The IRA passes outside D’s estate and therefore is not subject to the claims of D’s creditors at all. D’s other (probate) assets total $115,000 ($100,000 home + $3,000 bank account + $12,000 stocks). That amount to be divided among D’s creditors in order of priority, based on the PA statute cited earlier. The $115,000 should be paid to the creditors as follows:

Mortgage (Tier 1 Creditor) – paid in full - $85,000
Closing Costs (Tier 1) – paid in full - $15,000
Estate Admin Costs (Tier 1) – paid in full - $10,000
Nursing Home (Tier 3) – paid 50% - $2,500
Funeral Home (Tier 3) – paid 50% - $2,500
Credit Card Debt (Tier 7) – get paid nothing

Mistake #13 – Failure to Take Advantage of Tax Elections

Another common mistake on the part of Executors involves tax elections related to the estate administration. Many Executors overlook (or simply fail to take advantage of) tax elections that can be beneficial to the estate. Some elections are very basic, “standard issue” items that are just part of good legal practice. Others are more sophisticated.

Tax Election #1 - Election to Waive Deduction for Administration Expenses on the Federal Estate Tax Return

Estate administration expenses, including attorney fees, executor fees, realtors’ commissions, and other costs, may be deducted (1) against the estate’s taxable income for income tax purposes, OR (2) in calculating the estate’s taxable estate for estate tax purposes. But they cannot be deducted for both income tax and estate tax purposes [IRC §642(g)]. The Treasury Department has provided, by regulation, that estate administration expenses cannot be deducted for income tax purposes unless the Executor affirmatively elects not to deduct such expenses on the federal estate return. [Treas. Reg. §1.642(g)-1.]

Manner of Making Election. To make the election, the Executor should file in duplicate a statement (1) that the amount involved has not already been deducted for federal estate tax purposes, and (2) that the Executor waives any right to claim the listed administration expenses as an estate tax deduction in the future. That election statement is typically an attachment to the fiduciary income tax return filed for the year in which the amount is deducted for income tax purposes. [Treas. Reg. §1.642(g)-1.]

Time Limit for Making Election. The election can be filed at any time before the statute of limitation expires for the year in which the expenses are claimed. Treas. Reg. §1.642(g)-1.]

Importance of Election. This election is very simple but important because it arises frequently. It would typically apply any time an estate is under the federal estate tax filing threshold (currently $11,400,000) but has sufficient income to require an income tax filing ($600). In such a case, the administration expenses serve no federal estate tax benefit, because there is no need to even file an estate tax return. So the election to waive the expenses for estate tax purposes in such circumstances typically makes sense in terms of minimizing the estate’s tax obligations.

When Not to Make the Election. If an estate is large enough that a federal estate tax return is required to be filed, then it may very well make more sense to deduct the administration costs on the estate tax return rather than the fiduciary return. So in that circumstance, it may not make sense to elect to waive the expense for estate tax purposes.

Tax Election #2 - Election to Declare Fiscal Year

Unlike a trust, an estate is not required to report on a calendar tax year. An estate Executor has the right to elect whether to report for income tax on either a calendar or fiscal year. So an Executor can select whatever tax year end for the estate it wants in the first year. However, once the tax year end is selected, the estate must then stick with that chosen year end. However, many Executors may not even know of the need to report estate income for tax purposes, let alone be aware of what year to select. In such cases, the estate will probably get a less than optimal tax result.

Example. Decedent dies on July 1, 19x1. The decedent’s estate has $15,000 of taxable income from capital realized on the sale of stock owned by the decedent. The capital gain income was realized on August 1, 19x1. The attorney fee for assisting with the estate administration is not paid until the estate administration is concluded in the following year on June 1, 19x2. If the estate reports on a calendar year, then the deduction for the attorney fee will fall in a different tax year then the capital gain, and so it cannot be used to offset the capital gain income. If the estate reports for tax purposes on a fiscal year ending on June 30, 19x2, then the attorney fee and the capital gain income will fall in the same tax year, and the deduction for the attorney fee can be used to offset the capital gain income.

Tax Election #3 - Election to Treat Revocable Trust as Part of Estate

Another tax election that is often overlooked is the election to treat a revocable trust as part of the estate for income tax purposes. This election can be beneficial for tax purposes in that it can reduce the number of required tax filings and it can in some cases also get a better tax result.

How the Election is made. The election to treat a revocable trust as part of the estate for federal income tax reporting purposes is made by filing an IRS Form 8855. Both the Executor and the Trustee of the revocable trust must sign the Form 8855 indicating their consent to the election. Typically, the Form 8855 is included as part of the initial income tax filing for the estate (i.e., IRS Form 1041).

Effect of Making the Election. If the election is made, then the revocable trust’s existence is in effect disregarded and all of its activity is reported on the income tax return filed for the estate.

If the Election is Not Made. If the election is not made, then the revocable trust is a separate tax reporting entity following the settlor’s death. (This is so because the trust becomes irrevocable when the settlor dies.) That would typically necessitate separate tax filings for the estate and the trust. In addition, the separate tax reporting by the estate and the trust could potentially cause a mismatching of income and expenses that gives a less than desirable tax result.

Example. Settlor “S” creates a revocable trust. S funds the revocable trust with his investment assets but not with his rental properties. The investment account produces approximately $40,000 of income per year. The rental properties produce net rental income of $10,000. The rental properties consist of numerous low income units, a number of which are vacant or otherwise unprofitable. Following S’s death, there are many legal issues related to the condition and operation of the rental units. As a result, S’s estate generates a sizable legal bill of $50,000.

If the election is not made, then the attorney fee ($50,000) can be used to offset the rental income in the estate but not the $40,000 of investment income generated in the trust.

If the election is made, then the attorney fee ($50,000) can be used to offset both the rental income ($10,000) earned by the estate and the investment income ($40,000) earned by the trust.

Author: Jeffery D. Scibetta

Originally published in October 2019