by Lloyd McAlister
Mrs. Jones’ attorney: “Mrs. Jones, your father’s life insurance is taxable and at an estate tax rate of forty percent.”
Mrs. Jones: “But I didn’t think my father’s insurance was in his estate!”
Mrs. Jones’ attorney: “The life insurance your father owned is not part of his ‘probate estate’ but it is a part of his ‘gross estate’ for estate tax purposes.”
Legal terminology can be confusing, causing people to misunderstand important legal and financial consequences. Few legal terms create more confusion than the word “estate” and the variety of uses for the word which have different legal and tax implications.
When a person dies, we often speak of their “estate,” usually referring to the property and legal rights the deceased person owned at the time of their death. However, sometimes we mean something narrower in meaning, with a more specific application. For example, we might be talking about the “estate tax” due as a result of the person’s death, in which case we might use the word estate to refer to their “taxable estate.” However, technically, to arrive at one’s “taxable estate” we must start with their “gross estate” and deduct allowable deductions. Now, what at first might have seemed somewhat simple becomes more confusing.
When referring to one’s estate, we might also be talking about their “probate estate.” Again, what might seem simple can become quite confusing because we referred to “taxable estate” and “gross estate” above, yet what comprises one’s “probate estate” might be quite different than those other terms used to refer to tax matters. If a person dies owning property titled in their name without valid transfer on death successor owner arrangements, the disposition of that property after the owner’s death is technically subject to the administration of such property by the “probate court.” The probate court determines: what property fits in that category (and, consequently, is subject to the jurisdiction of the probate court), whether there was a valid last will and testament of the deceased person which disposes of such property and, if no valid will exists which completely disposes of the property, the disposition of the deceased person’s property according to state law (called the laws of “descent and distribution”).
Although all the property in a deceased person’s probate estate might also be in their gross estate, it will not necessarily all be in their taxable estate due to the “allowable deductions” which are subtracted from the gross estate to arrive at the taxable estate, deductions such as the marital deduction for property passing to a surviving spouse or the charitable deduction for property passing to a charity. Similarly, it is entirely possible some or even all the deceased person’s property is in that person’s “gross estate” (again, using the term in its technical sense to refer to the gross estate for federal estate tax purposes) yet little or none of it is in their “probate estate” because the ownership of the property was such that there was no need for a probate court to determine the lawful, successor owners. The very common use of revocable trusts (also referred to alternatively as living trusts, inter vivos trusts, loving trusts, etc.) is an excellent example; a person might establish the ownership of some or even all their property in the name of the trustee of their revocable trust in order to avoid the court-supervised administration of their estate, a legal process called “probate.” By virtue of the legal fact that the client, now deceased, did not hold the title in their individual name but rather held title in their name (or someone else’s name) as a trustee of their trust, there is nothing to probate (nothing for the probate court to administer); the successor trustee named in the deceased person’s trust merely needs to accept or confirm their appointment as trustee. Since the property in one’s revocable trust is subject to the “estate tax” it is included in their “gross estate” and, possibly, their “taxable estate” even though such property is not in their “probate estate.” In fact, the deceased person may have planned their “estate” so that there will not be a “probate estate” and, consequently, no need for a court-supervised probate proceeding.
So, if you speak of someone’s “estate,” be careful to be clear about the type of “estate” to which you are referring. Otherwise, you may believe others understand what you said, yet you may not realize that what they think you said is not what you meant!