In regards to management of an estate, one of the more complex areas to navigate for clients is understanding who owns what and how to best structure assets when conducting estate planning. The ownership structure of an asset will have long term implications for estate planning, taxation and asset protection issues when deciding on the acquisition and ownership of an asset.
Essentially it is a question of who is best to own what and how.
Whether the asset forms part of a client’s estate is directly related to how it is owned.
Once an investment has been acquired, substantial costs may be incurred when transferring the asset to a more appropriate entity or form of ownership.
We’ve broken down some key ownership structures below to help you understand the impact of each on assets you may potentially own or acquire.
Assets that are wholly owned by an individual pass to their estate on death. The Will, if any, determines who will benefit from assets which pass to the estate. Assets can pass ‘in specie’ and/or sold in the estate and the money distributed to beneficiaries.
As the assets form part of the client’s estate the assets are not protected from bankruptcy and the Will could be subject to challenge. Examples where sole ownership may be suitable are:
Where assets are owned jointly and one owner dies, their share immediately passes to the surviving joint tenant. This is useful if the asset is, for example, money in a bank account and the survivor needs ready access to cash. The benefits of the asset bypassing the estate are:
Joint ownership provides certainty that the asset will pass to the surviving joint owner. As the asset bypasses the estate, it generally cannot be subject to a challenge of the Will.
Another form of ownership is tenancy in common. This is where each ‘tenant’ who is the owner may have the right to a distinct proportion of the asset. For example, one tenant may own one third of the asset and another may own two thirds. When the asset is sold or disposed of each tenant will be entitled to their share of the proceeds.
When an owner as tenant in common dies, their share becomes part of their estate. The Will determines who benefits from the asset, therefore the client should have the Will drafted to include their share of assets which they hold as tenants in common. If the asset is divisible, it may be sold by the executor and cash paid to the beneficiaries, otherwise it can be transferred in specie.
Difficulties can arise for beneficiaries who inherit assets in specie and would rather have received cash. Where an asset is not readily divisible (such as direct property) and the existing owners wish to maintain the investment, the beneficiaries will generally try to sell their interest to the other owners. It is likely to be difficult to find any other interested buyers apart from the existing owners.
A trust describes the holding of property by a trustee (which may be one or more persons or a corporate trust company) for the benefit of beneficiaries in accordance with the trust deed.
A person may be both a trustee and a beneficiary of the same trust. However, they cannot be the sole trustee of a trust of which they are the sole beneficiary as no trust is in existence.
Assets of the trust may consist of investments and various rights and entitlements.
There are a number of types of trusts. These include:
A person’s Will does not affect assets which are legally held by a discretionary or fixed trust. The trust deed of the trust sets out the obligations of the trustee. This will determine what happens to the property in the trust upon the person’s death.
Discretionary or Family Trusts
Discretionary trusts are where assets are held in trust for beneficiaries and the entitlement of each beneficiary is not known. The distribution of any benefits (capital and income) is usually at the trustee’s discretion.
When a beneficiary of a discretionary trust dies, no trust assets pass to their estate. Any unpaid income and capital distributions, or any loans made to the trust, which were payable to them at the time they died, is payable to their estate. Debt owed to a trust is generally repaid out of the person’s estate.
A discretionary trust is established during a person’s lifetime. Reasons for establishing a discretionary trust include asset protection for small business owners and income splitting. The extent to which distributions are available to beneficiaries may be influenced by the operation of the tax laws.
Fixed trusts hold assets in trust for beneficiaries who usually own units in the trust. These units represent a beneficiary’s entitlement to income and/or capital of the fixed trust. A unitholder’s entitlement will determine how they will benefit from any earnings and capital of the trust. Unit trusts are offered by fund managers or can be privately operated by families or between business partners.
If a person who holds units in a fixed trust dies, their unit entitlement can be identified and will form part of their estate. Where the deceased had established loan accounts within the trust where money was lent to the trust, repayment of any loan is made to the estate.
When assets are held in the name of a company, the company is the legal owner and not a person who holds shares in the company. This applies even if the person is the majority shareholder and has effective control of the company.
On the death of a shareholder the shares in the company form part of the estate and a person can only bequest their share(s) in the company. Assets of the company cannot be disposed of under a person’s Will as they are the property of the company
A partnership is a legal relationship of persons who carry on a business activity with a view to profit. The terms of the partnership and the rights and obligations of the partners are included in a partnership agreement.
The death of one partner will bring an end to the partnership. However, on the death of a partner the partnership may be restructured. The degree of complexity in dealing with partnership interests depends on whether there is a written partnership agreement and, if so, the terms of the agreement.
A partnership agreement is important to overcome the problem which can occur if the executor demands the deceased partner’s assets to be transferred to the estate. This can cause problems for the continuation of the business by the remaining partners.
The agreement may provide that the deceased partner’s interest will be converted to a monetary value. This may take the form of an option given to the surviving partners to purchase the deceased partner’s share. A partnership agreement should include the method for calculating the amount which the remaining partners must pay for the deceased’s share and the mechanism for funding the buy out.
The partnership agreement and the Will should be co- ordinated so that the partnership business continues to operate after the death of one partner, to maximise the amount received by the estate.
Estate Planning is a complex process and should be worked through with a skilled professional to ensure the best outcomes for all interested parties. If you are starting to think about your family’s financial security, or are concerned that your current estate planning arrangements are not appropriate, give us a call.
Our team are experts in this area and can help guide your decisions.