Where there is a will does a trust get in the way? A defense of Virginia's Probate System

McGuireWoods LLP

You can hardly pick up the paper or open your mail without seeing an advertisement for a living trust seminar. Writing a will “is one of the biggest mistakes” you can make. After all, a will is a "one-way ticket to probate." A living trust¹, on the other hand, ensures that your estate will transfer quickly and without the expense of probate. Neither the court nor disgruntled relatives can alter your plan. Your family, and not the probate court, will be in charge. With the magical living trust, all expensive court proceedings and delays are eliminated, your privacy is preserved and the emotional stress on your family is minimized.

Given these promises, it is almost embarrassing to let a client leave your office without one. Some may even consider it malpractice not to recommend a living trust.²

Lost in all the hype is the fact that the probate process in Virginia is relatively straightforward and has a number of protections for family members, creditors and fiduciaries that are not available with a living trust. The delays, cost and litigation attributed to the probate system are more often caused by the composition of the estate, the claims made against it and the nature of the beneficiaries, than by the "out-dated" probate system. Advertisements and seminars notwithstanding, not everyone needs, or will benefit from, a living trust.

This article will examine some of the claims made in recent advertisements read and brochures received by the author promoting living trusts, and discuss some of the benefits of the probate process that neither the advertisements nor the brochures acknowledge.

Proper planning is needed to coordinate the unified gift and estate tax credit with the unlimited marital deduction. This planning, not the mere existence of a living trust, results in the estate tax savings. The living trust does not remove the assets from an individual's estate.³ A married couple with an estate of $1.35 million or less, with proper planning, will pay no estate taxes whether a will or a living trust is used to dispose of their assets.

Before the Taxpayer Relief Act of 1997 income tax treatment of a decedent’s estate was generally more favorable than income tax treatment for a trust after the grantor’s death. The 1997 Act largely eliminated these differences. A personal representative may now elect to treat certain qualified revocable trusts as part of the decedent’s estate for federal income tax purposes. However, certain differences remain that could be important in individual cases. For example, a personal representative may continue to hold the decedent’s stock in an S corporation for a "reasonable period of administration.”⁴ A trustee may hold the S corporation stock for only two years before post-death restrictions are imposed.⁵

The only tax avoided, or minimized, in Virginia, by the use of a living trust is the probate tax. The probate tax in Virginia is one-tenth of one percent (.001) and is assessed against any assets held in the decedent's name alone. The probate tax does not apply to assets that pass automatically upon death including assets held jointly with right of survivorship or assets, such as life insurance and retirement plans, for which there is a designated beneficiary. The potential probate tax savings, as a general rule, do not make the case to use a living trust rather than a will.

During the lifetime of the grantor, assets in a revocable trust are treated as owned by the grantor and are subject to his creditors.⁶ Upon death, the right of creditors, other than a surviving spouse or the Internal Revenue Service, to reach trust assets is not clear under Virginia law.⁷

Virginia has several early cases in which wives, unsuccessfully, tried to claim their statutory share against the assets of a revocable trust.⁸ Virginia's augmented estate statute has now eliminated the use of living trusts as a mechanism to avoid claims of the surviving spouse.⁹

Under federal tax law, the trustee can clearly be held liable for estate taxes. The personal representative has primary responsibility for the payment of taxes; however, any person in actual or constructive possession of the decedent’s property is treated as executor if none is appointed.¹⁰

1. 
   Probate protects statutory allowances for the family. Under Virginia law, a trustee has no obligation (or right) to pay the family allowance¹⁴, exempt property ¹⁵or homestead allowance ¹⁶ from the trust assets. In a probate estate, these claims are given priority over claims of the decedent's creditors. To claim the homestead allowance, the spouse or children must forego other benefits under the will or by intestate succession. Benefits from a funded trust apparently may be accepted in addition to the homestead allowance. These allowances currently total $32,000. Whether this is a "good" or "bad" difference between a will and a living trust depends upon your perspective.
   
2. 
   In some states, probate cuts off the claims of creditors. The majority of states bar claims not filed or presented within a set period following some prescribed event, usually the publication of notice to creditors in the local newspaper. For example, in Maryland, except as otherwise provided by statute with respect to claims of Maryland or the United States government, all claims against an estate, on whatever legal basis, are forever barred against the estate, the personal representative and the heirs and legatees, unless presented within six months after the date of the decedent's death; or two months after the personal representative gives the creditor notice that his claim will be barred unless he presents the claim within 2 months from the mailing or other delivery of notice.¹⁷ In contrast, the statute of limitations for making a claim against a trust is three years.
   

The ability to cut off claims of creditors within a relatively short period of time presents a strong argument to use a will rather than a trust in such states.

3. 
   Probate can protect the personal representative from future claims of creditors. Virginia does not require notice to creditors by publication except as part of the debts and demands procedure. The statute of limitations applicable to a particular claim applies even after death.¹⁸ However, the personal representative can protect himself from future claims of creditors by undertaking the debts and demands procedure followed by a Show Cause Hearing and Order of Distribution.¹⁹ If there are no objections at the Show Cause hearing, the court will enter an Order of Distribution directing payment, in whole or in part, with or without a refunding bond, as the Court determines, to “whomsoever the court has adjudged entitled thereto.”²⁰
   

4. 
   Probate protects the personal representative of an insolvent estate. As noted above, the allegation is that a probate court will order "your debts paid and possessions distributed according to state law, which may not be what you would have wanted;" whereas, with a living trust "[d]ebts are paid and possessions distributed to beneficiaries according to your written instructions."
   

5. 
   The living trust may actually create needless disputes over the source of payment for debts and bequests. Many living trusts contain language allowing the payment of taxes, bequests and expenses from the trust, for example: “At my death my Trustee may pay to or upon the order of my Personal Representative funds needed to pay my debts, funeral and burial expenses, costs of administration and specific bequests under my will.”
   

Assets "subject to probate" do not include jointly held accounts, accounts for which a beneficiary, other than the estate, is named, and real estate outside Virginia. Quite often, the bulk of an individual's assets is held in this form and is already “avoiding” probate.

1. 
   The cost of probate. Brochures promoting living trusts usually estimate the cost of probate at 3-10 percent of the estate's gross value, before debts are paid. This estimate is said to cover court costs, and legal and executor fees, which, by implication, are avoided by using a trust.
   

These costs, while generally not excessive in relation to the size of the estate, can be avoided, in whole or in part, to the extent that assets are titled in the name of a living trust at the time of the grantor's death. To the extent that a living trust is not funded during lifetime, these costs are not avoided.

2. 
   The delay caused by probate. In perhaps one of their most outrageous claims, some living trust promoters assert that it will take months or "even years" for the beneficiaries of a will to receive their inheritance, while the beneficiaries of a trust of similar size would receive their inheritance within four to eight weeks. An exception is sometimes made for larger estates where distribution would depend "primarily upon estate tax filing requirements."
   

As noted above, a personal representative can obtain the protection of an Order of Distribution within six months and make complete distribution by that time. A trustee cannot secure that protection and might deem it prudent to wait longer than six months to make final distribution.

In reality, the time and cost to complete administration of a will or a trust will depend upon the size of the estate and the nature of the assets. In many estates, the most important variable to determine the time and cost expended before complete distribution will be the nature of the beneficiaries. Not surprisingly, family members bring the largest number of will contests against each other.³⁰ The use of a living trust is not likely to change that dynamic.

3. 
   A living trust can avoid probate in more than one jurisdiction. If a grantor owns real estate in more than one state, depending upon the probate rules of each jurisdiction, transferring the property to the trust before death may simplify the administration process. However, before the foreign real estate is transferred to a living trust, that state's laws covering transfer taxes and recordation fees; inheritance taxes; homestead limitations (does transfer of the property to the living trust cause the property to lose its homestead exemption?); and zoning rules (will transfer of the property to a living trust result in the loss of “grandfathering” where very restrictive zoning laws have been enacted?) should be carefully examined.
   

A living trust does not guarantee privacy. To open an account for the trust many banks and brokerage firms require a copy of the agreement. In Maryland, a schedule of trust assets must be filed with the Register of Wills and becomes a public record. In D.C., the Register of Wills might require the filing of a copy of the trust agreement.

Under Virginia law, a trustee has a duty to disclose information to the trust beneficiary that is reasonably necessary to enable the trust beneficiary to enforce his rights under the trust or to prevent or redress a breach of trust.³² A trust beneficiary is entitled to review the entire trust agreement even if he is the beneficiary of only one of two separate trusts created under the trust agreement and he has received all the pages relevant to his trust.³³
While a copy of a trust may be harder to obtain than a copy of the will, an interested party, in all likelihood, will be able to obtain a copy of the trust and an accounting of its assets. When a client emphasizes his desire for privacy, it might be wise to determine why. Is he worried about the nosy next door neighbor? Business competitors? Or is he concerned about family members who are already fighting over his money before he is dead? Proponents of living trusts claim that because the will is a public document it may invite unhappy heirs to contest the will. Yet, if the family has a history of fighting, or has long been suspicious of each other, efforts to ensure privacy and avoid probate may lead to increased disputes among the heirs and between the heirs and fiduciaries. Court supervision might be advantageous in such a family.
A Living Trust is Harder to Contest Successfully Than a Will, So Your Wishes are More Apt to be Followed.³⁴ The preliminary question for a client who is concerned about a contest of his will, is the source of this concern and the basis upon which he feels a contest may be asserted. As with the client who is concerned about privacy, the use of a trust to avoid a contest, may invite suspicion and a contest. Living trusts are not immune from attack.

The Virginia Code sets forth the procedures by which an interested party may seek to impeach or establish a will, including the right to a jury trial.³⁵ An action to impeach a will must be brought within six to twelve months of probate. While these sections do not apply to trusts, a disgruntled family member could file a declaratory judgment seeking to have the trust declared invalid or set aside.³⁶

Because a living trust is not considered testamentary and does not require the formalities of a will to be effective, one ground on which a living trust is immune from attack is failure to follow testamentary formalities.³⁷ Oral trusts are permitted with respect to both personal property and real property in Virginia.

Many lawsuits over wills do not directly involve competing beneficiaries. A suit may be brought by a personal representative or a trustee because of an ambiguity in the provision of the will or trust agreement or uncertainty in the administration of the trust.³⁸ A beneficiary may file suit against a drafting attorney on the basis of breach of contract if the disappointed beneficiary believes he was an intended beneficiary of the will or trust agreement and because of the drafting attorney’s error, he did not receive the benefit intended for him.³⁹ A living trust does not minimize the likelihood of either type of action.

1. 
   A living trust can be attacked on the basis of the grantor's lack of capacity. Any person who has legal capacity may make a valid will. Generally the standard of capacity is: does the person know the natural objects of his bounty, the nature of his property, and does he know how he wishes to dispose of his property.⁴⁰
   

Virginia does not appear to have a case discussing the capacity required to make a will as compared to the capacity to create a living trust. Virginia's standard to create a will is relatively simple. Indeed, the Virginia Supreme Court has held that a pending competency hearing or subsequent determination of incompetency does not establish whether testamentary capacity exists at the time the will was executed.⁴³ The appointment of a guardian is not prima facie evidence of mental incapacity.⁴⁴

Clients, even with limited capacity, generally understand what a will is and what it does. A trust is a much harder concept to explain. Depending upon the client, it might actually be easier to contest a trust than a will on the grounds of lack of capacity.

2. 
   A living trust can be attacked on the basis of undue influence. Virginia has extensive case law on setting aside a will based on undue influence. A presumption of undue influence may arise where the contestant proves by clear and convincing evidence that: the testator was enfeebled in mind when the will was executed; the requisite confidential or fiduciary relationship was accompanied by activity in procuring or preparing the favorable will; and, the testator previously had expressed a contrary intention to dispose of his property.⁴⁵ There must be a confidential or fiduciary relationship and the relationship must be accompanied by activity on the part of the dominant person in procuring or preparing the will in his favor.⁴⁶
   

3. 
   The Commissioner of Accounts system may help prevent litigation. Sometimes dismissed as an unnecessary expense, the accounting requirement forces the personal representative to disclose the estate’s assets and their disposition on a regular basis. The Commissioner of Accounts office can then provide an informal forum for resolution of disputes that may arise between the fiduciary and the beneficiaries or creditors.
   

In Virginia, if an incapacitated individual does not have a power of attorney or a living trust, the court, upon the petition of an interested party, may appoint a conservator. The conservator is bonded and is required to report annually to the Commissioner of Accounts. These requirements may be attacked as the court running the estate as it sees fit, but in many respects, as unpleasant a process as it is, a conservatorship provides greater protection for the incapacitated individual than a living trust or power of attorney.

One of the most difficult aspects of drafting a living trust is the language used to "trigger" the authority of the successor trustee to act once the grantor becomes incapacitated. Few grantors are willing to cede title and control to their property to a third party until absolutely necessary. To the extent that an individual is willing to create a power of attorney that is immediately effective, with the expectation that the individual named will not act until necessary, a power of attorney may be a better option than a living trust.

A power of attorney is generally less expensive and complicated to create than a trust. Many banks and brokerage firms have their own forms that can be executed without the assistance of an attorney. As with a will, clients more readily grasp the concept of a power of attorney than a living trust.

Virginia law requires an agent under a power of attorney, upon a “reasonable written request made by a person interested in the welfare of a principal who is unable to attend to his affairs” to account for his actions taken within two years prior to the date of the request or the death of the principal.⁴⁸ An agent who refuses to comply can be held liable for the expenses and attorneys' fees of the requesting party.⁴⁹ A “person interested in the welfare of the principal” is defined as any member of the principal's family; a person who is a co-agent, alternate agent or successor agent under the power of attorney; and if none of those persons is reasonably available, the adult protective services unit of the social services board. A member of the family is defined as an adult parent, brother or sister, niece or nephew, child or other descendant, spouse of a child of the principal, spouse or surviving spouse of the principal.⁵⁰

While the common law requires a trustee to account to the beneficiaries of the trust, there is no clear statutory procedure to follow or a statutory right to assess attorney's fees if the trustee is not forthcoming. In addition, the class of beneficiaries who have the right to an accounting will usually be much smaller than the class of individuals deemed to be "a person interested in the welfare of the principal". It may be easier and less expensive for a family member to protect an incapacitated person under a power of attorney than a living trust.

As a final consideration, Virginia law protects the beneficiary whose bequest is sold by an attorney in fact. Absent a contrary provision in the will or power of attorney, a bequest or devise of specific property shall be deemed to be a legacy of a pecuniary amount if the specific property is sold during the lifetime of the testator while he is incapacitated.⁵¹ This protection is not provided if a trustee should sell or otherwise dispose of an asset held in trust.

For example, divorce or annulment of the marriage revokes any dispositions in favor of the spouse under the will, as well as any fiduciary nomination of the spouse.⁵³ Divorce revokes any revocable beneficiary designation for a former spouse.⁵⁴ These provisions specifically do not apply “to any trust or any death benefit payable to or under any trust.”

A bequest of securities includes additional securities owned by the testator at death resulting from stock splits, mergers or reorganizations. A bequest or devise of property applies to unpaid condemnation awards or unpaid proceeds from fire or casualty insurance.⁵⁵ This statute does not apply to distributions from revocable trusts.

Absent a contrary intention expressed in the will, bequests or devises to persons related to the testator who fail to survive the testator pass instead to surviving descendants of the deceased person.⁵⁶ The anti-lapse statute does not apply to trusts.

The “Slayer” Statutes provide that a convicted murderer (or fugitive) of the testator who receives a bequest or devise under the will is deemed to have predeceased the testator. The murderer does not take a survivorship interest in joint or tenants by the entirety property. Insurance proceeds are not to be paid to the murderer.⁵⁷ Property passing pursuant to a revocable trust is not explicitly addressed. Presumably this is not a major issue in most estates but would be an awkward subject to address in drafting.

* * *

A living trust is advantageous for a person who is ready to turn over management of his assets to a third party. A living trust may minimize the costs of probate in circumstances where the person owns real estate in several states. A living trust may help ensure privacy in cases where the grantor wishes to shield his planning from the public at large, not necessarily his family in particular.

To obtain the perceived benefits of a living trust, an individual must transfer title of his assets to the living trust during his lifetime. How many clients, especially younger ones, will be willing to do that? And how many will continue to maintain that titling as the nature and composition of their assets change over time?

Neither the probate system nor, as a general rule, lawyers, cause families to contest the wishes of an individual as expressed in his will. A living trust will not change human nature or make a dysfunctional family behave. Some of our clients who are worried about privacy and family fighting might be better served by the "public" nature of probate, with its required accountings and the oversight of the Commissioner of Accounts.