The Writer’s Estate
Awareness of estate planning issues can be especially important to writers because of the unique nature of property rights in written works. Proper planning ensures that the ownership of a writer’s works after his or her death will end up in safe and knowledgeable hands. In addition, some writers may wish to limit certain rights within the copyright, such as the right to publication, completion, or display. A writer may wish to deal very specifically with the disposition of various intangibles such as copyrights, trademarks, patents, trade secrets, and even passwords and social media accounts, websites, and email accounts or issues. A carefully drafted estate plan affords the opportunity to direct distribution of these rights and control how the works are used. For example, a writer who wants to donate certain manuscripts to a library or university, but only if certain conditions are adhered to, can specify these conditions in the legal documents that constitute his or her estate plan.
In addition to giving the writer significant posthumous control over his or her works, an estate plan can greatly reduce the overall amount of estate tax paid at death. Because valuations of written works for estate tax purposes are not precise, estate taxes may turn out to be significantly higher than might have been anticipated. Thus, it is very important for writers to reduce their taxable estate as much as possible.
An estate plan may be either will-based or trust-based. Each type has advantages, but both are legitimate forms of estate planning. Estate laws and probate procedures vary throughout the United States, and a plan that works well for one person in one state may be inappropriate in other situations. Proper estate planning requires a knowledgeable lawyer and sometimes the assistance of other professionals, such as life insurance agents, accountants, and bank trust officers, depending on the nature and size of the estate.
A will is a legal instrument by which a person directs the distribution of property in his or her estate upon death. The maker of the will is called the testator. Gifts given by a will are referred to as bequests or devises generally based on which state you live in. Certain formalities are required by state law to create a valid will. Most states require that the instrument be in writing and signed by the testator in the presence of two or more witnesses. In these states, the witnesses affirm by their signatures that the testator declared the will to be genuine and signed it in their presence. Some of these and other states permit unwitnessed wills, known as holographic wills, if they are entirely handwritten and signed by the testator.
When carefully prepared, wills not only address how the assets of the estate will be distributed, but also foster better management of the assets. Those persons responsible for administering the estate of a decedent are known as executors in some states and personal representatives in others. It may be a good idea for writers to appoint joint executors so that one has publishing or writing experience and the other has financial expertise. In this way, the financial decisions can have the benefit of at least two perspectives. If joint executors are used, it will be necessary to make some provision in the will for resolving any deadlock between the two. For example, a neutral third party might be appointed as an arbitrator who is directed to resolve any impasses after hearing both sides. It is also advisable to define the scope of the executor’s power by detailed instructions. A lawyer’s help will be necessary to set forth all of these important considerations in legally enforceable, unambiguous terms.
It is essential to avoid careless language that might be subject to attack by survivors unhappy with the will’s provisions. A lawyer’s help is also crucial to avoid making bequests that are not legally enforceable because they are contrary to public policy.
IN PLAIN ENGLISH
A will is a unique document in two respects. First, if properly drafted, it is ambulatory, meaning it can accommodate change, such as applying to property acquired after the will is made. Second, it is revocable, meaning it can be changed or canceled before death.
A will is revocable, meaning that the testator has the power to change or cancel it before death. Even if a testator makes a legally enforceable agreement not to revoke the will, he or she will still have the power to revoke it, although liability for breach of contract could result. Generally, courts do not consider a will to have been revoked unless it can be clearly shown that the testator either
• performed a physical act of revocation, such as burning or tearing up a will, with the intent to revoke it or
• executed a valid superseding will that revokes the earlier one.
Most state statutes also provide for automatic revocation of a will in whole or in part if the testator subsequently divorces.
To change a will, the testator may execute a supplement, known as a codicil, which has the same formal requirements as those for creating a will. To the extent that the codicil contradicts the will, those contradicted parts of the will are revoked. A testator may also execute a completely new will that takes the place of the old one.
Distributions
Before the property in a will can be distributed, all outstanding debts and taxes must be paid. When the property owned by the testator at death is insufficient to satisfy all the bequests in the will after all debts and taxes have been paid, some or all of the bequests must be reduced or even eliminated entirely. The process of reducing or eliminating bequests is known as abatement. The priorities for reduction are set according to the category of each bequest.
The legally significant categories of gifts are generally as follows:
• specific bequests or devises, meaning gifts of a particular kind or uniquely identifiable items (I give to X all the furniture in my home);
• demonstrative bequests or devises, meaning gifts that are to be paid out of a specified source, unless that source contains insufficient funds, in which case the gifts will be paid out of the general assets (I give to Y $1,000 to be paid from my shares of stock in ABC Corporation);
• general bequests, meaning gifts payable out of the general assets of an estate (I give Z $1,000); and
• residuary bequests or devises, meaning gifts of whatever is left in the estate after all other gifts and expenses are satisfied (I give the rest, residue, and remainder of my estate to Z).
Intestate property, or property not disposed of by the will, is usually the first to be taken to satisfy claims against the estate. (If the will contains a valid residuary clause, there will be no such property.) If this property is not sufficient, residuary bequests will be used. If more money is needed, general bequests will be used, and lastly, specific and demonstrative bequests will be taken together in proportion to their value.
If the testator acquires more property in the time between the execution of the will and death, the disposition of such property will also be governed by the will. If the will contains a valid residuary clause, the property will go to the residuary beneficiaries of the will. If there is no such clause, the property will pass outside the will to the persons specified in the state’s law of intestate succession.
Intestate Distributions
When a person dies without leaving a valid will, this is known as dying intestate. When a person dies intestate, his or her property is distributed according to the state law of intestate succession, which specifies who is entitled to what parts of the estate. These rules vary from state to state. An intestate’s surviving spouse will always receive a share, generally at least one-third of the estate, most often more. An intestate’s surviving children likewise may get a share, in some states depending on whether the children were children of the surviving spouse or a former spouse. If some of the children do not survive the intestate, the grandchildren of the intestate may be entitled to a share by representation. Representation allows surviving children to stand in the shoes of a deceased parent in order to inherit from a grandparent who dies intestate.
If there are no direct descendants surviving, the intestate’s surviving spouse may take the entire estate or may share it with the intestate’s parents. If there is neither a surviving spouse nor any surviving direct descendants of the intestate, the estate may be distributed to the intestate’s parents, or if the parents are not surviving, to the intestate’s brothers and sisters. If there are no surviving persons in any of these categories, the estate may go to surviving grandparents and their direct descendants. In this way, the family tree is constantly expanded in search of surviving relatives. If none of the persons specified in the law of intestate succession survive the decedent, the intestate’s property ultimately goes to the state. This is known as escheat.
Distributions to a Spouse Left out of the Will
State law will often provide a testator’s surviving spouse with certain benefits from the estate even if the spouse is left out of the testator’s will. Historically, these benefits were known as dower, in the case of a surviving wife, or curtesy, in the case of a surviving husband. In place of the old dower and curtesy, modern statutes give the surviving spouse the right to elect against the will and receive a certain share, such as one-fourth of the estate. This is generally called the spouse’s elective share.
Here again, state laws vary. For example, in some states, the surviving spouse’s elective share is one-third. The historical concepts of dower and curtesy are, in large part, a result of the law’s traditional recognition of an absolute duty on the part of a husband to provide for his wife. Modern laws are based on the notion that most property in a marriage should be shared because the financial success of either partner is due to the efforts of both.
DISTRIBUTING PROPERTY OUTSIDE THE WILL
Another aspect of estate planning is distributing property outside the will. This can be done by making gifts to individuals (known as inter vivos gifts) or by placing the property in trust prior to death. Thought should also be given to other methods of transferring property before or after death such as joint bank accounts which go to the survivor on the death of one of the account owners, or POD (payable on death) or TOD (transfer on death) designations that may be permitted for bank accounts or investment accounts, or through beneficiary elections available for things like retirement accounts. Married people should hold title to real property as tenants by the entirety, so that the property passes to the surviving spouse on death without the necessity for probate. Some states, by statute, now allow a TOD deed for real estate. Title to vehicles may be held by “x or y,” instead of by either individually, or by “x and y,” so that the surviving party may hold or dispose of the property without the need for probate or the signature of the other party. Be cognizant of the fact, however, that in having joint bank accounts during the life of both parties, or owning vehicles by two parties, while they both live, the “or” designation makes either party able to spend, sell, or otherwise deal with the property without the consent of the other party while both are alive.
The main advantage to distributing property outside of the will is that the property escapes the delays and expense of probate, the court procedure by which a will is validated and administered.
Gifts
In order to qualify as an inter vivos gift for tax purposes, a gift must be complete and final. Control is an important issue. For example, if a writer retains the right to revoke a gift, the gift may be found to be testamentary (occurring on death) in nature, even if the right to revoke was never exercised. The gift must also be delivered. An actual, physical delivery is best, but a symbolic delivery may suffice if there is strong evidence of intent to make an irrevocable gift. An example of symbolic delivery is when the donor puts something in a safe and gives the intended recipient the only key.
There used to be significant tax advantages to making inter vivos gifts, rather than gifts by will, but since the estate and gift tax rates are now unified, few tax advantages remain. One remaining advantage to making an inter vivos gift is that if the gift appreciates in value between the time the gift is made and the death of the giver, the appreciated value will not be taxed. If the gift were made by will, the added value would be taxable, since the gift would be valued as of the date of death (or six months after). This value difference can represent significant tax savings for writers who have recently realized fame and whose works are rapidly gaining in value.
The other advantage to making an inter vivos gift is the yearly exclusion from gift taxes. The general rule is that any gift is taxable, but fortunately, there are many exclusions from the general rule. The major exceptions are tuition or medical expenses paid for someone else, and gifts to a spouse, political organization, or charity. There is also an annual exclusion amount that applies on a per recipient basis. In 2016, the yearly exclusion was $14,000 per recipient. For example, if $18,000 worth of gifts were given to an individual in 2016, only $4,000 worth of gifts would actually have been taxable to the donor (who is responsible for the gift tax). Married couples can combine their gifts and claim twice the yearly exclusion per recipient.
Gift Tax Returns
Gift tax returns must be filed by the donor for any year in which gifts made to any one donee exceed the exclusion amount. It is not mandatory to file returns when a gift to any one donee amounts to less than the exclusion amount. However, if the valuation of the gift may become an issue with the IRS, then it is a good idea to file a return anyway. Filing the return starts the three-year statute of limitations running. Once the statute of limitations period has expired, the IRS will be barred from filing suit for unpaid taxes or tax deficiencies due to higher government valuations of the gifts. If a taxpayer omits gifts which should have been included on the return amounting to more than 25 percent of the total amount of gifts stated in the return, the statute of limitations is extended to six years. There is no statute of limitations for fraudulent returns filed with the intent to evade tax.
Trusts
Another common way to transfer property outside the will is to place the property in a trust that is created prior to death. A trust is simply a legal arrangement by which one person holds certain property for the benefit of another. The person holding the property is the trustee; those who benefit are the beneficiaries.
To create a valid trust, the writer must identify the trust property, make a declaration of intent to create the trust, transfer property to the trust (this is often a step that is missed and can create a multitude of problems), and name identifiable beneficiaries. Failure to name a trustee will not defeat the trust, since if no trustee is named, a court will appoint one.
The writer may name himself or herself as trustee, in which case segregation of the trust property satisfies the delivery requirement. Trusts can be created by will, in which case they are termed testamentary trusts, but these trust properties will be probated along with the rest of the will. To avoid probate, the writer must create a valid inter vivos or living trust.
Generally, in order to qualify as an inter vivos trust, a valid interest in property must be transferred before the death of the creator of the trust, who is known as the settlor. For example, if the settlor fails to name a beneficiary for the trust property or make delivery of the property to the trustee before death, the trust will likely be termed testamentary. So designated, the trust will be deemed invalid, unless the formalities required for creating a will were complied with.
A trust will not be termed testamentary simply because the settlor retained significant control over the trust, such as the power to revoke or modify the trust. For example, if a person makes a deposit in a savings account in his or her own name as trustee for another, but reserves the power to withdraw the money or revoke the trust, the beneficiary will still be able to enforce the trust provisions and claim the money in the account upon the death of the depositor (provided that the depositor has not revoked the trust). Many states allow the same type of arrangement in authorizing joint bank accounts with rights of survivorship as valid will substitutes. Property transferred under one of these arrangements is passed outside the will and need not go through probate.
However, even though such an arrangement escapes probate, since the settlor retains significant control, the trust property will likely be counted as part of the gross estate for tax purposes. In addition, if the deceased settlor created a revocable trust for the purpose of decreasing the statutory share of a surviving spouse, the trust will be declared illusory in some states. The surviving spouse is then granted the legal share not only from the probate estate but from the revocable trust.
Advantages of Using a Trust
The use of trusts to prepare a trust-based plan will, in certain situations, have significant advantages over a traditional will-based plan. For example, the careful drafting of trusts can allow the writer’s estate to avoid probate, which in some states is a lengthy and expensive process. Similarly, the execution of an estate through a trust-based plan can ensure a level of privacy not possible in probate court. Although these kinds of provisions provide some control over the estate, writers are cautioned that trusts cannot adequately substitute for a will if used haphazardly. Professional assistance is strongly recommended, and it is important not to miss the step of legally transferring the property to be included in the trust to the trust.
Life Insurance Trusts
Life insurance trusts can also be used for paying estate taxes. The proceeds of a life insurance trust will not be taxed if the life insurance trust is irrevocable and the trustee is someone other than the estate executor. Even when the trust is irrevocable and the trustee is a third party, the proceeds are taxed to the extent they are used to pay taxes to benefit the estate. The advantage to this arrangement, then, is not so much tax avoidance as guaranteed liquidity. This advantage is especially important for writers and other creative people, since otherwise survivors can be forced to sell remaining works for much less than their real value in order to pay estate taxes.
The Economic Growth and Tax Relief Reconciliation Act of 2001 significantly revised the law regarding federal estate and gift taxes. It imposes a schedule in which the amount of estates excluded from paying taxes is set at $5.49 million for 2017. The changes in the tax laws are complicated and have only enhanced the need for competent counsel in such matters. A number of states also have inheritance or estate taxes.
While the increase in the exclusion amounts will reduce the concerns about estate taxes for many writers, it is still useful to understand how estate taxes are assessed and the relationship between estate and gift taxes. It is also important to understand how issues, such as valuation of assets, can lead to higher-than-necessary tax burdens.
The Gross Estate
The first step in evaluating an estate for tax purposes is to determine the gross estate. The gross estate includes all property in which the deceased had an ownership interest at the time of death and before the will is administered. The key element in determining ownership is control. Thus, the gross estate will include all property over which the deceased retained significant control at the time of death. Examples would include life insurance proceeds, annuities, jointly held interests, and revocable transfers.
Under current tax laws, the executor of an estate may elect to value the property in the estate either as of the date of death or the date six months after death. The estate property must be valued in its entirety at the time chosen. If the executor elects to value the estate six months after death and certain pieces of property are distributed or sold before then, that property will be valued as of the actual date of distribution or sale.
Fair market value is defined as the price at which property would change hands between a willing buyer and a willing seller, when both buyer and seller have reasonable knowledge of all relevant facts. Such a determination is often very difficult to make, especially when writings are involved.
Disagreements with the IRS on Value
Although the initial determination of fair market value is generally made by the executor when the estate tax return is filed, the Internal Revenue Service (IRS) may disagree with the executor’s valuation and assign assets a much higher fair market value. For example, in 1979, the IRS claimed that writer Jacqueline Susann’s diary had an estate tax value of $3.8 million as a literary property. The diary, which neither Susann nor her executor had considered particularly valuable, had been destroyed by the executor pursuant to Susann’s directions.
When the IRS and the executor (or whoever represents the estate) disagree on a valuation, the matter will be litigated. The majority of these cases are settled out of court. Thus, there is very little case law dealing with the valuation of artistic or literary properties for estate tax purposes. The Estate of David Smith case is most often cited as an example of this type of valuation. While the decedent in this case was a sculptor and the controversy was over valuation of his creations, the same types of problems would arise in the attempt to value manuscripts in a writer’s estate.
When David Smith died, there were 425 works in his estate. The market for his sculptures was limited, since most pieces were large and abstract, but prior to Smith’s death, each of the 425 pieces had been photographed and marked with an estimated sales price. When the executors of the estate figured fair market value of the pieces, they first reduced the figure representing the sum of all the estimated prices ($4,284,000) by 75 percent to account for the devaluing effect that the sudden availability of so many sculptures had on the limited market. They then reduced that figure by one-third to account for the gallery’s commission, as set out in the agency contract between the deceased and the gallery that had the exclusive right to sell his work. Thus, the executors’ final figure representing fair market value on the tax return was $714,000. The IRS determined fair market value for the sculptures by simply adding up the one-at-a-time prices in Smith’s gallery contract, claiming that the simultaneous availability factor would have no adverse impact on the market value. The IRS, thus, set the total valuation at the $4,284,000 figure, and sued the estate for the tax deficiency.
When the case went to court, the court allowed a 50 percent reduction for sudden availability, but refused to deduct the gallery’s commission, holding that the measure of value is the amount received—not retained from a sale. Thus, the court’s final figure was $2,700,000—a compromise between the executors’ listed value of $714,000 and the IRS figure of over $4 million. Notwithstanding the reduction, the estate tax was devastating for the estate.
Mauldin v. Commissioner is another case in which the IRS claimed a tax deficiency based on disagreement over the value of artistic assets. At question was a series of cartoons and an original manuscript and sketches donated to the Smithsonian. Mauldin used experts provided by the Smithsonian to arrive at this valuation of the works. The interesting part of this case is that the court ruled that when one government agency (the Smithsonian) makes an appraisal in order to induce a charitable donation, another government agency (the IRS) should not challenge or disregard the appraisal after the contribution has been made.
In addition to valuing actual drawings or manuscripts, the executor of a writer’s estate will need to make some effort to value copyrights and other intangible assets owned by the decedent. There is no hard-and-fast rule for valuing copyrights. The method most widely used is the sinking fund method, which uses a formula known as Hoskins formula. Hoskins’s formula basically involves determining the present value of future earnings from the copyrighted material. Needless to say, there may be much disagreement about this figure.
As mentioned earlier, when an executor and the IRS disagree as to valuation, the court will decide the matter. In most cases, the burden will be on the taxpayer to prove the value of the copyright. Thus, expert testimony and evidence of the sale of the same or similar properties will be helpful, as in cases involving original manuscripts and drawings. In general, courts are reluctant to accept valuation by formula as determinative.
It is extremely difficult to determine a fair market value for a manuscript or the literary rights connected to a manuscript. The cases demonstrate that there is no guarantee court evaluations will necessarily be fair. Even a compromise approach by the court can result in artificially high valuations, which inflate a writer’s gross estate and can lead to higher taxes. An estate may therefore face real hardship in paying administration and tax costs when estate assets are not easily convertible to cash.
The Net Estate
The next major step in figuring the taxable estate is to evaluate the net estate. Typical deductions from the gross estate include funeral expenses, certain estate administration expenses, debts and enforceable claims against the estate, mortgages and liens, and—perhaps most significant—the marital deduction and the charitable deduction.
The marital deduction allows the total value of any interest in property that passes from the decedent to the surviving spouse to be subtracted from the value of the gross estate. The government will eventually collect the tax on this property when that spouse dies, but only to the extent such interest is included in the spouse’s gross estate. This deduction may occur even in the absence of a will making a gift to the surviving spouse, since state law generally provides that the spouse is entitled to at least one-third of the overall estate, regardless of the provisions of the will.
The charitable deduction is the tax deduction allowed when property is transferred from an estate to a recognized charity. The charitable deduction is especially significant to the writer. Although the income tax benefits from donating copyrights and manuscripts are negligible, the estate tax benefits may be substantial. In effect, the fair market value of donated works is excluded from the taxable estate. Although leaving the work in the estate will pass some value to those inheriting at a high rate of taxation, that value will be considerably less than the tax-free value of the work donated to a charitable institution. Since the definition of charity for tax purposes is quite technical, it is advisable to insert a clause in the will providing that, if the institution specified to receive the donation does not qualify for the charitable deduction, the bequest will go to a substitute qualified institution at the choice of the executor.
Once deductions are figured, the taxable estate is taxed at the rate specified by the Unified Estate and Gift Tax Schedule. The unified tax imposes the same rate of tax on gifts made by will as on gifts made during life. It is a progressive tax, meaning the percentage paid in taxes increases with the amount of property involved. Whether the estate tax will eventually be repealed altogether, be fixed at an intermediate amount, or revert to a former form will depend on future congressional action.
Paying Estate Taxes
Generally, estate taxes must be paid when the estate tax return is filed within nine months of the date of death, although arrangements may be made to spread payments out over a number of years, if necessary. It is not uncommon for executors to be forced to sell properties for less than full value in order to pay taxes. This situation can be avoided by writers obtaining insurance policies, the proceeds of which can be payable into a trust.
PROFESSIONAL ESTATE PLANNING
All writers should give some thought to estate planning and make the effort to address these issues adequately. Without a soundly prepared plan, there is simply no way to control the disposition of property. Posthumous control is especially important in the case of manuscripts, copyrights and so forth, and their attendant legal rights.
Sound estate planning may include transfers outside of the will, since these types of arrangements escape the delays and expenses of probate. It makes more sense to consult with an experienced professional to develop a comprehensive plan than to rely on form documents. The generally modest added expense associated with professional estate planning will most likely be recouped when the plan is finally executed.