Litigation Issues Involving Children in Estate Planning

“Litigation Issues Involving Children in Estate Planning.” That’s the subject of today’s ACTEC Trust and Estate Talk.

Transcript/Show Notes

This is Susan Snyder, ACTEC Fellow from Chicago. Most clients who engage in planning want to benefit future generations. Members of those future generations are frequently minors and young adults, which always creates unique circumstances but more so when the governing trust or estate is embroiled in litigation. To learn more about this topic, you will be hearing today from ACTEC Fellows Ray Koenig of Chicago and Bob Sacks of Los Angeles. Welcome Bob and Ray.

Thank you. This is Bob Sacks. There are numerous issues that come up when minors are involved in trust and estate litigation. One of the most significant issues for lawyers is how do we insure that minor children are bound by the outcome of the dispute and, particularly if there’s a settlement that other parties are coming up with. One approach is the doctrine of virtual representation, and under the doctrine of virtual representation, courts permit parents or others to step into the shoes for their children because their interests are aligned and, because they are aligned, there is no conflict between the parent and the child. In that situation, the parent can then act on behalf of the child, because their actions are helping both the parent and the child in the court’s view. Another approach, which comes up probably more frequently and addresses the possible conflict between the parent and the child, is having a guardian ad litem appointed to act on behalf of the one or more minors in the litigation. Guardians ad litem fulfill a really unique role because, at least under California law, they are termed as “not really a lawyer and not really a party.” They act on behalf of the ward, but they are not essentially the party in litigation as such. At the same time, they aren’t really acting as a lawyer; they are in an interesting role representing the ward in a combination of a lawyer/party relationship. Lawyers are often appointed to serve as guardians ad litem, so for the lawyers in the audience who might consider this, you should look into your state law, because guardians ad litem are often considered quasi judicial officers. Because of that, they can enjoy a quasi judicial immunity against possible claims by a ward. Also, under California law, because a guardian ad litem is not the lawyer for the ward, they are not subject to legal malpractice claims. So, guardians ad litem perform unique role in litigation in terms of trying to protect minors; they are very different though from what courts often appoint counsel to represent a party in litigation. Appointed counsel is an advocate for that party, and their job is to assess the party’s views, to try to express those views to the court as an advocate, and the lawyer’s personal views are not an issue. But a guardian ad litem is asked by the court, “What is in the best interests of this ward?” And so, in that role, they are acting very differently from appointed counsel, and it’s important to make sure you understand what your role is and that the court understands what your role is, because even judges don’t always understand this. Sometimes judges will say, “I’m appointing you as ‘best interest counsel’,” which, I think, they’re really looking at a guardian ad litem role, because if you’re supposed to express what the lawyer believes is in the best interest of the client, you’re not advocating for the client. In effect, although you could argue you are, you are expressing your personal views, which is more suited to a guardian ad litem. In terms of the powers of a guardian ad litem, they do have the power to bind their ward into the settlement. Their power is not absolute. For example, they cannot waive a right to a trial if that’s something the ward may have been interested in, but they can make practical decisions such as waiving a right to a jury trial. So, although the power of a guardian ad litem in acting on the ward is not absolute, clearly, as you can tell, they have very, very broad powers to act for their wards and certainly in the context of trust and estate litigation can bind them.

Thanks Bob. This is Ray Koenig speaking now. Let’s move on to a time when, let’s say, a minor’s estate or a trust is created, and the minor’s estate or trust are created for the benefit of the minor, or at least the minor benefits in some way from the trust. A common issue that is experienced by fiduciaries is when the parents of the minor want in some way to live in some way off the minor’s assets, either in the estate or the trust. And the issue becomes for the fiduciary, and of course counsel for the fiduciary, what can you do to help the parent, and how can you distribute money to benefit the parent that there are no laws on it? Of course there are laws on it. So looking at the estate aspect of the estate and not the trust, because trusts are governed differently, and looking at three larger states – Illinois, New York, and California – and under all three of them it’s pretty much the court decides how the money can be spent, so it’s all by court order. The guardian generally cannot make these decisions on their own. They can make recommendations to the court, and the court decides. What does the court have to do? The court has to decide if it’s in the best interests of the ward. But it can be, under Illinois law, and New York and California seeming to be similar, the best interest could be deemed pretty broadly and not just for the direct benefit of the minor, and sometimes it can benefit those around them. And some examples of where that happens and common examples, where there’s an incidental benefit from the minor’s estate for the parent – and those of us that practice in this area know that sometimes really pushed for the benefits of the parents, but some of the common areas would be when the estate purchases a home for a minor. Say the minor has a large estate due to a personal injury settlement, something like that, in the millions and the parents were wage workers – they don’t make much, they don’t have much, and they were living in a small, one bedroom rental. Can the estate spend money to benefit the minor, but also benefits the parents? The answer, it’s much more complicated than saying yes or no, but the answer is usually yes if it’s a benefit to the minor, but it’s also, incidentally, a benefit to the parents, and that’s completely acceptable. Another one is when a family can’t afford a car or can’t afford an appropriate car for the minor when they need a special type of car, like a handicap-accessible one; that’s pretty common. And another pretty common one, though, I will tell you in my experience judges usually grant them while cringing, is paying for a family vacation. If the minor has funds and will benefit from a vacation, why can’t the minor go on vacation? And you have to pay somebody to go with them to take care of them; usually there’s a disability, or they’re a minor. You can usually get at least one parent paid for to go on the trip and depending on the estate, sometimes you can get other family members paid for as well. And it’s a benefit to the minor. All these of course depend on how much money is in the estate, and a lot of it depends on the judge you’re standing in front of and how they feel about these sorts of things.

So, in trusts, it’s very different and obviously under trust law it depends on the trust document itself. You look in the document to see what you as fiduciary can or can’t do, but most good drafters will give a trustee a great deal of discretion to make decisions here, and the trustees will usually, in my experience assets are there, go a little bit further than a court would. The other big difference is in a trust you don’t really need a court order. You never want to see a court when you’re in a trust because you don’t want somebody coming after you as a fiduciary. So, and before we move on to the next topic, I think it’s important to talk a little bit about some things that a fiduciary can do or the attorney for the fiduciary can do when dealing with the parents. Some things you need to do is just manage the expectations of parents; let them know from day one what the standard is and what can or can’t be done, generally. They’re going to want a lot more detail than you can give them because they’re going to want to get hypotheticals or get answers to hypotheticals and you can’t usually give those, at least to the ones they want. Make sure to involve all relevant players in the conversation. Get the parents in the room; talk to them. If the minor’s old enough, get the minor in the room, just have a conversation so everyone’s on the same page. Another one is use the court to your advantage, meaning if you have a disagreement with the parents, and you can go to court, avail yourself to the court. And, as Bob said, you might get a GAL appointed that could help mediate a resolution to this. And finally, as fiduciary, you have a duty to the beneficiary, or you have a duty to the minor or the minor trust beneficiary and remember that and remember compromise is key;  look for ways to compromise with them with getting everybody on board.

Ray has made some very interesting points that can lead to another area for minors who maybe don’t want their parents or guardians living off them. And this certainly comes up in California – not infrequently with child actors in particular. And the process that dovetails with living off of your minor is your minor saying, “I want to be emancipated, so I am now treated, in most ways, legally, like an adult. And Mom and Dad, go live off your own funds.” In California, minors may be emancipated because they are legally married when they are underage, under the age of majority of 18 if they join the US military on active duty, or if they go into court to be emancipated. That involves a petition to the probate court, and, if it’s granted, the minors are treated just like adults in a host of ways in terms in making consent for medical treatment, psychiatric treatment, entering into binding contracts, and certainly in terms of filing lawsuits in their own name or being sued in their own name. This also means that if your client is an emancipated minor, they are bound by any settlement they enter into. So, emancipation is an issue that comes up not too frequently, but certainly in cases where a minor does have a vast, usually storehouse of assets from something, and often wants to often protect their assets from parents or others who would like to live off of them.

Thanks Bob, thanks Ray, for your thoughts on these unique issues dealing with children in litigation.

The income tax changes for businesses that families own provoke many planning discussions. The C Corp tax rate has dropped to 21%, now distributions from a C Corp to the hands of the owners are taxed at approximately 40%. Pass-through income enjoys a 20% deduction for qualified income. These apply to businesses taxed as S-Corps and Partnerships with income being taxed at just over 33% in the hands of the owners. Active family businesses taxed as pass-throughs are looking to see if they would benefit from being a C Corporation to make use of the new 21% rate to invest in and grow the business. For example, a family may own a manufacturing company taxed as an S Corp; the matriarch, the children, the grandchildren, a GST grantor trust may all be the owners. It runs an active business and is looking to grow. Management likes the 21% C Corp tax rate and wants to make use of NOLs [Net Operating Losses] to be generated by future investment. The family enjoys distributions and the grantor trust uses distributions to pay the note to matriarch. Planners will want to balance the company benefits with the needs to distribute property out to owners for cash flow, including the note payments. Looking longer term, how will the decision affect the sale of the business in the future? C Corp status can reduce the ultimate proceed amount passing to the owners, either due to a tax bite, or the buyer may demand a discount due to the C Corp structure.

We’re also looking at who benefits from this new 20% pass-through deduction under Section 199A. Generally, the way the deduction works is this: a taxpayer will calculate his bill, calculate his qualified pass-through income, then deduct 20% of the qualified business income and recalculate the tax amount. But not all pass-through income is qualified, the income must come from an active trade or business. The 20% is also limited to the greater of:  50% of the taxpayer share of W-2 income, or 25% of W-2 income plus 2.5% of the value of depreciable assets in service. It must be an active trade or business. Many businesses are categorized such that they will not qualify. Service businesses, such as legal, accounting, health, consulting, investment services, arts, athletics, and reputation- and skills-based companies, generally see further limitations. Higher earners service businesses won’t see the same benefit from the reduced rates for pass-throughs.

Planning can help taxpayers who may otherwise be dinged by these limitations pick up the benefits. Owners of these disfavored types of businesses are looking at ways that they may be able to divide up the businesses into lines that are qualified and lines that aren’t. Taxpayers are considering reorganizing businesses to house certain assets or employees in new ways to minimize limitations. The pass-through act benefits are only in place through 2025, which is another wrinkle, while the corporate rate is permanent.

To wrap up, clients will find many tax benefits under the new act with reduced estate tax exposure and new income tax reductions. But clients will need to act to get the best benefits. The new act doesn’t cure uncertainty – a major hurdle for our clients and their planning. So many benefits go away January 1, 2026, which makes acting now harder for clients as our clients anticipate living and running their businesses past 2026.

Thank you, Miriam. Thank you, Beth for helping us to understand better the new Tax Act and the opportunities that it presents.

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